Useful Small Business Scorecard
There are numerous macro economic forecasting tools, but we are always on the lookout for indicators that provide a more local and granular view of the health of small business.

We recently found a small business scorecard published by SurePayroll. This scorecard displays two simple metrics: 1) changes in employees numbers and the change in average salary per paycheck.

Data is provided by four general regions, West, Midwest, Northeast, and South, and by selected states.

February 2011 Summary Mixed
According to the February report, “2011 is becoming a rerun of 2010’s small business economy storyline. February marked the fifth consecutive month of flat or shrinking hiring numbers across the nation. The average paycheck size, however, continued to grow.”

Comment
A decline in hiring numbers indicates a continued lack of economic growth, but the increase in paycheck size seems to indicate that hourly employees are working more shifts, implying some degree of uptick.

Next Steps
Visit the SurePayroll website and review the tool. If you find value, you can signup for their RSS feed.

Why Every Organization Needs a Process Inventory

We’ve all been there. The telephone rings and it’s one of our best customers on the line letting us know that something has gone wrong - for the second time. These are telephone calls we hope we never receive. Once the call is ended, our first inclination is to find the person responsible and maybe raise a bit of cain.

Finding that person is one option, but a better course of action is to take a few minutes and think about the process that generated that call. That’s right, the culprit very likely is the process that produced that product or service, not the person that heads the department.

Effective and Efficient Customer-facing Processes Yield Positive Financial Returns
Every organization has processes - lots of them. Some of them are purely internal to the organization, but some of some touch the customer. These are the processes that actually deliver the goods and services that clients and customer pay money for. And that money, of course, represents our bottom line.

The need is to focus on the performance of those tasks that customers are willing to pay for, and the best way to do that is to develop a list, an inventory if you will, of all of your processes.

How to Identify a Process
Many of us don’t think in terms of processes, so that word can be a bit foreign. Instead of process, just focus on your organization’s “outputs,” the things (be it services or products) that your customers buy.

If you are a bank, for example, a client makes a loan - in essence they are buying the use of money from your bank. The steps that your loan officers, underwriters, and credit approval team go through to get the loan package ready for approval is a process. And it’s an important one because it touches the customer and has a direct impact on your bank’s performance.

How to Develop Your Process Inventory
Developing your process list is really straight forward. Simply spend five minutes and jot down a list of all of the things your organization delivers to the market place. Those things could involve painting a building, providing a working capital loan, or building jet engines.

Once you begin, you will quickly find yourself developing into a process detective. For a little more fun, have your managers come in and do the same thing. Within half an hour you will have a very good process list to work with.

Which Ones are Critical?
With the list in your hands, the next step is to reflect on which ones connect most directly to your customer through your products or services. As you go through this exercise, see if any of them float to the top. That is, they just seem to be more important than the others. This is your business intuition beginning to prioritize your processes.

Where Should You Apply Your Limited Resources?
All organizations have limited resources, mostly staff time and capital, and you want to deploy those resources where they will do the most good.

With your process inventory in hand, it’s a simple task to determine which processes have priority and where those resources should go.

In Summary
Creating a basic process inventory is a quick, first step in significantly improving the performance of your organization. The half an hour you spend on this exercise may be the most valuable 30 minutes you every spend.

Next Step
Pour that cup of coffee, set the timer for 5 minutes, and begin jotting down your organization’s outputs. You’ll be glad you spent the time.

Moody’s | Tower Group Presentation
I spent an hour this yesterday listening to a Moody’s | Tower Group webinar presentation on how commercial banks can gain a competitive advantage in commercial lending. The webinar was sponsored by American Banking, US Banker, and Bank Technology News.

The full webinar title was “Analytics as a Weapon for Competitive Advantage in Commercial Loan Origination.” With a topic title like that, I was expecting a technology presentation and I wasn’t disappointed. However, I also got some information I wasn’t expecting.

First, Some Interesting Information Bites
The first presenter from the Tower Group (a major banking research organization) showed a chart pointing to an small increase in C&I lending. This is the good news for community commercial bankers.

