As banks increase commercial lending efforts in an effort to maintain spreads during an ultra-low interest rate environment, maintaining strong underwriting standards will be increasingly crucial to both scaling up their lending efforts and stanching potential losses when the inevitable market correction happens.

That’s what drove David O’Connell, a senior analyst at Aite Group, to pen a recent report, “Commercial Lending: Why It’s Broken, How To Fix It.”

It’s broken, in a nutshell, because the present commercial underwriting process is rife with productivity losses that essentially hinder scale. O’Connell gives the example of a $10-million, asset-based loan given to a chain of lumberyards. As many as a dozen people or more might look at the deal and have some hand in writing, rewriting, editing and approving the loan. They’ll have a tremendous amount of data to consider, from historic cash flow to projected cash flow to ratings agency data. Underwriting a commercial loan effectively means a bank is in the publication business.

“The problem is, they don’t know it; they don’t have very good project management capabilities in place because they don’t realize that they’re in a production environment,” O’Connell said. “Because they don’t treat themselves as being in a production environment, lots of things can go wrong.”

It essentially comes down to managing all those data points, and investing in an automated solution should ensure that anybody who has a hand in the deal is viewing the most current version of the loan document, O’Connell said.

“Because the underwriter and relationship manager are spending so much time on these mundane issues, they have less time to look at deal structuring and credit analysis and they will probably come up with a less terrific deal structure,” he said.

That can pose problems further down the road, as interest rates start to rise. Whenever that may be, some borrowers will be able to service their debt just fine, some may hit a few bumps in the road and still others may be unable to service their debt at all.

“In the absence of automation, banks will be less able to discern among those three types of borrower, which means that banks will make mistakes,” he said. “The automation enables them to spend more time on credit risk and less time on the gunk of process. You have too many smart people in credit and underwriting doing things other than credit analysis and underwriting and deal structuring.”

Manual Vs. Automatic?

While community bankers say they are familiar with the type of cloud-based automation systems O’Connell discussed, they often say their operations, though scaled up in recent years, are still small enough to manage without investing in additional software.

“It’s common in larger companies where you’ve got a lot of hands touching the same deal,” said Robert M. Mahoney, president and CEO of Belmont Savings Bank. “They’re very departmentalized. One person works on the appraisal. You have another person doing the financial spreads, you have another person do the analysis. … Here, one person touches the deal, so there’s no need to have access to more than that one person. I think bigger companies would need that.”

But even automated solutions require some time and financial commitment to get it right.

“If you’re talking about releasing capacity by bringing on that software, a key thing I’ve learned in the past is, sometimes banks will not spend enough time researching a software or a service and not really understand what it is they’re signing up for and not provide enough support on the project management side,” said Neil Berdiev, of DNB Advisory.

Many bankers would rather invest in more seasoned lenders or experienced credit analysts.

“I think one of the challenges the whole industry faces is that, maybe up until the last few years where I think more people have come into the industry, most of the seasoned lenders are older. There’s a lack of experienced and trained credit analysts,” said Mike McAuliffe, chief commercial banking officer at Middlesex Savings Bank. “Especially when you get into a period where loan activity is very strong, you need to make decisions relatively quickly in a lot of cases, which means just having the horsepower to analyze a potential opportunity.”

And as cranes continue to rise above the Boston skyline, those underwriting standards will be more important than ever when the inevitable market correction comes due.

“When banks get in trouble is when they let their predictions get carried away and they assume that trees grow to the sky and that 5 percent annual increases in rent will become 5 percent annual increases with no adjustments,” Mahoney said. “I think some of that’s happening. I don’t think it’s flagrant or crazy, but we don’t think anything’s crazy until we look at it two years later.”