More than one strategy can lead to successful business-loan portfolios, lenders of several institutions and a banking regulator told attendees at the Federal Reserve Bank of Chicago's 41st Annual Bank Structure and Competition Conference. Among the panelists represented in this article are Jeff Plagge, president and CEO, First National Bank of Waverly, Iowa; Michael D. Sharkey, president of LaSalle Business Credit, LLC, Chicago (a subsidiary of ABN AMRO NV); Tom Okel, head of debt capital markets for Banc of America Securities; and John Bovenzi, FDIC chief operating officer.

Lenders employ different but equally effective strategies to control risk and build their business-lending portfolios. Factors in creating the strategy may include size of the institution, culture, expertise, and demographics of the markets they serve.

The First National Bank of Waverly, Iowa ($150 million), has found that relationship lending helps keep risk in check while also helping the bank compete with much larger banks and nonbank lenders, said Jeff Plagge, president and CEO. One of three privately held banks in Waverly (there are also two credit unions), First National has a $100 million loan portfolio, including $35 million in small business/commercial and manufacturing, $35 million in agricultural, and $30 million in consumer and residential real estate.

The bank has a $2 million lending limit. That figure increases to $2.7 million when combined with First National's sister bank, First National Bank of Cedar Falls. The First National Bank of Waverly maintains an 80% loan-to-deposit ratio.

To finance business start-ups or expansions, First National relies largely on the Small Business Administration (SBA) and the U.S. Department of Agriculture's Farm Service Agency guarantees, which limit the bank's risk to the nonguaranteed portion. These loans couldn't be sold in the secondary market without the guarantees, Plagge added.

Many of the bank's customers operate businesses that have been in the family for generations. First National has financed many of these companies since their inception. The bank conducts much of the business at the owner's site and plays a dual role as a financial advisor until companies get large enough to hire outside accounting assistance or internal chief financial officers.

"We really know the customers, and, in most cases, we know their families," Plagge said. "All of the relationships are one-on-one. These businesses are local, and we can see what is going on with them and talk to our customers. Although we risk-rate the credits, we don't credit-score for decisions."

That's not to say the bank doesn't use technology in its relationship lending, but the analysis information also is provided to the customers so that they can use the information to aid their own businesses. The bank helps retail, commercial, and manufacturing customers with year-end summaries of their results based on the analysis that the bank provides.

However, relationship lending has its own risks, Plagge explained. "Lenders may potentially lose some of their objectivity over time due to the close relationships that are formed. Customers can become very reliant on the lender for business and advice and not seek additional opinions from other third parties."

Additionally, the bank sometimes doesn't have enough timely or comprehensive information from customers regarding marketing, business, and long-term plans--all of which are important for the company's long-term health and for the bank's early recognition of any trouble signs.

Another risk in working with these types of businesses is that the owners try to do everything themselves and can easily burn out on the "office" side of the business, another important factor in the long-term success of the company and in its relationship with the bank.

"Community bank lending operations continue to change due to regulatory pressures to provide more analysis, risk assessments, and documentation," said Plagge, who also pointed to the need for an ongoing effort to remind loan officers of good credit quality as they work to get new loans and keep the existing ones.

Middle-Market Differences

Middle-market companies can rely more on asset-based lending, said LaSalle Bank's Michael D. Sharkey. (1) Nonbank lenders dominated asset-based lending until 1980, when more banks, leveraged buyout firms, and others entered the market. Asset-based lending began to gain acceptance among upper-tier, middle-market borrowers in 2000.

Asset-based lending uses collateral as the primary source of repayment, Sharkey said. This type of lending includes too much risk for some banks due to high leverage or refinancing of balance sheet assets. LaSalle Business Credit takes a security interest in the customer's collateral and lends on a formula basis. LaSalle regularly monitors the collateral to ensure that it stays within the guidelines of the formula.

LaSalle controls risk in what can be a tricky lending market through a combination of in-house auditors, daily collateral monitoring, documentation, asset appraisals, and monthly financial reporting, Sharkey said.

During a recent RMA audioconference, two business-banking executives discussed how credit scoring has evolved at their institutions--Hibernia and AmSouth Bank--and the efficiencies it has created. John O'Connor, commercial practice manager, Benchmark Consulting International, moderated the discussion. What follows is a summary of their remarks.