Good news always seems to be accompanied by bad news, and this webinar was no exception. The presenter noted that increasing regulatory burden in retail banking is causing some of the larger banks to move into commercial lending and, more worrying, down into the smaller commercial loan market.

The arrival of big banks in the community bank commercial lending sector is expected to increase competition and put further pressure on slim margins. Moreover, the presenter noted that the big banks are relaxing their lending criteria more quickly than smaller banks.

Some Interesting Information on Commercial Borrower “Wants”
The presentation included information from a recent Tower Group poll of 1,400 small to medium business owners ($50 million or less in annual turnover) about the most important elements in the banking relationship from their perspective. As you might expect, those interests differed according to business size.

For the smaller businesses, their prime interest was dealing with a bank that would give them a reliable line of credit to help them keep their business running. Many of those surveyed were surviving on operating capital but would prefer to be borrowing.

The key factors for larger businesses were ease of doing business and consistency in service quality, and those are important issues.

Technology to the Rescue?
At this point, the Moody’s Analytics presenter took over from the Tower Group team and gave a very good summary of the technology tools Moody’s has available for making lending decisions. The presenter made a point of the importance of calculating the effect of each new credit on overall portfolio profitability prior to approving the loan and how well the technology does those calculations.

In fact, Moody’s RiskOrigins product calculates net cash flows from loan to maturity, allowing the bank to view the expected impact on shareholder value of each loan.

The solution looked great in the presentation and it certainly makes sense to be able to calculate profitability for each loan before it is booked. The questions to ask, however, are how applicable is this technology from a cost and complexity perspective to community banks?

Can Simple Process Trump Complex Technology?
A key aspect of deploying the various elements of the Moody’s technology suite was to drive operational efficiency and quality of service into a bank’s lending process. This is a great idea, but it often is the case that organizations deploy technology in hopes that the inherent process in the software will solve internal process issues, only to find that it doesn’t.

Complex technology solutions can be difficult for small organizations to deploy and learn to use effective. And, these systems can easily cost $250,000 or more over their contract life.

Process Needs to Drive Technology
Before you sign that contract, walk all of your “doers,” the people that actually touch the credit lifecycle at some point or another, through the entire workflow of your lending process, tossing out things that don’t need to be done as they go.

When your team is finished with their “process walk,” you’ll have a clear, simplified process flow that fits your bank’s culture. It will be effective and efficient, and the technology requirements you need to enable the process will be there in plain sight.

As odd as it may seem, your processes are the horse; technology is the cart. We all know which needs to come first.

Simple Process Improvement Goes a Long Way
If you take this simple process improvement step, you will be responding to two of the three commercial borrower needs the Tower Group identified in their business owner survey: 1) your will make your bank easier to deal with and 2) your processes will deliver a consistent quality of service.


Differentiate on Local Knowledge, Not Technology
Smaller community banks differentiate themselves on the personal relationships with their borrowers and their unique knowledge of local business conditions.

Sophisticated software packages can spread financials and give overall probabilities of default, but they can never replace local knowledge and experience. What we used to call in the Army, “boots on the ground.”

Effective Processes Are a Community Bank’s Competitive Bedrock
A continual process improvement program (which is not that difficult or time consuming) will allow your bank to be as effective and efficient as possible and will enable you to compete on service quality and ensure that you are making loans that increase shareholder value.

The right technology can deliver a strong competitive advantage. The wrong technology can be a Lorelei, luring you to shore.

What Caused Centennial Bank to Fail?
FDIC Report Lists Board and Management Oversight Procedures as Cause of Centennial Bank Failure (1)
“Centennial failed because its Board and management did not effectively manage the risks associated with the institution’s significant concentration in ADC loans. The institution’s ADC loan portfolio consisted primarily of single-family residential real estate, much of which was concentrated in pre-sold construction loans, large residential loans over $500,000, and stated income loans.

