Perspectives

OCTOBER 26, 2016
Three Approaches to Small Business Lending that Drive Growth
By Mary Ellen Biery, Research Specialist, Sageworks

Business lending has been an important source of growth for banks and credit unions since the financial crisis, and it will continue to be a critical driver in the quarters ahead. In a September 2016 survey of bankers, 81% indicated that CRE and C&I will be their focus for growth.

Given the current market’s pressure to ‘grow or go,’ many banks will look toward loan growth, which is seen by many banks as a way to scale, helping them outpace rising costs of compliance while expanding their reach into their communities. Financial institutions effectively growing their business loan portfolios are tapping into an underutilized opportunity for loan growth – loans to smaller businesses – and are implementing changes that transform the customer experience.

Loans to operating businesses have historically tended to flow toward larger institutions. But financial institutions focused solely on large commercial loans are missing an immense opportunity to grow the loan portfolio and retain or attract customers. Large enterprises make up less than 1% of the nearly 29 million businesses in the U.S. Most businesses are actually sole proprietorships or small businesses.

“Small businesses don’t want to go to online lenders, but it’s easier for many of them and they often can get the money quickly,” says Peter Brown, a senior consultant at Sageworks. “There’s a huge opportunity because those small businesses need funding, perhaps more than many other businesses.”

Common Approaches Driving Growth
Institutions already growing their commercial loan portfolios profitably are doing so by taking action to upend some of the traditional pain points – for the borrower and the lender – related to business lending. These three approaches, often driven by technology, can offer a better customer experience.

1. Speed of application
Technology is helping institutions make the application process faster and easier for borrowers while streamlining the underwriting process for the financial institution. For example, file-hosting technology allows applicants to share electronic files of supporting documentation for loan applications, and electronic signatures also move the process along more quickly. A new technology for banks and credit unions can automatically import financial data from electronic tax returns directly into the loan application. This saves the borrower from time-consuming and error-prone data entry while simultaneously transferring the necessary information into the bank’s system for credit analysis, loan administration and life-of-loan management.

2. Faster decisions and transparency
The search costs involved in small business lending are high for both borrowers and lenders. In recent years, financial institutions have streamlined loan approval processes by implementing technology that automates credit analysis, decisioning and the annual updates to financial statements of current borrowers. Even if the application process has been streamlined as described above, the decisioning stages can also be expedited to increase turnaround times for borrowers.

With loan decisioning technology, the institution can choose how much of the process to automate while still maintaining and supporting the human element provided by experienced analysts. For example, with the right technology and process in place, lenders can be responsible for much of the application process, and with that information in the system technology can make a recommendation for approval, rejection or further review. For smaller exposure loans, these efficiency gains mean the institution’s trained analysts are focused on the loans or borrowers that most demand their attention, and business borrowers benefit from faster loan decisions and a more transparent process.

3. Competitive rates
Pricing a loan to match a competitor’s rate may win the new business, but financial institutions understand that doing so can come at a huge cost if the institution doesn’t take into account the risk level and whether the loan will meet the institution’s profitability goals. Technology makes lending operations more efficient and scalable and can provide greater insight into which changes to rates, fees or terms are advantageous to both the borrower and lender.

Conclusion
Financial institutions growing their commercial portfolios profitably use technology to provide superior customer experiences while fundamentally changing the risks and costs associated with lending to businesses. These institutions that have the ability to underwrite smaller loans to businesses efficiently and accurately stand to tap into important growth markets while more effectively meeting the needs of current members and clients.

Technology in these cases doesn’t replace the relationship that a financial institution has with a business borrower; rather, the goal is to replace the administrative touches. In doing so, lenders, relationship managers and portfolio managers can spend more time talking to customers about their needs rather than the administrative requirements for the institution.

After all, the customer doesn’t care about the institution’s administrative requirements – that small business just wants its money.

1 “Sageworks Summit Poll: CRE loans top focus in loan portfolio”, 10/4/2016. https://www.sageworks.com/datareleases.aspx?article=396&title=Sageworks-Summit-Poll:-CRE-loans-top-focus-in-loan-portfolio&date=October-5-2016

Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of the Financial Managers Society.

