What is the chief executive officer's role in helping an institution achieve profitability? Part of the answer is obvious: Have the right people in place and support a strong, independent loan review function.

Unfortunately, it takes more than that. The right people can go wrong in a destructive credit culture.

CEOs must insert themselves in the process to ensure that the appropriate culture is developing. Their involvement in the commercial loan process is a function of their organization's size, their priorities, and the demands on their time. Nevertheless, there are seven key areas that CEOs ignore only at great peril:

|How We Do Business'

* Credit culture. The CEO is responsible for the vision and values of an organization, and these ultimately drive the credit culture. The credit culture is a system of beliefs, styles, expression, and philosophy, or "how we do business around here." It is the glue that holds together the commercial loan process.

To influence the culture, CEOs should have a broad vision of the portfolio and agree with the portfolio philosophy developed by commercial loan management. CEOs should focus on target markets, diversification, profit and credit models, and the types of desired relationships.

Developing a broad vision and agreeing with the portfolio philosophy is not time consuming for CEOs. The issue is whether they really mean it.


* Concentrations. A small unit with high concentrations may seem innocuous when one looks at the overall organization. Yet, it can produce extremely unpleasant surprises. High concentrations often signal laziness, for they are the quickest and easiest means of producing volume.

Concentration limits are usually the most controversial element of a portfolio philosophy, and they need the CEO's total support. The best strategy for producing earnings consistency in a commercial loan portfolio, and when in doubt, diversify some more.

* Watch list. Today's nonperforming assets and charge-offs were predictable from the watch list of prior years. Therefore, CEOs should attend watch list meetings, occasionally if the portfolio is in good shape and frequently if it is not.

The meetings provide a good feel for reserve adequacy, the potential for surprise, and the general state of loan administration. They are also an excellent from which CEOs can expand on their vision and enhance the credit culture.

An Eye on Credit

* Approval process. CEOs should not participate in every or any loan approval processes, but they must agree with the system.

At a minimum, they should ensure that responsibility for every credit is clearly fixed on a designated individual who is clearly recommending approval; that every credit is analyzed consistently; and, when possible, that objective standards such as interest or debt service coverage ratios are used as initial screens or to help confirm risk-ratings.

CEOs should not make loans themselves. If they insist on running their own loan portfolios, they should not commit without discussions with their lending staffs.

The line refers to these as "corner office loans" and waits for the CEO to stumble. CEOs are rarely the beneficiaries of frank discussion and the market intelligence that is part of the line lending process.

Rewards System

* Recognition. Recognition is a greatly underused tool for reinforcing positive behavior. It costs little or nothing but works wonders in building a credit culture. It does require a little effort to search out people doing things right and then recognize them.

Promotions should be considered carefully, for they are powerful signals to the rest of the line on how to get ahead. Put simply, people who enhance the credit culture should be promoted, and those who don't shouldn't Promotions are tangible proof of whether CEOs mean what they say. They are watched very closely.

Incentives are also powerful tools in building or destroying a credit culture. They should be totally consistent with the portfolio philosophy, or they should be scrapped.

All incentive models should contain a credit model heavily weighted to watch-list control. CEOs should approve any incentive plan before it is initiated.

The Communications Business

* Signals. Despite the isolation into which some CEOs have retreated, they are constantly emitting signals that are interpreted by their organizations.

These signals may be more important than the CEO's carefully worded written and oral communications, for they let people know if the CEO really means what he -- or she -- is saying.

A good barometer of how well a CEO communicates is how well he receives bad news. A CEO well may have an "open door" communications policy, but then shoot the messenger who announces a surprise. The CEO may even say the right things, but his body language suggests an execution in preparation.

Receiving bad news is a time for CEOs to listen. If CEOs inappropriately handle what other individuals are saying, they will shut off critical information and guarantee worse surprises in the future. CEOs should ask people to communicate with them.

For example, they should have commercial loan managers discuss with them the state of the portfolio and the people who run it.

CEOs should give managers an opportunity to prepare so that they hear what managers think and not what managers think CEOs want to hear.

* Growth. Historically, rapid growth has been an excellent predictor of credit problems. Many failed bankers believed that they were smarter than the competition or that the competition was stupid. In an over-banked environment, it is difficult to be significantly smarter than everyone else.

There are ways to increase income other than through volume; these include reduced provision and noninterest expense, better pricing, and noninterest income. Watch the volume numbers in the budget, particularly in a recession.

Also watch the signals sent at budget time. Lenders can always produce volume, regardless of market conditions, but CEOs may regret it later. Growth cannot compound itself at a constant rate in perpetuity. Economic cycles are great equalizers.

Leading the Way

In summary, the leadership of CEOs must impart a high level of energy. CEOs must change attitudes and create commitment. They must take people to where they have never been and create for them an environment in which they can reach their potential.

People will excel and sacrifice for such a vision. Leadership will make all the difference in fulfilling that vision.

Mr. Morsman is an executive vice president at Norwest Bank Minnesota. This article is based on a chapter in his book, "Commercial Loan Portfolio Management," published by Robert Morris Associates.

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