Much has changed in the lending industry since the spread of COVID-19 began. Through it all, First Republic Bank has remained at the forefront of adapting to this new era while continuing to provide extraordinary service to its clients.
In particular, the pandemic has brought sudden changes to the real estate market that have forced agents and brokers — as well as lenders — to adapt quickly to a changing marketplace. Market volatility has affected the lending landscape while social-distancing measures have altered the client experience with everything from appraisals to closings and notarizing documents.
Chief Banking Officer Mike Selfridge was recently interviewed in front of an audience of residential real estate agents about the pandemic, the innovations First Republic has brought to the lending process and how banks are adapting to the new lending environment.
Below are some highlights from his comments:
Do you think the lending industry is better prepared to weather this pandemic crisis than it was in the great financial crisis of 2007–2008?
Mike: Yes, I do believe that the banking industry, as a whole, is far better prepared to endure this crisis than the great financial crisis of 2007–2008. Keep in mind this is a crisis caused by a pandemic, whereas the crisis in 2008 was a financial crisis. Above all, the new regulations enacted after the 2008 financial crisis — namely Dodd-Frank in 2010 — have created a much healthier banking system that is able to endure an economic downturn.
Unlike in 2008, banks today have more capital, more liquidity and stronger credit portfolios. This has led to a safer, sounder financial system going into this crisis. However, many banks have pulled back on lending in certain areas and have become a bit more cautious during the pandemic.
As you said, many banks are tightening lending standards in light of the pandemic. How has First Republic done so as well?
Mike: First, we have been very consistent over the last 35 years, particularly when it comes to lending. We have not dramatically changed our approach to lending over time. While we may adjust occasionally, we remain consistent. In fact, we first became a little more cautious in our underwriting several years ago, well before this pandemic.
At that time, we felt that markets and values were moving up faster than what we thought was a sustainable rate of growth, so we took a more conservative stance to lending in certain areas. For example, with loan-to-value ratios (LTVs), our average LTV for loans originated in 2010 on multifamily properties was 61%. In Q2 of 2020, the average LTV for loans originated in multifamily was 53%.
But, as I mentioned, we had been reducing our LTVs at origination in multifamily loans for some time. We did not reduce them dramatically, just modestly, as we became a bit more cautious about remaining consistent and steady in the market.
How have the effects of the pandemic, especially the need for social-distancing measures, affected First Republic’s mortgage process?
Mike: In general, banks had to adapt to a new market. At First Republic, we accelerated a number of digital initiatives that were already underway in order to serve our clients well and further improve the client experience overall.
For example, if you think of the traditional mortgage process, it is like a supply chain like anything else. In it, the banker meets the client, takes their application, collects documentation and evaluates the credit request. Then a loan is approved on certain conditions, disclosures are sent to the client, and an appraisal is ordered and conducted. Finally, mortgage documents are drawn, signed, notarized, recorded and closed. This “supply chain” involves a number of human interactions that suddenly couldn’t happen during COVID-19.
First Republic was able to adapt quickly. We digitized much of our mortgage process, such as gathering information and safely and securely signing documents. With these measures, we now have the ability to cut the time for client signing down considerably and to facilitate smoother execution.
We feel that these digital initiatives have sparked a lot of creativity that will benefit clients going forward, and I think for the banking industry there will be “digital green shoots” that are lasting and will improve the level of service and execution for the consumer.
You mentioned appraisals. Has that process changed as well?
Mike: As I mentioned, we had to adjust the appraisal process during COVID-19 early on in the pandemic. It was often uncomfortable for clients to have the appraiser physically come into their home to inspect it and provide a valuation. In fact, it was often uncomfortable for our appraisal panel as well. After all, we are all people. It is entirely natural and rational to want to be safe and to take precautions, especially since it is not necessarily a socially distanced situation to have a stranger in your home, going room to room.
In light of that, we’ve leveraged desktop appraising — a process that uses data and analytics — and driving by the home to assess its value. With our conservative lending standards, plus a great appraisal and analytics team, this new process allowed us to limit or eliminate human interactions and continue to lend appropriately. Furthermore, it has become quite an efficiency improvement as well.
How should banks handle low interest rates? After all, these rates are a big part of their revenue.
Mike: Banks should always review their asset/liability exposure — that is prudent banking. In addition, they should always look to manage and mitigate the risk associated with the movement in interest rates. If that is not properly managed, then banks can find themselves exposed to a pricing mismatch of assets and liabilities.
This can lead to a number of other risks, including compression of the bank’s net interest margin (NIM), which is simply a ratio of a bank’s net interest income (such as what a bank earns on assets like loans) minus the cost of the bank’s liabilities (such as what a bank pays on deposits) divided by that bank’s average interest-earning assets. It’s an expression of a bank’s gross margin in many ways.
In a low-rate environment — and today is one of the lowest we’ve seen — managing this interest rate risk is very important. Naturally, this “spread income” that I mentioned is often the majority of a bank’s revenues, and a bank is often dependent upon the steepness of the yield curve. In other words, lending at a higher rate than a bank pays on its deposits is a fundamental source of a bank’s profitability.
However, much also depends upon the composition of a bank’s balance sheet and, above all, ensuring that credit quality is strong.
What do you think has allowed First Republic to thrive in this challenging environment?
Mike: Our commitment to simplicity has always been what sets First Republic up for success and apart from the competition. In this case, by simply implementing the necessary changes to the mortgage process and remaining consistent in our lending standards, we’ve been able to overcome the unique challenges posed by the pandemic. However, most importantly, that same commitment to simplicity has also ensured that we remain laser-focused on our top priority, which is providing our clients with exceptional service.
Mike Selfridge is First Republic Bank’s Senior Executive Vice President and Chief Banking Officer. Over the last 30 years of his career, he has held leadership positions at Silicon Valley Bank, HSBC and Wells Fargo.
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