About the Author

Mary Ellen Biery, Research Specialist, Sageworks
Mary Ellen Biery is a research specialist at Sageworks, where she produces accounting and banking content for the company’s blogs and websites, as well as for other outlets. She is a veteran financial reporter whose work has appeared in The Wall Street Journal and on Dow Jones Newswires, CNN.com, MarketWatch.com, CNBC.com and other sites.






NOVEMBER 10, 2016
A Review of Swap Hedge Accounting 
By Brian Matochik, Senior Vice President, FTN Financial Derivative Products Group

Hedge accounting is a set of accounting rules established by FASB that standardizes and governs the way swap transactions are accounted for. To those of us who are not accountants (and maybe even to some of us that are), this term may seem daunting and complicated. However, hedge accounting is actually very beneficial for financial institutions that are looking make longer-term loans and hedge the risk by using interest rate swaps.

The purpose of hedge accounting is to not only establish guidelines and consistency for how swaps should be accounted for, but also to reduce the potential earnings volatility in derivative transactions that qualify for this type of accounting treatment. Because interest rate swaps are required to be marked to market, income volatility could arise if their market value changed significantly and had to be taken into earnings. For example, the market value of a pay-fixed swap will move similarly, but inversely, to the market value of a bullet bond with similar par amount and term. Therefore, a swap’s price volatility can be substantial, which is why hedge accounting is certainly worth considering.

There are two types of hedge accounting treatment, as outlined in the table below:



Fair Value Hedge
For a fair value hedge, the swap will be recorded as an asset or liability on the balance sheet with an offsetting value adjustment to the hedged asset or liability. As long as the structure of the hedge and the item being hedged are closely matched, there is little to no earnings impact. This is especially useful for institutions that use swaps to hedge long-term fixed-rate commercial loans (loan swaps executed with individual borrowers, i.e. back-to-back swaps, do not require hedge accounting treatment).

Cash Flow Hedge
For a cash flow hedge, the swap will be recorded as an asset or liability on the balance sheet with an offsetting value recorded in OCI (Other Comprehensive Income). Cash flow hedge accounting is comparable to how banks account for AFS securities, where the value of a hedge is offset as a component of equity. Similar to a fair value hedge, as long as the structure of the hedge and the item being hedged are closely matched, there is little to no earnings impact. Cash flow hedges are useful for hedging trust preferred securities, FHLB advances and other floating-rate liabilities.

Some institutions choose to bypass hedge accounting treatment and simply mark swaps to market in earnings, which is the alternative option to hedge accounting. In these cases, institutions will often move an asset to a trading account to help offset swap market values. However, since hedge accounting reduces the potential earnings volatility that would come from changes in the swap’s market value, it is beneficial for institutions to consider this approach first when exploring any hedge strategies.

There are, of course, certain documentation requirements and steps involved in order to be able to elect hedge accounting treatment, and it is important for institutions to partner with a knowledgeable counterparty for full accounting support to ensure compliance. However, when used properly, hedge accounting is an important tool that institutions can use to reduce earnings volatility from hedging instruments.

Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of the Financial Managers Society.

About the Author

Brian Matochik, Senior Vice President, FTN Financial Derivative Products Group
As a Senior Vice President in the Derivative Products Group at FTN Financial, Brian is responsible for customer hedging strategy development and hedge accounting support, as well as derivative trade execution, management and implementation, with a focus on hedging strategies for community banks.  He is involved in all aspects of FTN Financial’s Hedging Program including loan structuring, pricing, trade execution and client support. Mr. Matochik graduated summa cum laude from the University of Memphis with a B.A. in International Studies and also holds an M.B.A. from the University of Memphis Fogelman College of Business and Economics.  






OCTOBER 17, 2016
FMS Quick Poll: Social Media
By Financial Managers Society

What constitutes a “community?”

