Executive Summary: Many banks continue to ignore or underemphasize what for many should be their highest priority segment, the non-borrower. The result: lower returns in the small business area, higher commercial portfolio volatility, and a missed opportunity to build relationships.
Every third-party analysis we have seen, as well as our own work, points to the fact that the majority of small businesses are non-borrowers. Further, non-borrowers are usually the most profitable business customers and drive the overall profitability of many small business and lower-end middle market portfolios. Given the current economic environment, the number of non-borrowers (both voluntary and not so voluntary) is increasing. Yet, few banks operate with a focus on this biggest of commercial segments.
Banker bias.
At least five factors have resulted in a limited and inconsistent focus on non-borrowers.
* Asset emphasis. Until recently, most banks have been asset growth-oriented, even willing to sacrifice returns in order to show asset growth. At least in the short term, however, many banks have moved to an emphasis on deleveraging. Coincidently, in the near term finding high quality loan assets has presented a challenge for most banks.
* “Ease” and timing of loan sales. Typically, loan sales are easier to generate than non-credit sales, and the timeframe for doing so is shorter. Borrowings are often event driven (for example, an acquisition, a construction project, or a business expansion opportunity.) The “event” often involves a tight timeframe in which financing needs to be obtained. Conversely, cash management and most other fee-oriented sales do not involve a similar time constraint for decision making.
* Banker DNA and knowledge. Most commercial bankers grew up as lenders and lending is the activity with which they are most comfortable. While many banks pursue training to try to reorient them to broader relationship management, the results of that effort are mixed at best.
* Compensation. We have worked at multiple banks in which senior management stated that they wished to increase deposits, cash management, and other fee related activities. However, these banks gear virtually all compensation and incentives to loan sales. As you would expect, that is where the bankers focus their time.
* Real or perceived product gap. Bankers often hesitate to sell non-loan products because of their concerns that the products fail to meet customer requirements. In some cases those concerns are misplaced; however, in other instances, they highlight the need for the bank to evaluate and improve its deposit and cash management offer.
A path to non-borrower success.
We think there are some fundamental steps that banks need to take in order to focus on non-borrowers.
* Rethink segmentation. The companies you focus on today may not be the companies you need to focus on for success in this area. Most banks fail to highlight non-borrower customer segments. Banks need to consider a range of industries/company types including: homeowners’ associations, title and insurance companies, and churches, among others. One bank we know even had a focus on hedge funds, not to lend to them but to serve their cash management needs.
However, banks need to know that even if a customer is a non-borrower he will still expect to be able to borrow from his banks when and if the need arises. A willingness to lend to certain segments should be part of the bank’s “non-borrower” segmentation strategy.
* Hire; don’t retrain. As noted above, selling to non-borrowers requires a different emphasis and skill set versus what most lenders possess. Management’s choice is to try to retrain (oftentimes putting “a square peg in a round hole”) or hire non-credit specialists. Increasingly, we find the latter approach more effective. We have seen banks lever deposit-only salespeople to build up their activity in this area.
* Change compensation to encourage deposits/fees. This is very basic, but still usually overlooked at many community and regional banks. “You get what you pay for” applies to banking as well as most other things.
* No peanut butter investing. Years ago, a column in the Financial Times noted how managers often spread their investment dollars around like peanut butter rather making more significant commitments to a few high impact opportunities. Banks need to ensure they are allocating an appropriate level of investment to the products and solutions non-borrowers require. Otherwise, the bank will be competing at a competitive disadvantage.
Concluding thought.
Banks are once again talking about the value of going “back to basics.” There are few activities more basic, and potentially more profitable, than focusing on the non-borrowing customer. Banks that do so will generate higher ROEs and a steadier profit stream as well as the opportunity for extensive cross-sell. Banks that fail to emphasize this area are allowing a basic profit stream to slip away.