Although they are pretty good at it in Canada, the banking business is not the simple moneymaking machine it may appear to be.
The results are often stellar, but the margin of profit is actually quite narrow on each deal booked. The business is founded on confidence, which explains the cautious approach to lending. We take modest risks over many millions of transactions and typically come out alright.
Life inside the head of a Canadian bank risk manager -- more than a two-letter word.
The Friday just before moving to Prince George to take on my credit risk management job, I had my relatively modest assigned lending limit, as most bankers do. The following Monday morning, upon arrival I was told: "You got a lot smarter over the weekend," as I was handed a letter increasing my new limit substantially. Two or three years later that limit grew further, but as the numbers grew, the lending principles stayed the same.
Mentored by capable colleagues, I was taught to look past the story told by the writer of the loan and go directly to the numbers. The simple dollars and cents never showed as much flair for creativity as a small town loan officer might, and we were usually able to get close to making a decision without reading their prose. We focused on empirical issues addressed by questions like:
1. Does the business's track record suggest that it is likely that they will be able to afford the new loan payments with a comfortable margin of safety?
2. What does the comparison of our risk to the borrower's risk look like? Are they putting enough of their own money in as well?
3. What collateral can we fall back on if something goes wrong?
4. Do they exhibit the characteristics of a reliable owner, manager, and payer of debt?
With hard data as our friend, and a growing expertise in the industries resident in our area, the separation of church and state was nigh unto sacred in our business. That is, risk managers are seasoned lenders who:
Have separate management reporting lines from the sales force, and;
Are not compensated for loan growth.
Two Very Painful Letters:
This not to suggest that saying "no" was the easy answer. On the contrary, "no" usually comes across as "NO!" and must be justified in very careful detail. It is usually argued and second-guessed, and is accompanied by disappointment. If we fail to find a compromise, we risk losing a client and generally unleashing sadness on the earth. On the other hand, "Yes" is a high-five, a happy borrower, perhaps flowers on the desk and a celebration.
On the Other Side Now
There is a certain upsidedownness to living in the other side of the money management business. Still, among the investment evaluation formulae, the principles have broad crossover.
First, with regard to the numbers, when evaluating an investment, we still need to look beyond the hype and consider the things a banker would, such as:
1) Does the investment produce cash flow from a sufficiently proven business to make it likely that my dividend or interest payment will continue for the foreseeable future?
2) Is the company overburdened with debt such that the decision-makers have little to lose by making reckless strategic decisions?
3) Is the investment guaranteed? If so, by whom, and what is the nature of the guarantee?
4) What does the track record look like? Is this an investment you would be comfortable recommending to your grandmother?
Church and State
Whether your style is analysis-by-Google, a deep dive into your favorite investment blogger, or a Face to face meeting with a professional, there is no shortage of financial advice available. As we did as risk managers, you will still need to sort the rhetoric from the data and be careful that your source of advice is sufficiently objective.
To borrow a baseball analogy, don't be too prone to swing for the fence. A team with a solid track record of hitting singles and doubles, and solid defensive core will generally win out over the one with one or two long ball hitters and no consistency. It's a the long season. There will be some disappointment and losses, but stick to your proven system and it will pay over time.
A few well-worn rules to live by. In an efficient market these remain stubbornly true.
- If it sounds too good to be true, it probably is. Boring is good for core investments.
- The higher the promised return, the higher the risk.
- Take some measured risk. Don't expect to get ahead by eliminating every possible anxiety, but no reward is worth ruining your sleep for months on end.
- A genuine trust is crucial when taking advice on any complex matter. Listen to your gut.
And if you don't feel right... you know the two-letter word.
Mark Ryan is an advisor in Prince George with RBC Wealth management,Dominion Securities (member CIPF) and can be reached at [email protected].