Whereas a clear designator such as geographic proximity might have definitively answered that question in the past, the notion isn’t quite as clearly cut these days. The explosive growth of social media has redefined both what a community is and where it is – shifts that are proving profound for personal and business relationships alike.

What is the impact on a community institution, for example, if the community it serves begins to migrate to the virtual world of social media? How does a bank or credit union continue to reach out to its community to connect, communicate and engage when those customers are more likely to log on than walk in? We were curious as to how FMS members were using social media and how it was affecting engagement with their customers. With close to 125 responses in our latest Quick Poll, it certainly appears as though members are attempting to reach out to their customers via social media, but the details lie in the degree to which they are committed to that effort.

Of the 122 respondents in the poll – 104 from banks and 18 from credit unions – 56% consider their institution to be either a highly active (multiple posts per week, dedicated staff, regular interaction with customers) or somewhat active (a post at least every week, occasional interaction with customers) social media user (see Figure I). Meanwhile, 21% of poll participants maintain a social media presence but don’t consider themselves particularly active, and 23% aren’t on social media at all, for reasons ranging from compliance concerns to lack of resources to a belief that their customers just aren’t interested.

FMS Quick Poll

For those who have chosen to maintain a social media presence, has the effort proven fruitful in terms of engaging their communities? The answer is somewhat, but perhaps not as much as they would like. Only 7% of respondents describe the level of interaction with their customers via social media as vibrant, while 36% consider their social media efforts worthwhile but not a terribly high priority, and another 30% note that their customers rarely engage with the institution on social media (see Figure II).

FMS Quick Poll

In terms of where FMS members spend their time and resources on social media, Facebook is far and away the most frequently utilized platform at 44% among poll respondents (see Figure III), followed by LinkedIn (24%) and Twitter (19%). Members see far less value, however, in posting photos to Instagram or videos on YouTube (6% each).



Across these and other platforms, poll respondents are clearly trying to highlight their standing in their communities, with 36% frequently sharing local news and events (see Figure IV). Another common social media use is posting basic announcements regarding branch hours, closings, etc. (29%), while less common uses include product promotions (20%) and personal finance advice/articles (14%).

FMS Quick Poll

Responses across asset sizes were fairly consistent, though larger institutions ($500 million and up) reported greater levels of social media interaction with their customers than their smaller peers. It is interesting, however, that even among the larger institutions a “vibrant” level of engagement was hard to come by.

Thanks again to everyone who participated in our latest FMS Quick Poll. If you didn’t have a chance to complete the poll, be sure to weigh in with your views on social media in the comments section below or on FMS Connect!




SEPTEMBER 22, 2016
Fed Elects to Punt: Eyeing the End of the Year, FOMC Leaves Rate Unchanged Again
By Robert B. Segal, CFA, Atlantic Capital Strategies, Inc.

The Federal Reserve left its policy rate unchanged for a sixth straight meeting, saying it would wait for more evidence of progress toward its goals, while projecting that an increase is still likely by year-end.

“Near-term risks to the economic outlook appear roughly balanced,” the FOMC said in its statement after a two-day meeting in Washington. “The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.”

Three officials, meanwhile, dissented in favor of a quarter-point hike. Esther George, president of the Kansas City Fed, voted against the decision for a second straight meeting. She was joined by Cleveland Fed President Loretta Mester and Eric Rosengren, head of the Boston Fed.

The central bank’s “dot plot” showed that officials expect one quarter-point rate increase this year. Officials scaled back expectations for hikes in 2017 and over the longer run. Policymakers see two rate hikes next year, down from their June median projection of three. They see the Fed funds rate settling in at 2.9%, down from a 3% guess in June.

“Our decision does not reflect a lack of confidence in the economy,” Fed Chair Janet Yellen said at the press conference. “Since monetary policy is only modestly accommodative, there appears little risk of falling behind the curve in the near future.” She noted that a “cautious” approach is all the more appropriate given that short-term rates are still near zero, and therefore the Committee can more effectively respond to inflation pressures by raising rates than to falling inflation by cutting rates.

