Best practices in lending and credit technology

RMA Journal, The, July-August, 2005 by Steve Williams

Williams discusses the developing trends in bank technology that will impact how community banks service their consumer and commercial loan customers over the next five years. This article is an edited summary of remarks Williams made during a recent RMA audioconference.

Consumer Lending Trends

Four major trends are impacting consumer-lending technology. First is the growing consumer debt bubble. Although many credit officers recognize this bubble, statistics show credit, as an outstanding percentage of income and net worth, is growing at all-time highs. From a technology standpoint, there is now a greater need for risk analytics in the consumer area as well as better risk-based pricing.

A second trend in consumer lending is the continued growth of indirect lending competition on the auto side. Credit unions and dealers continue to increase their market share over the banks. Over the past 12 to 18 months, there has been an explosion of networks like DealerTrack, which are Web based networks that tie dealers into lenders.

RouteOne, a company owned by major auto providers, is trying to control and drive more of the production flow of the indirect market. From a technology standpoint, this has made community banks and lenders realize they may need to participate in Web-based networks if they want to compete in the indirect market. Banks that decide not to be an indirect lender must determine their expectations for their consumer lending business.

The third trend in consumer lending is where you find the most growth--home equity lending. From a technology standpoint, this process is still much too slow for the average bank. Approvals often take three to five days and close in two to four weeks.

Best-practice institutions use automated valuation models (AVMs) that enable them to approve loan applications and close on the loans in just a few days. They also cross-sell home equity products from the mortgage base.

The fourth trend in consumer lending is the "mortgage blur," which has resulted from more and more consumer banks approving first-position mortgages. Over the past few years, more 10-year fixed and five- and seven-year balloons have been approved in banks' consumer portfolios. First mortgages are running into secondary ones through Fannie Mae and Freddie Mac. As a result, many consumer-lending systems have had to be retrofitted for the mortgage business. Expect this mortgage blur between home equity and mortgage loans to continue.

Meanwhile, institutions like Wells Fargo are offering hybrid products that are both a line of credit and an amortizing loan. In the future, consumer lending will be much more entrenched in real estate lending.

Key Commercial and Small-Business Trends

A big trend in commercial lending is the migration from a transaction-based approach that focuses on credit to the more broadly defined commercial banking approach. Banks want well-rounded, sales-oriented bankers who sell loans as well as handle deposits, cash management, and other fee-based services. As a result, banks need better relationship pricing, better loan-officer profitability systems, and better calling systems. Innovative players are tying their incentive plans to loan volume as well as to the growth in revenue and profitability from other products.

Small-business programs and automated small-business lending have continued to mature. Five years ago only the big banks split the organization into large- and small-business strategies. In the next five years, more banks, particularly the larger community banks, will need to focus on a different small-business strategy.

From a systems standpoint, community banks don't want to rely totally on scoring. They don't want a total division between the group that handles small-business lending and the group that handles the large corporate borrowers. They want to scale analysis to the type of borrower. For instance, the same loan officer may use a full-blown credit write-up process for certain deals and use an abbreviated or scored process for the smaller deals. It's not so much separate departments as separate analyses.

From a regulatory standpoint, community banks should be aware that some of that methodology required of the larger banks under Basel II eventually will creep into how examiners review your credit risk. As a result, your systems and processes will need to be more formal and sophisticated. Systems Moving to a Web Services Architecture Systems are increasingly moving to a Web-services-based architecture. Point-of-sale Web tools, in particular, are growing in popularity. For instance, many retail branches are using a simple Web-based application to capture consumer and small-business loan applications. Consumers can use these tools on the Internet. They also are being used in bank call-centers by lenders and branch employees.

Automated underwriting in the consumer market has become widespread. Business scoring also will become popular in the next three to five years. The loan-size cutoff for using credit scoring is, conservatively, about $250,000. Larger banks may go higher on the small-business side. Usually small-business loans over that amount are real-estate-secured loans that require more analysis.