Our client work indicates that, at many banks, the core middle market segment (say $50 million+ in revenue) is suffering from slowed growth and lowered returns. Mid-sized companies now operate with improved liquidity management and an increased number of financing options. More so than in the past, the well-performing middle market company now comes close to dictating lending terms rather than relying on a relationship banker’s input.
However, while bank returns on lending are down, the segment is continuing to attract more smart competitors seeking growth opportunities.
This past weekend’s Financial Times features a column extolling the attractiveness of the middle market to bankers: “Some of the big banks that switched their focus away from the mid-market during the 1990s boom have had second thoughts. New entrants are moving into mid-market investment banking. Hedge funds with bulging wallets are waving their cheque-books.”
The article then goes on to mention CIT’s announcement that it is forming an investment banking arm aimed at mid-sized companies and also cites Merrill Lynch and Citibank as other players putting a high focus on this segment. In addition, hedge funds are highlighted as a new competitive force: “Hedge funds can take on more leverage than banks, which may mean they can generate attractive returns by borrowing from [banks] and lending on to companies that the big banks would spurn. Hedge fund supporters believe they will also prove more flexible than banks when borrowers get into trouble.”
Traditional Approaches to the Middle Market Will Suffer
Banks cannot afford to approach the middle market with their traditional “shotgun” marketing approach. The new competitors are targeted players, exploiting specific capabilities in certain knowledge-based areas. CIT will focus on M&A and related financing activities; as the article states, “Merrill Lynch has been cultivating the mid-market, both for advise on mergers and acquisitions and in terms of loans”; the hedge funds are coming into companies in which they believe their structuring capabilities and management provides value.
What none of these players are focusing on is straight money-over-money lending. To this day, many bank lenders are stuck in this rut and, in our view, that strategy results in reduced returns and mediocre growth.
Picking a Path to Growth
If they are to achieve sustainable profitability, commercial banks need to make some decisions concerning the middle market.
What should banks choose as their focus? The best middle market players are picking their spots — in effect, avoiding less attractive customers. The old Chemical Bank, now Chase, provides a great model for to the banks to consider. Chemical led the way in developing very strong industry groups in areas as diverse as advertising, media, and not-for-profits. At the new Chase, this approach has served as the base for their national expansion drive.
Beyond industry segments, other banks are focusing on their product expertise as a differentiating factor. Whether investment banking, commercial real estate, or another area, banks can bring “unique” capabilities to customers and targets, and companies appear willing to pay for this expertise.
How can they systematically achieve meaningful cross-sell? Being a generalist middle market lender almost certainly condemns a bank to eroding returns. Cross selling of cash management and retirement products, among others, is not an option, although many banks operate as if it were. Remarkably, insufficient focus and energy continue to exist around promoting cross-sell. At many banks, it seems to be a “nice to have” rather than a basic profit foundation.
We expect that, rather than relying on loan-oriented relationship managers, more independence and autonomy will be given to product-based sales persons. Product sales staff will take a more aggressive role both in analyzing non-credit opportunities with current customers and in marketing directly to those customers. An enhanced non-credit direct sales force may be one of the most effective approaches for a bank wanting to diversify beyond credit.
How should the relationship manager’s job change? To this day, although the chief sales contact to the middle market, traditional RMs spend no more than 25-30 percent of their time selling. Instead, they are underwriting, administrating, and monitoring. In fact, at many banks, the administrative burden has gotten worse in recent years tying the banker even more firmly to the desk. Unless banks reexamine and change the RM’s job, they will not achieve higher productivity and sales; it is that simple. Bank managements need to evaluate the job and determine the priorities they wish to set for the RMs.
Now the hard part. Once they make those decisions, they then need to execute consistently across the bank rather than allowing the RM to define his/her own position. Too often, the RMs decide how to spend their time, resulting in a marginal sales focus. A banker’s comment from ten years ago is just as relevant today (unfortunately): “Selling is what I do after I do everything else.” Clearly, that is not a growth-oriented approach.
Concluding Comment
The middle market can be a highly attractive segment. However, it will not perform for banks that pursue it with the same approach they used 20 years ago. Greater selectivity in the type of customer pursued and the products sold is one part of the solution. Rethinking the RM’s job from the ground up is another. Focusing on both areas and then executing consistently post-analysis can create a meaningful profit growth engine. The alternative is a slowly eroding franchise and a constant and, ultimately, losing fight for growth.