While we honor the Irish this St. Patrick’s Day, it is important that banker’s don’t leave loan profitability to luck. Given the talk of rising rates, we expect a rash of borrowers that have loans coming due in the next three years to want to refinance and lock in lower rates. Accordingly, our prepayment model for floating rate, adjustable and fixed rate loans expects loan prepayments to increase for community banks over the course of 2015 and 2016. This might be bad luck for some, but it is probabilistic for us. While this is potentially a large loss in value for some banks, it is an opportunity for other community banks that are on the ball and want to steal customers away. Today, we present data from JP Morgan Chase that is more evidence that utilizing prepayment protection, particularly yield maintenance, can boost your loan portfolio performance and put the odds of profitability back in your favor – something better than luck.
While we have and will continue to discuss how to market and present commercial loans to place your bank in the best competitive position, today we want to talk about how to protect your loans from being part of this competition. It starts with making sure you have prepayment protection built into your loans. Last month we equated the average value of prepayment protection equal that of a Tesla. We then supported that claim and broke down the value of different types of prepayment structures. We also walked bankers through the steps on how to position and explain our favorite form of prepayment protection – symmetrical yield maintenance. The symmetrical yield maintenance is a structure that allows borrowers to receive a fee should rates move up and they wish to prepay the loan. We have developed a proprietary structure that allows your borrowers to benefit from rising rates, while placing your bank in the best position to capture that value and retain the customer should the borrower sell the business or property. All this past information can be found HERE.
In case you need further evidence, we present another bank’s take on our position. JP Morgan Chase diagramed what yield maintenance means to portfolio value on various types of loans throughout the country. This isn’t our data, it is JP Morgan Chase’s and we present it below because it is another way to look at prepayment protection and it validates our internal data.
As can be seen with the overlaid trend line, the more your loans have yield maintenance protection the higher increase in yield you can expect over the course of the loan largely because of the longer you have that loan on your books. The data indicates that on average a portfolio has about 16% of the loans with yield maintenance, adding 30 basis points of additional yield. While this might not seem like much, consider that 30 basis points are material, as that is 8% of the average bank’s margin. If your bank can achieve a portfolio of loans with 40% protected with yield maintenance, that can add some 67 basis points, or 18% increase in your loan’s margin.
In case you don’t think you can sell prepayment protection in this market (see our previous referenced blog and video HERE), we say this is a function of lender training. At CenterState and the largest 100 banks in the country, symmetrical yield maintenance is a standard loan provision. If you are looking to increase the value of your bank, now is the best time to market new loan opportunities, suggest refinancing for your existing customers and go steal customers from other banks. To increase your odds of profitability and put the Irish winds of profitability at your back, utilize yield maintenance on your loans to increase the lifetime value of your customers, boost product profitability and manage credit risk.
Submitted by Chris Nichols on March 16, 2015