Limited loan underwriting on a substantial portion of Centennial’s loan portfolio and deficient credit administration and related monitoring practices also contributed to Centennial’s failure. Some of these practices and their apparent significant impact on the failure of Centennial are the subject of ongoing investigative activities. Although not a primary cause of failure, Centennial relied heavily on brokered deposits to fund its ADC lending activities and maintain adequate liquidity. When the institution’s financial condition deteriorated, access to this funding source was restricted, placing a strain on the bank’s liquidity.” (1) Read the full report at this link.

TSG | TrakPointe™ Reflections
Community bank boards and senior management teams do really well at tracking and monitoring the traditional FDIC-mandated risk categories. These types of risks and the required stress-testing and reporting are well known.

What seem to be happening, though, is that the FDIC now is zeroing in on a new category of risk that exists in many organizations but rarely is tracked and managed. If you have been reading our Quick Insight articles and blog posts over the past year or so, you will recognize this as what we at TSG call “process risk.”

How Army Tank Gunnery Qualification Can Help You With Your Process Risk
I learned about process risk as a young Army lieutenant training my tank crews to make it through tank gunnery qualification. That was way back during the Vietnam period, and if your crews didn’t qualify, you didn’t get promoted. Pretty draconian; but also very effective.

Being a good tank crew isn’t rocket science, but it takes a simple, foolproof process, good communication skills, lots of practice, and a constant review of how each member of the crew - driver, gunner, loader, and tank commander - are doing their jobs. In actual combat, crews have only a few seconds to identify an enemy target and go through their firing sequence - the ultimate in lean process engineering. (Click here for a description by tank crews).

So, Just What’s the Connection Between Tank Gunnery and Process Risk?
Process risk is nothing more than people not following stated policies and procedures. In community banking, virtually everything is a process, from opening new accounts, to underwriting credit files, to tracking loan portfolio composition, to. . . Well, you get the picture.

The FDIC is finding that bank’s are not following their stated policies and that bank boards and senior management are not providing adequate oversight. November of this year witnessed the first FDIC lawsuit against a failed bank board for failing to provide this oversight.

Is There a Solution?
Yes, there is an easy way to provide the oversight the FDIC is demanding.

First, make a short list of the processes associated with your critical processes, such as credit underwriting, annual credit review, loan portfolio concentration; your list likely will have five to ten processes.

Second, determine if you have written policies for each of these processes.

Third, and most important, assess if you have a method for evaluating staff compliance with these policies and if you actually are using them. By easy, we at TSG mean being able to open the web browser on your computer and, within no more than four clicks, being able to know if there is a compliance failure with any of these critical policies.

It’s fine to have a written policy on the bookshelf, but that won’t help when the FDIC finds those compliance lapses.

How to “Get Squared Away” in 30 Days or Less
“Squared away” is one of those phrases I learned early in my Army career. Loosely translated it means “get organized.”

If you have areas that need improvement , we here at TSG can apply those hard-learned tank gunnery qualification lessons at your bank, and get you on the road to being FDIC-quality “squared away” in less than 30 days.

Visit us at TSG.LA or TrakPointe.com. We’ll be happy to explore your concerns. No obligation.

FDIC Sues Failed Heritage Community Bank Directors
On November 1, 2010, the FDIC filed a lawsuit against eleven former directors and officers of Heritage Community Bank, based in Glenwood, Illinois.

The complaint states that the directors and officers made imprudent or improper commercial loans while “...the defendants depleted the bank’s capital by making millions of dollars in dividend payments to Heritage’s holding company and paying generous incentive awards to senior management.”

The suit notes that Heritage executives and directors financed projects “without any meaningful analysis of their economic viability” and states that the defendants made loans to large-scale commercial real estate and speculative single-family housing projects, areas where they had “virtually no experience.”

More Suits on the Way?
With 304 banks failed since January 1, 2008, the Heritage suit could be the beginning of an FDIC program to hold boards and senior management directly accountable. In these cases, unless directors can clearly prove they followed appropriate and approved policies, they can be held personally liable for financial losses.

