Publications & Resources

October/November 2001
Focus: Lending & Credit

Loan Growth Strategies For Community Banks

By D.L. Auxier

Loan growth strategies have become popular for community banks wishing to increase Return on Equity and combat shrinking profitability caused by declining core deposits and narrowing margins. Declining interest rates, increasing competition, and shifting consumer demand, make it extremely difficult to profitably implement and manage a loan growth strategy. Striking the proper balance between achieving your targeted growth and originating suitable loan investments requires the development of a disciplined approach.

Planned Strategies

A growth strategy should be part of an overall financial plan addressing liquidity, credit and interest rate risks, and contribution margin. Just as an investment portfolio manager grows the securities portfolio through a balance of acquisitions and sales that meet predetermined portfolio guidelines, the loan investment manager must assess the "suitability" of loan production within the overall asset/liability plan. Growth for growth’s sake may well result in a long-term investment in low yielding, credit-compromised, liquidity impaired assets. Suitability guidelines should be established upfront and loan production measured against those guidelines.

Financial Elements

The following chart depicts the basic financial elements of the delicate balance between loan growth and acceptable profitability:


Funding - Absent your ability to grow core deposits, you will have to look to other forms of borrowing such as the FHLB, non-core wholesale deposits, or off-balance sheet financing via securitization. Your strategy should address the additional cost associated with borrowing. The cost and duration of this funding should be carefully analyzed in conjunction with the anticipated loan origination or acquisition.

Origination/Acquisition - Growth strategies can be implemented by expanding the use of the retail origination process as well as secondary market purchases. Direct and indirect origination of additional loan volume is a function of marketing and pricing. Careful analysis of the cost of these channels should be undertaken. Indirect origination channels can result in effective yields far below directly originated loans due to fees paid to originating dealers. The additional marketing and promotion expense associated with ramping up direct origination should be considered as well. Additionally, make certain the loans you are originating comply with secondary market requirements for liquidity. Illiquid loans will reduce your ability to manage your portfolio as flexibly as you manage your securities portfolio. You should preserve the option of secondary market sales for liquidity and as part of managing your balance sheet holdings.

Management- Not all good credit loans make good loan investments. Most financial institutions have difficulty approaching their loan portfolios as an investment and the lending process as investing. Loans are perceived as long-term assets and are typically originated to “hold to maturity” with little thought as to liquidity and price volatility. Whether a loan is a good investment or not is often measured purely on creditworthiness. When investment risk is not adequately addressed, the result can be anemic returns, an underutilized asset, and a “ball and chain” in times of needed liquidity. The answer lies in managing your loan portfolio with the same level of diligence that you apply to your securities portfolio. A successful loan growth strategy must address competitive forces in the marketplace as well as enable the bank to manage the loan portfolio through effective loan investment analysis and efficient use of the secondary market.

Balance

Monitor your originations carefully, stay focused on your overall growth plan and dispose of, through loan sales, those loans not meeting your balance sheet objectives. The key is selling loans that are not suitable for the balance sheet, holding suitable loans, and buying product types you cannot originate in your market or to add diversity. Subject your loan portfolio to the very same economic analyses you apply to your securities portfolio.

As you evaluate your loan growth strategies, balance is the key. Striking a balance between the need for net interest margin and good loan investments requires vigilance. Vigilance will allow you to transform the loan portfolio into a managed asset. Set the guidelines and monitor them periodically, just as you do with your securities portfolio. Then you will be able to implement a loan growth strategy that enhances loan investment yields, reduces exposure to credit and interest rate risk, and offers future flexibility.

D.L. Auxier, a CPA, is an Asset Strategy Manager at First Tennessee Capital Assets Corporation, a wholly owned subsidiary of First Tennessee National Bank. Auxier can be reached at (901) 435-7917 or dl.auxier@ftcm.com.


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