We have written in the past about the importance of community banks closing loans as quickly as possible after the borrower’s acceptance of pricing and terms. Banks that can close loans with alacrity can earn a higher return on the credit and deliver better customer satisfaction. In today’s environment the following factors are creating incentives for banks to close loans quickly: a) intense competition, b) Federal Reserve raising interest rates, c) a flat yield curve motivating borrowers to favor fixed-rate loans (with more risk to lenders), and d) political uncertainty translating to market volatility. We highlight below the importance of loan closing speed and offer some hints on how banks can increase this speed.
Increase Closing Speed and Reduce Risk
There are a number of ways that community banks can increase the speed at which they close their commercial loans. All of the highlighted recommendations are simple and available to almost all banks and lenders without additional costs or systems, or substantial change in the process.
- Provide the decision makers (borrower, counsel or broker) a written explanation and timeline of the steps to loan closing. Outline the underwriting procedure, and timeline for third-party appraisers and the documentation process. Provide the timeline and range for each of these steps.
- Get the decision makers to sign-off on the timeline. While not a binding contract, get the borrower to acknowledge the timeline and agree to a funding date. The moral suasion of agreeing is almost as important as a binding agreement.
- If you collect a loan origination fee (and most banks do collect some fee), make that fee non-refundable after the agreed upon closing date. The bank may agree to extend the non-refundable date, but having some financial hammer helps speed the closing process.
- Resist agreeing to a fixed rate on a loan in advance of closing. When banks agree to a fixed rate in advance of closing there can be one of four outcomes between the rate setting and closing: 1) rates go up, or 2) rates go down, and then for each of these two outcomes the loan may close or not close (four outcomes in total). The outcomes are summarized in the table below:
The table shows that the bank loses out in almost every outcome (except when rates fall, and borrower takes the loan and only because the borrower is rate insensitive – which is a poor banking strategy and begs the question of why the loan was not priced higher at inception). It is best to set the loan rate tied to an index prevailing on the day of closing because: 1) it maximizes yield and reduces the risk for the bank, and 2) motivates the borrower to close the loan as quickly as possible to eliminate interest rate risk. On the other hand, setting the loan rate in advance gives the borrower an incentive to drag out the closing process.
- It costs the average community bank approximately $14k to book a new commercial loan, but only about $2k to modify or amend an existing commercial loan. The difference between a new credit and an existing credit (all else equal) is 5.1% in ROE. Furthermore, it is much faster to amend a loan than to book a new credit. Commercial loan prepayments are running between 25-35% in the industry. All this points to focusing on amending and extending existing credits because you can close the amendment faster than you can book a new loan and the loan amendment is much more profitable for the bank. Banks should recognize this reality and motivate lenders similarly for amendments as for new loans.
- Successful lenders provide a solution rather than sell a product. Borrowers believe that any bank can provide them a loan, but successful lenders take the time to understand the borrower’s industry, are knowledgeable about the borrower’s specific circumstances and goals, and are solving a specific borrower need. Lenders that provide a solution eliminate the borrower’s temptation to shop the loan and lessen the desire of borrower’s to slow the closing process. Lenders should be aware of each closing if they are providing a tailored solution to that borrower’s need, or simply selling a commoditized loan.
Loans that close faster are much more profitable for community banks and typically result in higher customer satisfaction. While there are many institutional changes that banks can affect to increase loan closing speeds, there are many steps that banks and lenders can take that are almost costless and do not require a corporate change. In today’s very competitive and challenging commercial loan market, the speed of closing is an essential tool for commercial lenders.
Submitted by Chris Nichols on October 11, 2017