Let’s face it – early budget planning for 2011 is showing most banks they are in a world of hurt when it comes to non-interest income (NII). With the onslaught of regulatory initiatives designed to take even more of the burden of individual responsibility away from the consumer, key non-interest income drivers such as interchange and NSF must be augmented with new revenue sources. Well, it just so happens there are hidden NII-jewels waiting to be discovered in the commercial lending line of business, and the good news is they’re pretty easy to find. We just have to figure out how to overcome the prevailing mindset, fee fear factors, that all commercial bankers seem to have, such as:
All of these points are valid, but should not preclude us from aggressively pursuing NII in the commercial line of business. Because most banks do not have performance management systems related to fee income, the lenders perceive aggressive pursuit of fee income as charging fees all of the time, and without consideration of the uniqueness, size or relationship value of the deal. As a result, when a bank analyzes a fee income associated with commercial loan portfolios, it invariably finds random pricing of fees and collection rates among officers.
GonzoBankers need to establish a more disciplined management framework to determine how the organization can overcome the fee fear factors and chart its own destiny to drive greater fee collection performance.
A management framework is simply a tool to depict any desired result and the key business drivers of said result. When applied to loan fee income, the management framework that results is shown in figure 1.
Using this framework we will examine the current state of banks and their capabilities to manage or influence these NII Key Business Drivers within the context of commercial lending fees.
In the commercial lending space the primary KPDs of NII are:
Pricing of loan fees should be set based on the type of fee, by product, and tiered based on the size of the credit. For example, consider origination, commitment and loan processing fees and how standard pricing may apply as shown in figure 2.
The table is a simple illustration of how pricing may differ based on product and the size of the credit amount. Key points to observe are: 1) rate-based fees may often have standard pricing that declines as credit size increases; 2) fixed dollar based pricing (loan processing fee) increases as the credit amount increases; and 3) distinction needs to be made as to which fee type applies to product type or group.
In addition to standard pricing, management also needs to set target collection rates at the same level of granularity at which standard pricing is established. This gives more flexibility to lenders when negotiating larger deals, and allows the consideration of other relationship attributes to contribute to the final deal pricing.
Probably the biggest driver of NII results is fee collection performance measurement, and it is by far the weakest area in terms of the capabilities of banks to influence NII. Key areas to evaluate are:
In today’s world, lenders are typically evaluated on total dollars of NII generated without regard to the source. A lender may have a goal of X dollars in fee income, but from whence that income cometh is usually of little importance. As a result, year after year NII goals are set based more on portfolio inertia than on clear and distinct performance goals based on specific fee types.
The key to effective scorecards is that for any given fee we measure both the effective pricing and actual collection rate as compared to standard pricing and target collection rates – see figure 3. Effective pricing should be calculated based on fees collected at the transaction level and then averaged over the reporting period. Collection rates are computed based on the count of fees that were charged in a fee group divided by the total number of opportunities (transactions) within that fee group.
At most institutions loan fee data resides in a hodgepodge of places with no one owner or clear direction for use as a NII performance management tool:
So, what’s left for a GonzoBanker to do? Ideally, the best place for extracting the fee income data is from the loan accounting system as there are myriad data elements for reporting and analysis. If at last resort the only way to track fee income is a manual process using Excel worksheets, then do it. The reward is well worth the effort.
The scorecard is critical to holding lenders accountable and serves as a major determinant of how effective lenders will be at generating NII. Other critical areas to sales force effectiveness are skills and training, and incentives that are more directly tied to performance.
Skills and training
The skills necessary to be a high performer at fee income generation are hardly considered, but are simple to address. First, fees are not clearly defined in terms of purpose, or basis, and secondly, fees are not communicated to customers in terms of a value proposition. For example, consider the origination fee. The definition: to cover the cost of originating the loan, risk assessment and due diligence. The value proposition to the customer: these activities help the bank manage risk and ultimately offer the best rate as a result.
Clear definitions and purpose give lenders confidence to boldly go after fees as part of the overall deal pricing. Also, when there is a clear basis for the fee, a reduction is often the result in negotiation as opposed to a complete elimination.
Incorporating fee specific effective pricing and collection rate performance metrics into the NII component of the lender incentive plan will drive fee income and sales effectiveness. If the traditional approach continues, to just look at an overall dollar amount of NII without fee specificity, our NII outcomes are more left to chance, than to endeavor.
Financial institutions searching for hidden revenue jewels, whether buried in non-interest income, market expansion, acquisitions, vendor contracts or card interchange fees, turn to Cornerstone Advisors.
Cornerstone’s multi-faceted experts can work with you to reveal the profit potential inherent in a variety of strategic choices. Contact us today to get started on your institution’s treasure map.