How Can Directors Mitigate Their Risk?
Current Loan Policy
Banking is a risk based business and taking no risks means making no loans. Everyone, including the FDIC, understands this.

The question, however, is how to minimize risk and to ensure that a bank makes no loans that fall outside the bank’s approved risk profile. The FDIC Manual of Examinations Policies lists the areas that need to be addressed in a bank’s lending policy:

• General fields of lending
• Normal trade area
• Lending authority of loan officers and committees
• Responsibility of the board of directors in approving loans
• Guidelines for portfolio mix, risk diversification, appraisals, unsecured loans, and rates of interest
• Limitations on loan-to-value, aggregate loans, and overdrafts
• Credit and collateral documentation standards
• Collection procedures
• Guidelines addressing loan review/grading systems and the allowance for loan and lease losses
• Safeguards to minimize the potential of environment liability

The Manual of Examinations goes on to state that a bank’s loan policy should not be a static document, but needs to be updated as economic conditions change over time. One could imagine that this means at least annually.

The Loan Review System
Getting the loan on the books is only the first step in the process, however. Section 3.2 of the Risk Management Manual of Examination Policies goes on to talk in detail about a banks “loan review system,” and what it expects banks to monitor.

• To promptly identify loans with well-defined credit weakness so that timely action can be taken to minimize credit loss
• To provide essential information for determining the adequacy of the ALLL
• To identify relevant trends affecting the collectability of the loan portfolio and isolate potential problem areas
• To evaluate the activities of lending personnel
• To assess the adequacy of, and adherence to, loan policies and procedures, and to monitor compliance with relevant laws and regulations
• To provide the board of directors and senior management with an objective assessment of the overall portfolio quality, and
• To provide management with information related to credit quality that can be used for financial and regulatory reporting purposes.

Depth of Reviews
The Manual notes the following critical elements of a loan review:

• Credit quality
• Sufficiency of credit and collateral documentation
• Proper lien perfection
• Proper loan approval
• Adherence to loan covenants
• Compliance with internal policies and procedures, and applicable laws and regulations, and
• The accuracy and timeliness of credit grades assigned by loan officer.

How a Board Effectively Track These Requirements?
The FDIC’s requirements essentially outline three critical bank processes; underwriting the loan, approving the loan, and monitoring the loan from funding through sale or payoff.

The simplest way to manage these requirements is to visualize the key risk elements in these processes in what we at TSG call a “Loan Portfolio Risk Dashboard.”

This risk dashboard would show the following information in visual form - additional information could be added:

• Percentage of portfolio value by geographical area
• Percentage of portfolio value by NAIC code
• Percentage of portfolio value outside of trade area
• Percentage of portfolio value to one borrower
• Date of last loan policy review and approval by board
• Percentage of loans reviewed over past 12 months (or in accordance with loan policy)
• Percentage of loans not in compliance with loan covenants (financials received, compensating balances, on hand, etc.)
• Percentage of loan portfolio value with exceptions to loan policy
• Number of loans with loan officer onsite visit during past 12 months
• Average profitability of loan portfolio against year-prior

Human Risk Management and Mitigation
All of the risk factors that a bank faces are, in some fashion, connected to human nature. This includes market risk, which generally is considered beyond a bank’s control.

While boards and senior management cannot control or manage external risk, they can, however, ensure that staff comply with the critical process requirements embedded in the bank’s loan policy. We can do this by instituting simple control mechanisms that require people to certify that they have accomplished critical tasks as required by policy.

While the possibility of false certification certainly exists, a tracking system brings accountability to individuals and to the system as a whole, and clearly demonstrates to examiners that the board and senior management are serious about policy compliance.

Summary

• The FDIC’s Heritage Bank suit signals a much more active FDIC, with serious personal financial implication for board members and senior management.


• Creating a Process Risk Dashboard is a simple, affordable, and highly effective method of ensuring compliance with lending policies.


