First quarter 2007 results for the banking industry will show some negative surprises. The margin squeeze continues, propelled by the flat yield curve and a competitive environment in which lenders are increasingly desperate for volume. Deposits remain hard to retain and grow, as consumers and businesses want more for their money. As one client commented, “core deposit declines and unfavorable deposit mix changes continue.” Credit quality is also beginning to look increasingly shaky, and not just in the sub-prime area. 2007 is proving to be a tough year for earnings growth.

One bright spot for many players remains the small business area. Yes, loan margins are compressing there too and deposits within that segment are also shifting to higher cost options. Nonetheless, banks can improve performance in this area by focusing on increased efficiency and productivity across the small business “value chain.”  Remarkably, many banks continue to ignore the revenue and profit opportunities resulting from lower operating expenses, improved sales performance, and higher per account profitability.

Let’s look at a few of the key elements of the small business value chain or “business system” and outline some of the near-term opportunities available to banks.

* The Product Offer. Most banks offer too many rather than too few products to their small business customers. The product array of which many banks are so proud often confuses the target as well as the sales staff. Most small business-related profit comes from no more than four areas: short-term business loans, business deposits, owner loans, and owner deposits. Get the majority of the share of those products and the majority of the relationship’s profits come with them. Trying to sell too many products can dilute the marketing effort and the bank’s brand. Furthermore, adding on additional products to the mix can become an excuse for not being extraordinarily successful at selling the core products.

* The Sales Staff. At most banks, sales productivity remains at abysmally low levels. Too many managers provide excuses for poor performance rather than taking the obvious but tough steps required to improve performance. Obvious but tough step number one: make sure sales managers demand effective selling. Frankly, the time for excuses is long past. Senior management should act to insist that the required sales processes are in place so that a sales culture can develop. Many banks operate with sales managers who either lack the will, the insight, or the chutzpa (a New York phrase) to get the job done. Message to top management: Either replace those people or suffer poor results.

Sales people should be spending 70% or more of their time selling. If not, top management should assess why its sales people are not selling and act to increase that percentage. They should do that yesterday.

* Underwriting and Credit Decisioning. The industry is under-using the ability to auto decision loans in the small business space, as many banks continue to operate with a Score+ approach, whereby the bank scores an app but then has an underwriter manually review the score. This belt-and-suspenders method needs to be eliminated or at a minimum reduced.

A bank’s reticence to rely on scores results from its traditional customized approach to underwriting credit, appropriate for commercial but not for small business lending. It stands in the way of increased performance and, in some cases, common sense. Credit scoring of small business loans works; in fact, many adopters believe it works better than the old fashioned (and much more expensive) high-touch approach. For many small business loans, auto decisioning offers a cheaper, faster, and higher quality alternative to current methods. Banks looking to improve their profits and productivity should highlight this functional capability.
 
* Segmentation. Many players continue to attack the small business space with a general offer aimed at attracting any and all small businesses to their bank. However, different industries and customer types offer dramatically different profit opportunities to banks. Similarly, only certain customer types will find a particular bank attractive to them. Increasingly, being a “general” small business or C&I lender means eroding returns, as competitors specialized by industry, product, and/or demographics cherry-pick the customer base.

One area for particular focus involves deposits. Virtually every bank is experiencing a tougher environment for deposit retention and growth. Nevertheless, few banks have any sales staff specifically designated to try to capture deposits, even though approximately 60 percent of small business customers are non-borrowers. A handful of best practice players have aligned sales persons against this target segment. While the impact does not occur overnight, the banks we know with a deposit-only effort believe this focus has paid off.

* Incentives. To this day, many banks refuse to pay for performance. Now, no bank would ever admit to this failing, but a look at a bank’s compensation policies will indicate whether management wants to pay based upon performance or some other criteria such as time served or cultural fit (no boat rocking allowed). A few companies have actually cut salaries, eliminated any caps on upside incentives, and fired up their salespeople. Conversely, one banker told me that his spending any additional effort selling really was not worth it because his compensation depended upon his entire unit’s and his total bank’s performance. One or two more sales made little difference to his personal bottom line while negatively impacting his lifestyle. In this case, the bank’s incentive structure encouraged a sales slowdown rather than a push.

Concluding Thoughts

Best practice examples abound in the small business space and bank management can take advantage of them. Implementing change often requires a sense of urgency. If management cannot create a sense of urgency in the current operating environment for banks, when will they ever be able to introduce productivity- and performance-enhancing changes?