At this time, markets place the chance of a rate increase by year-end at 60%, down slightly from 65% after the Fed’s April 27th meeting. This compares with only 10%, however, at the end of June. The yield on the benchmark 10-year Treasury note traded recently at 1.65%, compared with 1.85% at the end of May.

In its latest banking profile, the FDIC said community banks reported net interest income of $17.5 billion during first quarter 2016, up $1.3 billion (8.2 percent) from the prior year. Net interest margin of 3.56% was up two basis points from the year earlier, as asset yields increased two basis points and funding costs were unchanged. Going forward, however, margins are projected to trend downward as asset yields are under pressure while funding costs remain near floors.

In this environment, some institutions may wish to consider a more active investment style. A number of organizations limit their investment allocation to a few areas in which they are comfortable, such as mortgage securities or agencies. With this approach, however, the institution may be sacrificing income as well as increasing balance sheet risk.

In fact, portfolio managers at many banks have been busy realigning their investment distributions. With the decline in rates in recent quarters, portfolio cash flow has spiked and according to industry reports, the destination for this cash has largely been municipal and other non-agency bullet securities.

This shift should not come as a surprise, as organizations continue to struggle with margin challenges in the face of a flatter yield curve. Depositories choose these types of securities to provide additional yield and position the portfolio more appropriately for the current rate environment. The predictable cash flow feature makes them an attractive alternative even with the longer duration.

Investment sectors often become overvalued. Investors concerned about rising rates have flocked to short-duration mortgages and floating-rate notes, driving up prices and pushing down yields. At the same time, the market tends to punish entire sectors during times of stress. In these cases, investment officers should consider selling the “rich” securities and moving into the undervalued ones.

Earlier this year, corporate bond spreads widened dramatically as energy prices fell and the stock market plunged. This affected most corporate issuers regardless of credit quality. Apple Inc., for example, issued five-year notes at a spread of 100 basis points to Treasuries, about double the normal spread. This happened in spite of Apple’s strong balance sheet, consistent profitability and ample liquidity.

Investors moving out of short-duration mortgage securities and into high-quality corporate bonds at this time could have realized higher levels of current income and more stable portfolio cash flow characteristics. While corporate bonds are not appropriate for all investors, the same strategy can be utilized with other securities that offer favorable total return potential.

Maintaining flexibility for managing the investment portfolio can reduce overall rate sensitivity through a range of tactical and strategic transactions. An active manager tends to spread exposures to a variety of higher-returning sectors, while moving out of market segments that become expensive.  Successful active management also entails a willingness to think independently in terms of position and sector weightings. When properly implemented, active management strategies can lessen an institution’s exposure to declining margins, helping to offset the impact of a challenging investment landscape.

About the Author

Robert B. Segal, CFA, Founder/CEO, Atlantic Capital Strategies, Inc.
Robert B. Segal, CFA is founder and chief executive officer with Atlantic Capital Strategies, Inc. Bob has been in the banking industry since 1982, having worked in several community banks with roles in mortgage banking, sales and trading, and asset liability management. He is a frequent speaker at industry events and contributes to many regional and national finance publications. His firm provides investment advisory services to community-based institutions. Bob can be reached at bob@atlanticcapitalstrategies.com or 781-276-4966.

Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of the Financial Managers Society.




SEPTEMBER 1, 2016
Using Cloud Technology to Improve Security and Reduce Costs 
By Toby Lawrence, President, Lawrence Advisory Services

According to a June 15, 2015 article in Forbes, author Joe McKendrick notes that “by 2020, 62% of organizations in a recent survey say they will be running 100% of their information technology in the cloud.” That prediction was made by BetterCloud based on a survey of 1,500 companies. BetterCloud further reported that only 12% of the survey respondents currently run their IT out of the cloud. This projection of growth is consistent with what other technology experts are predicting.

Why are so many companies planning to move to the cloud?