• Making the dashboard visible to the board, senior management, and loan officers will drive compliance with policies and provide a highly useful tool for demonstrating effective loan policy oversight to FDIC examiners.


• The TrakPointe™ solution from TSG, Inc., can deliver a fully functional Loan System Review dashboard within 45 days. TrakPointe™ is deployed with no annual contract or service fee and can be canceled with a simple 30 day notice.

43 Percent of Internet Users Visited Social Media Sites in 2009
The PEW Internet and American Life Project reported in 2010 that fully 43% of Americans that accessed the Internet in 2009 visited a social media site, up from 8% in 2005. Other sources indicate this trend is increasing, and Facebook was the Bloomberg Businessweek cover story for September 27, 2010.

Check Your Mobile Phone at the Door?
Many financial institutions are busily writing policies that forbid the use of social media at the workplace. Unfortunately, everyone with a smart phone has the Internet, and access to social media websites, right in their pocket.

Train - Don’t Forbid
Just like the telephone and fax machine before it, the Internet and its related social media technologies are a trend that simply cannot be controlled.

Instead of swimming against the tide, develop short, simple social media policies and proactively teach them to your staff. Many community banks already are using social media and we’re certain many would share their policies. If you don’t have one, send us an email and we’ll help you find one.

What About That Pesky Compliance Issue?
If you intend to use social media to “communicate with the public,” those communications fall under SEC retention requirements.

But, don’t quit yet, there are a number of firms that can easily solve this issue for you without requiring another in-house software system. These are Internet-based solutions, and you’ll be on “Cloud 9” before you know it:

Backupify (Louisville, KY) (Backupify.com)
Dexrex Gear (Cambridge, Mass) (dexrexgear.com)
Eternos (Seattle, WA) (eternos.com)
Iron Mountain (Boston, Mass) (ironmountain.com)
LiveOffice (Torrance, CA) (liveoffice.com)
Mimecast (London, England) (mimecst.com)
Smarsh (Portland, Oregon) (smarsh.com)
Sonian (Needham, Mass) (sonian.com)

Three Simple Questions Will Point Your in the Right Direction
We’ve been asked many times about social media’s value to community banking. We got asked so many time, in fact, that we held our first community banking social media workshop at the Annenberg School’s Center for the Digital Future on July 7th.

The answer to the question about the value of social media to any organization is based on a few basic factors: 1) are the people you are trying to reach or your stakeholders using social media?, 2) would you like to have a two-way conversation with your target market, and 3) are you willing to dedicate some time to understanding social media and the role it could play in your customer communications plan?

The Sixty Plus Crowd is Pretty Hip After All
I just read a piece in the New York Time by Jenna Wortham stating that the fastest growing segment of Facebook users is people over 65, with 6.5 million of them creating an account in May of this year alone. Facebook now has 500,000,000 members. Those are pretty staggering numbers.

Would Your Business Like to Interact with Any of Those Half Billion People?
Half a billion people in one place on the Internet is a pretty lucrative target and businesses are flocking to Facebook. Businesses can create Facebook page, post information, receive customer feedback (or choose not to), all with a minimum of effort and the technology platform is absolutely free!

Read Groundswell by Charlene Li and Josh Bernoff
Summer’s here and its time to kick back a little and do some reading in the back yard or by the pool. After you’ve finished reading The Girl with the Dragoon Tattoo, get Groundswell. If you are at all interested in this thing called social media, you’ll be fascinated with what Charlene and Josh have to say, and you’ll be checking the boxes to see where you fall.

State of the Internet - Where are We and What does it Mean for Your Business?
As a Senior Fellow at the Center for Digital Future, I’m available as a lunch or evening speaker to talk about the current results of the Center’s ongoing research into how people are using the Internet and how it has changed their lives.

You can reach me at Robert.Hess@tsg.la or rhess@digitalcenter.org .

PCBB Does it Again
I just returned from another great Pacific Coast Bankers Bank conference in San Francisco. Being in “The City” was great but, as always, it was Steve Brown, Chris Nichols and their team that really made the trip special.

