Almost every bank we talk to complains about the level of competition in their market. The most common statement we hear is “Banking is more competitive in this city than anywhere else in the country.” While many bankers lament about pricing and structure, few banks take the necessary steps to overcome this market challenge. One way to combat these market pressures is to conduct product positioning strategies. Product positioning strategy involves identifying your target customer base, assessing the most important features for those customers, selecting a product that delivers those features, and finally effectively differentiating your product from your competitors’ products. In this article, we explore how to pull this off and look at a case study of one bank that did.
Separating Your Products
When banks position a product or service, it is paramount to decide if the product they create and deliver creates a sustainable competitive advantage versus the competition and if their employees can effectively position and communicate that competitive advantage. Products that have a sustainable advantage, or some unique offering that competitors cannot match, still often fail unless the front line can properly describe that advantage over the competition. Especially in commercial banking, where products are complicated and nuanced, the positioning and description becomes important and becomes an integral part of the product.
Rather than discussing product positioning strategies in a vacuum, we will highlight how this process works with a case study. One of the banks we partner with is FNB. FNB’s asset size is $540mm, and it is a commercial bank on the East Coast which opened 12 years ago.
Assessing target customers
FNB’s management team concluded that its best customers are local investors and business owners that primarily require financing for capital-intensive or real estate centered deals. The target customer base for FNB is certainly not unique for community banks across much of the market and here are excerpts from their written sales plan that has the bank focusing on the following customers:
Larger OOCRE and NOOCRE: Owner occupied commercial real estate and non-owner occupied real estate is preferred because of the high overhead cost of delivering the bank’s services. FNB would not be profitable originating smaller sized loans and, therefore, loans above $1mm will be prioritized.
Credit Positioning: FNB will focus on higher credit quality because of the long-term sustainability of the bank’s capital and ultimately higher return on assets (ROA). This is not as simple or forgone target market for many banks because the decision carries with it the downside risk of lower yield and NIM. FNB will be sacrificing margin to obtain other important ROA drivers.
Customer Positioning: FNB will focus on a higher level of customer sophistication to allow more value added products and service to be sold to the same customer base. The ability to generate non-interest income from this customer base will also be paramount. More complicated and larger businesses will be favored to allow higher cross-sell opportunities. These types of clients will require more banking solutions. FNB will position three to four products per relationship with a goal of having in excess of a fifteen-year average customer life. A stickier relationship helps increase revenue for the bank and increases the bank’s pricing power.
While FNB’s criteria above are not earth shattering, management truly believed that the above customer focus was a ROA optimizing strategy and then focused on developing products that maximized the above criteria to the exclusion of other, competing criteria.
Identifying Product Features
- Because FNB is focused on long-term relationships and long-term financing opportunities, the bank wants to deliver long-term financing commitments. To accommodate longer term financing, credit quality must be high – and that is a good fit for FNB’s strategy.
- Since FNB is focusing on business finance, flexibility in variable versus fixed rate options must be available, especially in the current interest rate environment.
- FNB understands that non-recourse loan requests will be a competitive advantage. FNB will entertain non-guaranteed loans when LTV levels and other covenants offset the credit risks.
- FNB also decided that because future financing needs are unpredictable for its clients, its loan products should also accommodate an accordion features, multiple drawdowns and forward rate locks. This allows borrowers to set up financing for future needs but all subject to borrower covenants and future bank underwriting and approval.
- FNB’s clients are business owners and investors. This client base has unpredictable financing needs. Loans are frequently restructured, 1031s are common, borrower entities change, and further advances on existing liens are common. The bank wanted to allow that type of flexibility for its commercial loan product.
Selecting a product that delivers
Let us now consider the specific borrower details in this case study. FNB’s lender identified a $2.9mm loan opportunity. The loan is a refinance of an existing credit with a national bank that has less than two years to maturity. The collateral is a 14-unit commercial property, appraised at $5.9mm. The borrower is an LLC owned by three local business owners who jointly own seven other properties in the city and have their own professional practices (two doctors and a lawyer). The sponsors were not happy with service at the national bank and were not fond of the “rotating door” of lenders. Further, the sponsors wanted to refinance $2.9mm at inception with an opportunity to draw an additional $1.1mm (cash out) at any time over the 18 months for future CRE purchases to be identified.
The sponsors had also expressed a desire for a non-recourse loan and did not want to pay a closing fee or pay for the appraisal. The national bank was made aware of the sponsors’ negotiation with FNB and offered a loan extension for ten years, at a fixed rate equivalent of LIBOR plus 2.00%. The sponsors then wanted FNB to match terms or to provide the longest possible fixed rate. Weeks before the anticipated loan closing, two other community banks delivered term sheets showing five-year fixed rates at 3.75% and at 4.10%. It would appear on the surface that FNB cannot make a deal work because of competitive pressures. The requested loan seems, on the surface, complicated, unprofitable and not a bankable transaction - yet another example of competition making banking unprofitable for every lender.