To improve security over private customer/employee data

The number and severity of cybercrime and security breaches are both escalating. According to the National Cyber Security Alliance, cyber security incidents have surged 38% since 2014, have cost victims anywhere from $300 billion to $1 trillion a year in the United States alone and, on average, have reached a cost of $3.79 million per data breach.

Smaller to mid-sized companies simply can’t afford the level of sophisticated controls the large data centers that manage cloud networks have. These data centers typically have physical access controls such as:

● 24-7 guard staff protection

● biometric screening that verifies the identity of those entering the facility by checking their fingerprints or retinas

● motion detection-driven cameras to automatically film anyone on their premises

Because they are supporting thousands of clients, the data centers also can afford to have the latest and greatest firewalls and other cyber prevention tools to limit unauthorized access to data. Additionally, workstations can be easily encrypted with the cloud so that if an employee loses his or her workstation, the data on it will remain secure.

Does moving to the cloud improve security? Certified public accountants are known for being conservative and are required by their ethics standards to protect the confidentiality of their clients’ personal data. Thus, it’s not surprising that according to an article entitled “Three Trends that Will Transform Your Accounting Practice in 2016” in the December 3, 2015 issue of the CPA Practice Advisor, one of the three most significant trends identified for the industry in 2016 is that CPA firms are moving their networks to the cloud to help them better protect the confidentiality of their client data.

To improve responsiveness for users working remotely


Cloud technology accesses data and software through the internet. When working on a desktop or laptop, all the user is really doing is seeing images of the software application but no data is being transferred back and forth through the internet. The data and software reside on the virtual servers within the data center and never leave the data center, which also improves security. The cloud is more responsive than traditional servers, helping to improve employee productivity; this becomes increasingly significant as more and more employees work remotely for at least part of their job.

To make software updates and backups automatic

In traditional networks, network administrators rely on users to load software patches or updates to workstations via email or have to load them themselves, workstation by workstation. This often leads to patches not being implemented or users in the same entity using different versions of software, either of which can lead to various operating problems. In cloud technology, backups typically occur automatically to both servers and workstations at set intervals ranging from every 15 minutes to several times a day.

Further, in traditional networks, servers are only backed up once a day and workstations are only backed up when the user manually does it. In cloud technology, the best providers include off-line backups of servers and user workstations with the backed-up data being stored in two or more separate locations. If a cyber hacker tries to infect your network with a virus or ransomware email to hold your data hostage until paid, you can go to your backup and lose only a minimal amount of activity completed that day. Disaster recovery – once a major risk for most companies – becomes almost a moot point with a reputable cloud provider.

To allow technology administrators to monitor employee private internet usage and block unauthorized software or websites

According to a recent survey by Salary.com, 64% of respondents stated that they visit non-work related websites every workday. Using thin client technology1, IT administrators can monitor and set limits on employee usage of the internet, preventing employees from downloading unauthorized software or accessing websites that the company considers inappropriate.

To save money

The biggest two reasons that so many companies are moving to the cloud are to improve security and to save money. Consider:

● A company using the cloud no longer needs physical in-house servers. These servers can cost anywhere from $12,000 to $15,000 each, and most companies have multiple servers. Laptops and desktops can cost anywhere from $800 to $1,700 each. With the cloud they can be replaced with dummy terminals costing anywhere from $90 to $500 per unit.

● Laptops and desktops typically need replacing very three years based on industry norms, while dummy terminals can last 5-7 years, resulting in additional cost savings.

● It takes less time to administer a cloud-based network because you now have automatic software patch updates and thin client technology to manage internet use. Therefore, less technology staff or vendor assistance is needed.

1 “Thin technology involves a lightweight computer that is purpose-built for remoting into a server, and can be used with both cloud and non-cloud based networks. However, the benefits are maximized when it is used in conjunction with the cloud. 


Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of the Financial Managers Society.

About the Author

Toby Lawrence, President, Lawrence Advisory Services
Toby Lawrence is President of Lawrence Advisory Services, which provides various value-added consulting services to banks and credit unions throughout the country. The web site can be located at http://www.lawrenceadvisory.com.









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