Fewer people are involved in the loan origination and approval process today, thanks to efficiencies resulting from credit scoring. Over the past 10 years, many institutions began using an automated, score-only process to decide loan requests under $25,000. That number has been creeping higher as institutions gain confidence in the ability of credit scores to predict success in the loan portfolio.

How Scoring Evolved at Hibernia

Hibernia, a $22 billion institution operating in Louisiana and Texas, began using a judgmental scorecard by Fair Isaac to process small business loans in 1993. At the time Hibernia had 1,500 accounts in its $150 million small-business portfolio. Danny Hebert, senior vice president and manager of Hibernia's business banking center, said his institution was one of 17 banks that participated in the development of Fair Isaac's first pooled scorecard, which Hibernia began using in 1995.

In 1997, when it had 10,000 accounts in a $1 billion portfolio, the bank was using the scorecards to make small-business credit decisions on loans up to $50,000 without requiring financial statements.

In 2003, Hibernia introduced its own custom score. It currently has a $3 billion portfolio and 50,000 accounts.

Factors for Success

Hebert attributes Hibernia's successful credit-scoring program to these factors:

* Dedicated resources for scorecard management, including reporting and analytics on scorecard performance, especially overrides, and performance by score bands as well as scorecard modeling and validation.

* Vigilance in catching input errors and performing ongoing audits for that purpose.

* Clean data capture and coding.

* Understanding and buy-in of credit scoring by the sales force and central-lending units, especially management.

How Scoring Evolved at AmSouth

AmSouth Bank, a $50 billion regional bank in the Southeast, began credit scoring in 1995 with a FICO pooled card. Two years later it began using only credit scores to decide loans up to $35,000. When it introduced its custom scorecard last year, AmSouth increased its score-only threshold to $100,000 for certain product lines.

"Data verification and validation are a highly critical aspect of this process," said George F. Buchanan, senior vice president and business-banking senior credit officer, AmSouth Bank. "We have a dedicated resource team that analyzes the ongoing credit quality and the makeup of all the score components. Much of our data entry on loan applications is handled remotely, so we have a quality-control team that reviews the applications to ensure that all the data is entered correctly. This review is very important for validation. It is necessary to have good quality data on the front-end."

Hibernia was using a centralized system to input applications at the time of the audioconference, but Hebert said it would move to remote input of application data in the second quarter. "A lot of banks are now pushing this function out to the sales force, essentially eliminating data reentry," said Hebert. "At Hibernia we're now scoring all applications up to $250,000. In our small-business portfolio, loans under $250,000 represent approximately 80% of the loans."

Of the many efficiencies resulting from Hibernia's highly automated process, Hebert said the most important is that fewer people are involved in the origination and approval process for 80% of its loans.

The Decision Process

"Driving some of our efficiencies and success on the origination side is how we stratify our decision processes," Hebert explained. "We have several dedicated underwriting units based on the dollar size of the credits under consideration and the amount of due diligence required. We have one underwriting segment that is dedicated to credit decisions up to $50,000 based purely on scores. We use a second underwriting group that decisions credits from $50,000 to $250,000. That decision process involves a credit score and one year of financial statements and tax returns on borrowers and guarantors. It's still a very quick process, still very score dependent, but there are some overlays.

"For loan decisions over $250,000, we use more traditional underwriting techniques and have two underwriting groups. One group considers credits from $250,000 up to $500,000. For those, we use a very simple, almost checklist-type underwriting. From $500,000 on up to our limit of $5 million, we use a more traditional, but streamlined, analysis."

Buchanan said AmSouth has two groups in its underwriting center. "We have an objective underwriting team for the first tier, score-only / score-plus process. This group also handles some of our score-plus applications, looking at a few other elements in addition to the scores. Our subjective underwriting team is much more traditional. Like Hibernia, it has a graduated process for evaluation. For transactions between $100,000 and $250,000, it's very streamlined but escalates in complexity as the loan amount requested increases."

