Back to Basics

Looking past the hype of fee income

By Dan Shannon

Recent regulatory changes, such as the Durbin Amendment and Regulation E, have caused financial institutions to re-evaluate their practices for sustaining revenue growth. While many community banks have addressed the challenge of maintaining their revenue streams by relying on noninterest fee income, they also have realized that a return to focusing on the fundamentals of interest income, their most important source of revenue, has become increasingly important.

The four key elements of a successful lending business for community banks are pricing discipline, sales and negotiating skills, operating efficiency and timely credit decisions, and management reporting and incentive systems. How well each community bank performs these drivers of lending will ultimately determine its lending success.

Let’s review each of these areas.

1. Pricing discipline. While competition for loan activity is strong, using an effective pricing discipline versus pricing loans to match or beat competitor offerings is the best strategy for realizing substantial revenue growth. Therefore, your community bank’s success hinges on having a sound starting point for loan pricing and an understanding of the price needed to reach the organization’s objectives.

With an effective pricing discipline in place, your bank can rate borrowers and loans appropriately based upon risk, thereby ensuring your bank receives the appropriate income for different grade loans and their credit risk. Ultimately, proper grading and pricing will lead to increased net interest margins. Proper grading and loan pricing relies on a formalized pricing process. New loans and renewals should be evaluated against standard pricing parameters established for each risk-rated lending transaction type and the overall lender’s portfolio.

Because cross-selling other services and securing core deposits from customers are also important, your community bank’s executive management should encourage these activities to improve relationship profitability and create value-added sales activity. Ensuring that your bank collects fees for customer services that warrant a payment is equally important.

The following techniques will help banks collect additional fees for their services provided to customers:

-Establish targets for the absolute level of fees as well as a threshold for the acceptable level of waivers due to reasonable management discretion;

-Generate routine management reports to provide continuous feedback on progress;

-Reduce the opportunity for unapplied fees by automating possible fee charges; and

-Reiterate the importance of fee income to the bank in staff meetings or sales workshops.

2. Sales and negotiating skills. Most successful relationship managers rely on developing customer-facing skills to help expand their customer relationships. An equally important skill is the ability to successfully negotiate the terms of an agreement. Because this is the stage when the stakes are highest in a relationship, it is vital for relationship managers to develop this skill.

Key activities in effective loan negotiation include:

-uncovering and prioritizing the needs that lie beneath the negotiation points for the customer and the bank;

-conducting meetings that develop solutions in a way that enhances the relationship;

-using a creative process to break through seemingly insurmountable impasses;

-leveraging tactics that keep negotiations centered; and

-using principled negotiation to achieve better outcomes.

3. Efficiency and timely decisions. While it is very important to have an effective pricing discipline and savvy relationship managers, these are not the only factors in well-performing loan portfolios. Operational efficiency is another critical component for success. Customers expect and value timely decisions and error-free processing in the funding of their loans. They expect quick credit approvals and answers to any inquiries they might have. By empowering loan operations employees to work in teams to improve and streamline the processes, community bankers increase customer response times.

Technology is integral to effective and profitable loan processes. Imaging and workflow management, underwriting tools and document preparation systems all need to be aligned and optimized. Misaligned duties and responsibilities within your community bank should be identified and adjusted as well. For example, experienced senior staff members are sometimes engaged in low-value-added tasks such as ordering appraisals, filing security agreements and preparing loan documents. This is particularly common in commercial lending.

Another example of staff misalignment is deploying resources in markets with low business potential, as well as assigning portfolios that overload certain lenders. This can be avoided by evaluating the potential of all markets your bank serves and realigning its staff to balance out the resources.

Lastly, redundant checks and controls that serve little or no purpose in improving quality should be identified and removed.

4. Management reporting and incentive systems. The old saying that “you get what you measure” could not be truer in the lending area. Lender production and relationship reporting tends to be heavy on new business and asset quality, and somewhere between low-key and silent on other matters of profitability.

Community banks can improve their overall lending performance by improving their reporting and compensation systems. Implementing reporting systems that measure performance of product goals and objectives for profitability and margin income or returns is important. In doing so, banks can drive their staff to exceed performance metrics.

Executives should also demand periodic reporting of the performance of individuals against their goals, and these individuals should expect coaching and other corrective actions to focus them on achieving desired results.

Finally, lenders’ incentives need to be designed to ensure collection of fees and achievement of margin/return goals that emphasize loan production and asset quality. Additionally, the CFO or his or her representative should contribute profitability metrics to include in each lender’s incentive plans.

By getting back to basics and addressing the controllable aspects of its lending business, your community bank can improve its overall revenue more dramatically than by focusing on noninterest income alone. Although fee revenue has garnered many recent headlines, the time has come to focus on increasing lending revenue. endmark

Dan Shannon is senior vice president of FIS Consulting Services, a division of services provider FIS in Jacksonville, Fla.