Mick Jagger and Goldilocks
OK, I admit I am probably a bit more of a “seasoned” citizen than a lot of our blog readers. That said, I can assure you that I was not around when Goldilocks and the Three Bears was penned by Robert Southey in 1837. However, I am old enough that the Rolling Stones were a favorite musical group of mine in my formative years.
Most financial institutions are probably well into 2019 planning and budgeting. The considerations of the planning process bring to mind the deep philosophical issues raised by Mick Jagger and Goldilocks. Jagger famously sang, “you can’t always get what you want.” Goldilocks found one bowl of porridge to be too hot, one too cold and the other was just right.
As banks and financial institutions evaluate their markets, growth goals, competition, credit quality and profitability, the focus will typically come down to balancing three critical areas: volume (V), price (P) and quality (Q). Everyone would like to grow the portfolio by double digits while enjoying strong interest margin and fees. And while we are at it, no past dues, non-accruals or charge-offs. Since we know this is unattainable, we need to balance the three considerations above.
Each institution will balance these factors against the macro constraints of competition in the market, overall market growth, where we are in the business cycle, etc. Micro considerations, including current profitability and portfolio quality, will also impact the weighting given to V, P and Q.
How might this look in reality? If our primary goal is portfolio growth (V), then all other things being equal in the marketplace, we will need to reduce pricing and fees (P) and be more aggressive on loan structure (Q). In other words, compromise on pricing and loan quality. Depending on your institution’s current credit profile and market competition, this may be an acceptable strategy in the short term. However, be prepared to respond quickly to red flags on the credit side in terms of covenant defaults, past dues and delinquent client reporting.
If the primary focus is to be pricing (P) and increasing net interest margin, be prepared to not win as many competitive deals. And because high (credit) quality deals will generally have multiple proposals with competitive pricing, be prepared to accept a higher risk profile in the deals won.
Finally, if the strategy is to focus on improving credit quality (Q) or the risk profile in the portfolio, perhaps because of the risk in the current portfolio or macro marketplace concerns, volume of new loans and relationships and overall pricing are likely to suffer. As in the pricing scenario discussed earlier, high quality deals will attract multiple competitive proposals, so your institution will need to be creative in winning the mandate for any new relationship.
Goldilocks or Mick Jagger? While we should certainly attempt to find that ideal balance of pricing, growth and credit quality where the temperature is “just right,” we are likely to find ourselves in the position where “you can’t always get what you want.” However, as the next line of the song says, “but if you try sometimes, you might just find you get what you need.” Thanks, Mick!
Richard Rudolph is Senior Consultant at Enlighten Financial, a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape, and lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Rick directly, please call: 920.264.9150.
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