The ITS Peer-to-Peer Program provides free technical assistance to agencies seeking to improve transportation operations through the deployment of intelligent transportation systems (ITS). This program is designed to complement and expand the technical assistance available from the staffs of the Federal Highway Administration (FHWA), Federal Transit Administration (FTA), and Federal Motor Carrier Safety Administration (FMCSA). Any public agency that is involved in the deployment of integrated ITS technologies is eligible to receive assistance through the program.

The tenets of the Peer-to-Peer Program are to be effective, responsive, confidential, and free of charge. The effectiveness of the program stems from the knowledge and experience of more than 130 ITS experts who participate as peers and provide deployment advice. The program is responsive to satisfy time constraints identified by the client, and the majority of requests are satisfied in 30 days or less. The program is confidential for the requesting agencies, allowing them to make strategic decisions quietly without prematurely engaging the consultant community. This assistance is provided free on request to enable agencies with limited resources to participate. These characteristics of the Peer-to-Peer Program make it an attractive resource for short-term assistance needs.

The program is not new. Because of its strong focus on satisfying the needs of its clients, the program has enjoyed favorable response and participation for nearly four years.

The program enables an agency to tap into the expanding knowledge base on ITS. Deployment of ITS throughout the nation is vast and is constantly advancing, and the Peer-to-Peer Program makes it easier for an agency to find the specific ITS information that it needs. This saves the agency time and money, enabling the agency to focus more of its resources on ITS deployment.

When a request for assistance is received, program representatives assess the request and determine the appropriate support -- providing relevant reports and other material, over-the-phone advice, or a site visit. The technical capabilities of FHWA, FTA, and FMCSA are tapped as the first resource to satisfy the client's needs.

The scope of the technical expertise available through the Peer-to-Peer Program cuts across two dimensions of ITS deployment. First, the program offers technical assistance across the ITS infrastructure program areas -- metropolitan, rural and statewide, and commercial vehicle operations -- and the overarching areas of the National ITS Architecture and the National ITS Standards. Second, the program expertise covers the entire life cycle of ITS development, encompassing problems and opportunities identification, existing system assessment, concept of operations/information requirements development, system design, system testing and validation, system implementation, and system evaluation and maintenance. The ability to furnish technical assistance in all stages of ITS deployment makes the program useful to any agency -- whatever its level of ITS deployment maturity.

The program's peer experts have provided assistance on a range of issues regarding ITS deployment and the maximization of the clients' return on their ITS investments. Some representative topic areas encountered in the program are:

* Planning and Programming/Procurement.

* Operations and Maintenance.

* Resource Materials Location.

* Partnerships/Cost-Sharing Issues.

* Education/Training/Facilitation.

* Awareness/Outreach.

* Design and Installation Specifications.

* Modeling and Simulation.

* Information Technology (Hardware and Software) and Telecommunications.

Clients include the offices of FHWA, FTA, and FMCSA; the headquarters and district offices of state departments of transportation; transit authorities; turnpike and tollway authorities; metropolitan planning organizations; city and county transportation and public works offices; and transportation management agencies.

The majority of the more than 130 ITS professional peers who lend their expertise to the Peer-to-Peer Program represent public agencies that have had experience in ITS deployment. The peers from the public sector are of great value to the program. They demonstrate to clients that ITS can be successfully deployed, giving clients a measure of confidence. Public sector peers also promote the technical assistance resources available through FHWA, FTA, and FMCSA when they describe their experiences.

Only a small portion of the program's peers come from the private sector; nevertheless, private sector peers are particularly helpful in the newer technical areas for which public support is not yet available.

New peers are being added continuously to the program through nomination or self-nomination, introducing additional expertise to the collection of available knowledge.

The program's success is evidenced by the growing number of requests for assistance. Approximately 420 requests have been received and processed since the program's inception in June 1996. The number of requests has increased at a rate of nearly 5 percent per year.

