Article : How to Choose a Bank

By David W. Kellogg, Fall 2015

How should a business choose a bank that will best support their business goals?

I have a unique perspective, having been both a commercial banker for over 15 years, and more recently representing privately-owned companies for over fifteen years. Choosing the right source for your debt capital as well as other financial services is a critically important decision for any business. Here are my guidelines that I use when advising my clients:

  1. Bank Size: The size of your bank matters, but there is no simple answer to the "best size bank" question. If a company has large borrowing needs, they certainly want to be sure that their bank has plenty of capacity to handle their current needs, as well as some room for growth. A company should not be one of the largest borrowers at a bank. If that is the case, then the borrower will be under extra scrutiny if the borrower has some financial performance problems. The larger banks can also be somewhat more bureaucratic and rigid from a policy standpoint than the smaller community banks. However, the large banks can often provide very competitive loan pricing, and their monitoring is often quite "hands off" for smaller credit relationships.
  2. Institutional Capacity: The bank that a borrower chooses to be their primary bank must have the institutional capacity to provide the capital and services that are required. In addition to providing loans, what other services are needed? Cash management, international services, local branches, investment management, etc.? Larger banks tend to be able to provide a broader range of services, but some small banks can also compete with the larger banks on more exotic services. There is also the option of obtaining some services from a secondary bank (international cash management, for example). However, if a company can have all of their banking services with one bank, there could be some pricing benefit, as well as streamlining of processes.
  3. Credit Culture: This factor can be the most difficult to evaluate, but can also be the most important one over the course of a banking relationship. At different points in the economic cycle, all banks shift their credit appetite and tolerance for risk. An extreme example is from late 2008 through 2009. At this time, all banks were more conservative than in "normal times" due to extreme economic uncertainty. However, some banks cut back almost entirely on new loan activity, while others were still in the market (though more selective, of course). What I have found is that banks who are most aggressive during the boom times, are forced to cut back more aggressively when the economy weakens. Also, banks that have the strongest capital structures and better credit quality loans in their portfolio are best able to ride through the down-turns without tightening up drastically on credit terms. In sum, I like to do business with banks that provide loans to credit-worthy borrowers through both the good times and the bad times. A related factor is a bank's experience and comfort level with specific industries. For some borrowers that are in unique industries, it may be especially important for their bank to be supportive of and knowledgeable about their industry. This can allow a lender to not be surprised (and over-react) when certain events occur that are unique to the borrower's industry.
  4. Bank tolerance for negative events or borrower performance: What happens if a borrower has financial problems? All borrowers want a bank that will stick with them when they are under financial pressure and they need support the most. From a bank's perspective, they of course need to protect their interests when a borrower's credit profile deteriorates. I have found that some banks are much better than others at not over-reacting to negative events, but instead looking at the overall risk profile and risk of loss. Often, the most important factor in determining how a bank will react to negative news is the quality of the historic communication and trust between the borrower and lender. If the borrower has been quite open with their lender with both the good and bad aspects of their business over time, then the lender will better support them in difficult times. In addition, there are some bankers who do a better job of expressing concern to their borrowers when there are some negative trends in the borrower's performance. Everyone knows that a borrower should try not to "surprise their banker", but the banker should also not "surprise the borrower" with an over-reaction to negative performance. Open communication is critical.
  5. Personal Chemistry: As important as the institutional fit between borrower and lender is, it's also important that there be good personal chemistry between the individuals involved. For a banker to fully support a borrower, even when the borrower is experiencing some challenges, there needs to be a trusting and supportive relationship between the borrower and the primary relationship manager at the bank. Ideally, there is also some relationship between members of bank senior management and the borrower. This can very helpful if the bank relationship manager needs approval from their senior management on any exceptional items.
  6. Loan Pricing: This is often the factor that a borrower will focus on the most when it comes to evaluating different loan options. While getting a highly competitive rate/fee combination is certainly important for any borrower, I did not put this at the top of my list for a good reason. Banking is a highly competitive industry, especially during relatively good economic times, such as we are in now. As a result, it's relatively easy to ensure that a borrower is getting a competitive rate by getting term sheets from a few different banks. There are times, however, where I will advise a borrower/client to take a financing offer that may have slightly higher rate/fee terms as compared to another bank. This can be advisable depending on the other factors noted elsewhere in this article. I am wary of taking a financing offer where the pricing seems "too good to be true", as I might be concerned that the bank will not work with the borrower in difficult times. The bank must make an adequate return on their loan in order to justify their risk on the transaction.
  7. Loan Structure terms, such as:
    • Term of loan
    • Amortization rate
    • Rate lock options
    • Pre-payment penalties
    • Financial performance covenants
    • Guarantees
    • Collateral requirements
    • Performance and collateral monitoring
    • Loan advance rates
    There are numerous other structure issues that can be important to the deal, but at least these points should be specified in the Term Sheet provided by each bank. The exact definition of certain financial covenant terms should also get particular attention. For certain kinds of borrowers, these definitions should be modified to take into account unique capital structures, seasonality, etc.

Final Thoughts

When representing borrowers as they seek debt capital, I've found that the best approach is to select a small group (3-4) of potential lenders. This will of course include the incumbent bank, who should be in the best position to service their existing customer. A complete package of financial and other information will be presented to all of the lenders, along with a specific financing request. Meetings are held with all lenders so that they can best understand the borrower's company, industry and financing needs going forward. After Term Sheets are received from all lenders, one or more lenders are chosen to negotiate final terms with. I do not find that it is productive to turn the process into an "auction" in order to squeeze the absolute lowest pricing out of the banks. Instead, a borrower should make a decision based upon an evaluation of all of the factors discussed here. In this way, a financing transaction should be profitable for both the borrower and the lender.

© Copyright David W. Kellogg 2015. All rights reserved.


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