However, because FNB conducted a product positioning strategy, and because the borrower is FNB’s target customer, FNB created loan product features that are almost perfectly aligned with its customer base. FNB won the loan and obtained a profitable relationship.
FNB was able to deliver the following loan to win the business:
- A term loan priced at the equivalent of LIBOR + 2.40% (note that the pricing is higher than the national bank’s by 40bps).
- The borrower has an option to fix the rate for up to 15 years to match the tenor of the leases on the collateral.
- The loan advances an initial amount of $2.9mm and then has an accordion feature. The accordion feature allows the borrower to draw an additional $1.1mm within an 18 month period. The entire amount can be fixed or floated at the borrower’s option.
- The bank was able to obtain a 25bps loan origination fee and another 1.3% non-interest income fee through the loan platform. This fee amount was used to offset the $4,500 cost of the appraisal (for which the borrower does not come out of pocket, but effectively pays for over the life of the loan).
- The loan can be assigned or assumed. The borrower may transfer the loan through the 15-year life to another piece of collateral, a 1031 exchange, or via a sale to another borrower as long as FNB can underwrite the new collateral or the new borrower on the same collateral.
- FNB is in a position to earn additional fees if the borrower avails itself of the assignment or assumption feature.
- FNB effectively locks the clients for 15 years to be able to cross-sell additional services and vie for the sponsors’ personal banking business.
Differentiating your product
How did FNB present the product to the customer and how did its lender differentiate the features against the national bank and the two community banks? FNB presented the below quote sheet to the borrower allowing the borrower to choose a variable rate loan at LIBOR + 2.40% or fixing the loan for five, seven ten or even 15 years. The lender explained that the monthly cost to carry the $4mm credit (final loan outstanding) is only $900 more per month on 15 years versus the five years. With interest rates expected to rise, it would not make sense to subject the loan to a contractual reprice in five years. The competing community bank offers were differentiated as inferior given the repricing risk to the borrower.
Further, the national bank could not approve the loan for a 15-year maturity but FNB could. Both competing community banks priced the five-year fixed rate lower than FNB – but the differentiating features of FNB’s proposal were too compelling for the borrower.
The lender went further to differentiate FNB’s product from the two community bank offers of five-year fixed rates at 3.75% and 4.10%. Not only should the borrower lock in rates now for longer term as interest rates are expected to rise, but FNB’s loan was transferable (assignable and assumable) so that in a few years if the sponsors sold the property, they can take the remaining loan balance and term to maturity and apply it to the new collateral – all without changing today’s low rate. Additionally, FNB’s loan rate would remain at today’s attractive rate, while the competing community banks would take every opportunity to reprice their five-year fixed rate loan to market if the borrower wanted to restructure the loan, change sponsorship, add additional money or do a 1031 exchange. The lender indicated that the other community banks were showing a contractual term of five years but would take every opportunity to reprice the loan and remove the borrower’s locked in rate during that five-year period if interest rate rose.
The lender went on to explain how the rate can be locked in today for the additional $1.1mm-advance which the other community banks could not accommodate. FNB’s offer was still 40bps higher than the national bank’s rate, but the borrower never mentioned it and was happy to get away from the revolving door of lenders. FNB also allowed the personal guarantees to toggle on and off. The guarantees would be eliminated if in the future the LTV on this loan based on the value of this property or future acquired property in aggregate fell below 50%. This was not a difficult credit decision for FNB given the general purpose nature of the collateral and perceived stability of real estate values in the city.
The additional $1.1mm draw was a unique offering that was not matched by the national bank or the two competing community banks. But the loan platform utilized by FNB allowed it to price the feature (subject to credit approval and underwriting) and even allowed the borrower to take the additional draw on fixed rate of interest. The lender also differentiated the bank’s willingness to pay for the appraisal and charge only a 25bps origination fee. The FNB earned a 25bps fee amortized over the 15-year term, and a $52k non-interest and non-FAS 91 fee which sweetened the ROA for FNB and allowed the bank to set aside $4.5k to cover the appraisal costs.
Community banks that use effective product positioning strategies can find tremendously profitable and stable loan opportunities in their market. FNB bankers utilized a unique product to go after target customers. Equally important, they not only understood their products but when to apply it to best help the customer. If your bank faces heavy competition, take a page from FNB and customize your products and deliver unique loans to target customers in a knowledgeable way and you won’t have any fear from the competitive forces of banking.
Submitted by Chris Nichols on May 03, 2017