Statistical evaluation of the dose--response function in lead epidemiology is rarely attempted. Economic evaluation of health benefits of lead reduction usually assumes a linear dose-response function, regardless of the outcome measure used. We reanalyzed a previously published study, an international pooled data set combining data from seven prospective lead studies examining contemporaneous blood lead effect on IQ (intelligence quotient) of 7-year-old children (n = 1,333). We constructed alternative linear multiple regression models with linear blood lead terms (linear-linear dose response) and natural-log-transformed blood lead terms (log-linear dose response). We tested the two lead specifications for nonlinearity in the models, compared the two lead specifications for significantly better fit to the data, and examined the effects of possible residual confounding on the functional form of the dose-response relationship. We found that a log-linear lead-IQ relationship was a significantly better fit than was a linear-linear relationship for IQ (p = 0.009), with little evidence of residual confounding of included model variables, We substituted the log-linear lead-IQ effect in a previously published health benefits model and found that the economic savings due to U.S. population lead decrease between 1976 and 1999 (from 17.1 [micro]g/dL to 2.0 [micro]g/dL) was 2.2 times ($319 billion) that calculated using a linear-linear dose-response function ($149 billion). The Centers for Disease Control and Prevention action limit of 10 [micro]g/dL for children fails to protect against most damage and economic cost attributable to lead exposure. Key words: child IQ, dose response, health benefit, health policy, lead.

Few researchers doubt that lead exposure has significant health consequences at levels below those considered medically acceptable just decades ago, although there is still debate over what levels of lead exposure, if any, can be considered harmless. Key to this debate is determining the form of the dose-response function describing how the amount of exposure is related to the magnitude of the health effect.

There are two basic forms of the dose-response function for lead: a simple linear model, in which the increase in health effect is a linear function of increasing blood lead concentration (BPb), and a nonlinear model, in which the amount of health effect change attributable to lead changes according the region of the dose-response curve studied. A special case of the nonlinear dose-response function is a threshold model in which the response to lead decreases as a function of decreasing dose until it reaches a lead dose below which there is no further detectable change in health. An alternative threshold model is one in which the response to lead changes as a function of increasing dose until an upper lead bound is reached, at which point the increase in health damage exceeds predictions, as in cases of high doses producing organ damage.

Although epidemiologists have become increasingly sophisticated in construction and diagnosis of models describing their data, as a whole, we generally pay much less attention to systematically and rigorously addressing the specification of the dose-response function. A number of public health issues depend on adequately specifying the form of the dose-response function for lead, chief among them regulatory action.

Cost-benefit analyses should form the backbone of regulatory decisions regarding permissible exposures or background concentrations of toxic substances in both population and occupational settings. In such an ideal world, the savings in health care, disability, and productivity gain realized from reducing exposure to a particular substance are compared to the cost required to achieve that reduction in exposure. Policy analysts seek the "sweet spot," where the marginal costs of lead reduction equal the marginal benefits (i.e., where the slopes of the cost function and benefits function are equal) (Pacala et al. 2003). Even if in the real world less easily quantifiable factors affect regulatory decisions, all parties to regulation have some notion of costs and benefits in mind when presenting their cases to regulatory agencies.

One recent publication (Grosse et al. 2002) presented data on the economic benefits of nationwide lead reduction due to childhood IQ (intelligence quotient) loss attributable to lead over the last 25 years. These authors conservatively used a linear dose-response function of lead-IQ as part of their model, stating that there was insufficient evidence to determine the shape of the dose-response function. The economic savings predicted by their model were in the range of hundreds of billions of dollars over the lifetime of a yearly birth cohort.

The lead-health dose-response function selected for the benefits model has clear implications for policy decisions based on it. A threshold model suggests that once reductions of population level of lead reach the threshold, further lowering of lead would have no beneficial health or economic consequences. The current Centers for Disease Control and Prevention (CDC) action limit of > 10 [micro]g/dL for children (CDC 1991) would be justifiable on health grounds alone if there were a threshold somewhere near that limit. A linear model suggests that equal reduction in population BPb is accompanied by equal reduction in health consequence from any starting level of lead. Under a linear dose-response model, even though the health benefit would continue to increase with further population lead reduction, the present CDC action limit might be justifiable on economic grounds if the cost of further population BPb reduction far exceeded the recoverable economic benefits. A nonlinear model, especially one in which health benefits are greater for lead reduction nearer the population's zero lead point than farther from it, would argue for further reduction in population lead levels and CDC action limits if the accelerated health benefit at lower lead levels exceeded the increased costs of lead reduction to those levels.