Excuse me—you're standing on my bonus … reflections on credit culture

David H. Wesley

Banks have been widely lauded for their performance through the most recent downturn. Pressure for revenue growth has invariably led to deal creep--pricing concessions, then deal structure concessions (covenant, guarantees, advance rates, etc.), and then the rationalization that otherwise marginal credits are acceptable. It takes both courage and conviction to remain disciplined and diligent to not trade off your credit risk principles. Looking back at performance during the last downturn, some things were done particularly well, while others could have been done better.

Lenders with a strong, balanced credit risk culture performed particularly well. However, there still exists the tendency for originators to pursue volume without regard to profitability or asset quality, especially when incented on volume alone. That's when otherwise marginal credits start looking more attractive.

A lesson we must particularly enjoy, because we keep relearning it, is that the credits we are approving today will have to carry us through the next credit cycle downdraft; hence, consistency is key in our credit risk culture.

Following are a few of the excuses that we all have heard (or have used) in the credit approval process, along with their subliminal translations.

It's a great real estate play.

Translation: The underlying credit is financially challenged with skinny cash flow coverage and is a high-risk deal with little to no equity.

We have to do this to get the business.

Translation: The relationship manager is unable to negotiate against the competition and get the deal without making significant underwriting concessions.

If we do this, we will have their business forever.

Translation: No one else is willing to do this deal.

They are a long-time client.

Translation: We should relax our credit standards.

If we decline this deal, we will not get a shot at their next deal.

Translation: By doing this marginal deal, we will get a shot at more marginal business, and the relationship manager will get more incentive compensation.

The business is ours to lose.

Translation: The relationship manager has already led the client to believe you can do this deal in advance of getting approval.

The real estate will execute well.

Translation: The underlying credit is weak, but the relationship manager's bonus potential is strong.

We are a real estate lender.

Translation: The intrinsic credit parameters are weak and cash flow is marginal at best, but you know you cannot get hurt with dirt.

The leverage does not matter since we have the real estate.

Translation: Who cares about leverage, free cash flow, profitability, margins, and trends? I just want my bonus.

The client says his current lender does not understand the business.

Translation: Beware, as the client is either "tapped out" or possibly is a workout credit that the current lender wants to exit. Look in a mirror to see the "greater fool."

We have an MAI appraisal that supports the request.

Translation: The appraisal is a made-as-instructed real estate valuation.

The client does not want to guarantee the deal.

Translation: The client wants your money but does not want to assume any personal risk or obligation, as it is too risky for him personally (but this is still a great deal).

This is a great opportunity.

Translation: This is a better opportunity for the relationship manager to get a bonus than it is a good transaction for the corporation.

These are good guys.

Translation: This is a marginal deal with skinny cash flow coverage, and the client has no equity to put in the deal.

He is a strong operator.

Translation: Regardless of the fact that overall financial and operating performance indicates the contrary, the relationship manager needs the volume.

This is a key member in the market, and we will get a lot of their business.

Translation: By stretching to do this marginal deal, you are going to get the opportunity to commit to more of the same marginal deals.

It is a relationship issue.

Translation: The relationship manager's incentive compensation is at risk, rather than the client relationship. Your failure to approve will personally cost the relationship manager a few bonus dollars.

They are too big to fail.

Translation: Size and tier ranking are significant strengths and outweigh the financial weaknesses; moreover, the relationship manager's bonus will be the equivalent of hitting a personal trifecta.

This is a "slam dunk."

Translation: It is not my money at risk, and credit quality is not my responsibility. However, my incentive compensation is at risk if we do not do this deal. So, let's do the deal!

The client is a public company.

Translation: Do not bother me or my client with any questions. They are a public company, and you can get all the financial information you need off the Internet to underwrite the transaction. So you do not need to perform the usual degree of due diligence to really understand the embedded risks.

High leverage and low debt service coverage are inconsequential due to the company's quality of management, operational capabilities, and favorable prospects.

Translation: Despite clear warnings of financial deterioration, volume generation is more important than quality or profitability.

We really need to stretch on this deal.

Translation: We need to relax our credit standards and underprice the deal in order to make our production targets and for the relationship manager to get a bonus.

While the preceding is tongue-in-cheek, the value of prudent credit risk management and the need to manage credit risk better should not be underplayed. Asset quality, profitability, and volume are interdependent and, at times, conflicting. Success in our industry is a function of discipline and consistent execution. We have to maintain and sustain a balanced risk-reward perspective. There has to be a more thoughtful, disciplined approach to credit risk management.

When rewarded solely on the basis of "bringing in the deals," we develop a book-and-forget mentality. By not demanding clear accountability or ownership for the performance of a lender's portfolio, we cultivate an environment in which maintaining the quality of credits already on the books is not emphasized. Lack of ownership is further exacerbated if management does not have a good way to measure and monitor relationship manager performance and therefore is hesitant to assign accountability. Relationship managers who consistently, shamelessly, and aggressively put their self-interest above the bank's best interests cannot and should not be tolerated. When the originations effort is not balanced by quality and profitability controls, problems inevitably occur.

The market's retribution for mismanagement of credit risk is swift, severe, and sobering. While a bank might lose some business because a competitor is willing to do the deals, its strategic credit risk management decisions should unequivocally and consistently be in the best interest of the shareholders, clients, and employees. Volume generation at the expense of asset quality and profitability should not be tolerated. Consistency is key to managing the upside potential and the downside risk when creating shareholder value, optimizing performance, and avoiding reputational impairment. Remaining disciplined and diligent in our credit risk management practices is not an option--it is a matter of survival.

Contact Wesley by e-mail at David.Wesley@Regions.com.

David Wesley is senior vice president and senior regional credit director for Regions Bank, a regional bank headquartered in Birmingham, Alabama. He's been in banking for 31 years; his last contribution to The RMA Journal was in 1993.

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