Hot Issues ... and What We're Doing about Them

By Foster, Beverly | The Journal of Lending & Credit Risk Management, November 1997 | Go to article overview

Hot Issues ... and What We're Doing about Them


Foster, Beverly, The Journal of Lending & Credit Risk Management


The Journal asked associates form seven financial services firms, "What is considered a 'hot issue' for your institution and what are you doing about it?" While most responded that growth is a priority, their strategies for growth vary. Also in the running as important issues are risk management and merging cultures.

Doug Weld Senior Vice President and Chief Lending Officer, Tokai Bank of California

A Strategic Alliance

Tokai is a prime example of a niche market player. The question that is always raised: What is the difference between a niche lender and product concentration? I would suggest that the only difference is quality of risk management and staff expertise. Today, Tokai Bank's portfolio of 85% commercial real estate demands that the bank find new methods of distribution whenever real estate lending is threatened. The recent rebound of real estate brought with it a new threat in the form of nonbank competitors, such as conduit issuers, life insurance companies, finance companies, and other institutional buyers of real estate loans. These firms raise money through other methods, such as public debt, policy premiums, and so forth. Because of their lower cost of funds, these firms have the capacity to lend at a fixed rate over longer periods than most banks that rely on their core deposits or funds raised in the money markets.

As intense competition for real estate loans increases, Tokai is faced with erosion of its real estate customer base unless the bank can create a comparable fixed-rate product.

At the same time, however, a majority of Tokai's nonbank competitors face the challenge of insufficient in-house staff to directly originate these loans. They must rely on third parties, such as mortgage bankers or mortgage brokers.

Tokai has discovered an opportunity to provide its existing customer relationships with access to long-term loans through a strategic alliance with its nonbank competition.

The product being offered is one for which Tokai retains the "first loss" piece of the credit - between 10% and 15%. The institutional investor buys the other portion of the note on a senior basis of first-in, first-out. This allows the investor to purchase the lower risk tier, similar to purchasing rated conventional mortgage-backed security paper, but to have the asset review and control of a whole loan sale. Since Tokai retains the highest risk piece, it reserves as if the entire asset is still on the books. The bank is able to establish this reserve from the sale of the senior portion of the note, allowing the bank to have sale treatment on the revenue stream sold. By retaining the highest risk piece, Tokai also retains customer contact and control over most operational and day-to-day decisions.

This type of strategy certainly is not for every bank. Tokai's concentration in commercial real estate allows the bank to focus its resources to ensure the underwriting is bullet-proof. Strong market research, highly skilled employees, and expert portfolio management are Tokai's best hedge against risk. Each bank considering Tokai's strategy must determine which industry, if any, is worthy of this type of investment.

Tokai's emphasis is core product expertise and slow, steady growth, not quick higher yield returns. It is important to note that Tokai is not a publicly owned or traded company in which the shareholders might place greater emphasis on return than on risk management.

These new strategic alliances should permit Tokai to retain its customer base and lending relations while offering a new longer term product. It is also Tokai's goal to use these strategies effectively for cross selling and marketing new products.

Richard Harbaugh President and CEO, Overland National Bank, Grand Island, Nebraska

Looking for a Niche

A small community bank ($140 million in assets), Overland National Bank is part of a $2 billion Nebraska-based multibank holding company. …

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Hot Issues ... and What We're Doing about Them
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