Key Conference Take Aways
You never leave a PCBB conference without something a community banker could implement immediately (assuming time and resources) and improve their business. Here are some of the key points that caught my attention (in conference order, not necessarily order of importance):

• Mobile banking has arrived. The major banks have implemented it and community banks need to get on the train or be left at the station. (35% of US households no longer have a landline telephone. There are 28 million mobile banking users and the number is growing).
• Mobile deposit capture is here - USAA is using it to great effect.
• Social media. Again, the big banks (Wells, BofA, Citi) have mastered what social media is about in banking and they will use these tools to become more “community” than community banks. Every community bank needs to spend some time understanding social media and what it means - or does not mean - for their business model.
• The regulators are putting restrictions of the amount of brokered deposits. The more risk you have in your portfolio, the more capital they are going to demand you have.
• ROA is critical.
• You need to “desensitize” your deposit base.
• Figure out who the bottom 20% of you customers are - they actually destroy 45% of your profits - and move them along to the bank across the street.
• The future will place a premium on operating efficiency.
• Regulators are going to be asking for more data and information.
• Regulators will be looking at the number of loans approved “with exceptions.”
• Focus will be on asset quality, liquidity, and capital.
• IRR is a focus. Guidance is in FDIC 2010 Advisory on IRR Management.
• Boards need to understand the risk profile of the bank.
• What is the banks customized business metrics that the bank is managing to?

Social Media Workshop
TrakPointe/TSG will be holding a half-day workshop on social media for community banking July 7, 2010 in West Los Angeles. Attendance at this initial workshop is free, but is limited to ten participants. The session will be held at the Center for Digital Future, 11444 W.Olympic Drive, Los Angeles. To reserve one of these slots are to be added to the waiting list, contact Robert Hess, robert.hess@tsg.la, 424.245.5382.

Our firm became deeply involved in the concept social media through my role as a Senior Fellow at the Center for the Digital Future, Annenberg School, USC, and through several social media-related projects for the Department of Defense.

Blogs, Facebook, YouTube, Twitter, we've all heard about them and wonder if they make sense for community banks.  If you are older than 50, it's probably a challenge to get your head around these tools.  If you are younger, it's a lot easier.

We have created a hands-on, two-week mentored familiarization program for social media evaluation and we will be talking about social media in this column from now on.  As a first step, though, spend a few minutes at First Atlantic bank's blog and think about what value it would bring to you if you were a First Atlantic client.  Notice that First Atlantic has Twitter, Facebook, and LinkedIn accounts.

“At the close of the fourth quarter 2009, the number of state-chartered banks decreased by ten to 208 from December 31 one year ago.  Assets went from $242.5 billion to $227.6 billion, down $15.0 billion or 6.2% over the same period. Total equity capital decreased at a slower rate, down 3.0%, going from $28.1 billion to $27.2 billion at the close of the fourth quarter, causing the equity capital to total asset ratio to increase from 11.58% to 11.97%.  Loans were down 8.6%, going from $171.7 billion to $157.0 billion, while deposits increased 3.6% from $167.1 to $173.2 billion. This caused the loan to deposit ratio to decrease to 90.64% from 102.75% a year previous.

For the fourth quarter of 2009, state-chartered banks reported $1.0 billion in net losses, off $131.4 million or 14.5% from the $906.7 million net loss reported in the fourth quarter 2008.  Loan loss provisions were up $1.7 billion from $3.2 billion to $4.8 billion, an increase of 53.2%.

The net interest margin was down from 3.23% one year ago to 3.21%.  Loan loss reserves in the fourth quarter 2009 were up 31.0% to $4.0 billion from $3.1 billion one year ago; however, noncurrent loans went from $4.6 billion to $7.3 billion in the same period, which caused reserve coverage of noncurrent loans to decrease from 66.61% to 55.37%.  Other real estate owned increased 87.5%, going from $625.0 million to $1.2 billion.”