How To Facilitate The Tactical Refinance To Increase Retention

Increasing Loan Portfolio Return

One of the easiest ways for community banks to increase profitability is to stem commercial loans from refinancing to a competitor.  Competition is intense, and community banks that develop a strategy to retain profitable clients can increase income substantially.  While most banks devote resources to marketing, sourcing, and booking new business, much less emphasis is placed on maximizing profitability on the existing loan portfolio by identifying and controlling customer loss (or refinancing risk).  We would like to share one specific strategy that we have seen banks use to identify clients at risk of refinancing.  We also share with you a sample letter that we have used effectively to approach existing clients to discuss internal loan modification opportunities to minimize customer loss.


The Numbers


It costs the average community bank between $6k and $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 return on equity (ROE).  Stated another way, a bank is 5.1% ROE ahead on the same loan by not losing the credit to a competitor.


This is a material difference in return that is just a snapshot in time. When a customer gets refinanced away, not only does the bank, need to replace the current assets and liabilities, but they need to replace the future cash flow value of those assets and liabilities. Thus, the loss of cumulative lifetime value is much greater and instead of being 5.1% ahead, it is more likely multiple times that depending on other current and future lines of business.


The economics of loan origination versus loan retention are intuitive, and the results make sense.  The cost of garnering new commercial loans is very high.  Booking a new client involves enormous costs in marketing, underwriting, and documentation.   Unfortunately, the prepayment speeds on commercial loans at community banks are high and running at over 35% per annum at many community banks.  Banks that can simply decrease commercial loan prepayment speeds at the bank by 50% can increase the bank’s loan portfolio ROE by about 80 basis points (bps). There is no other way to achieve such a large incremental return on a loan portfolio without much investment.


The table below shows that there are about $364B commercial loans at the national banks in the US that are due or have a repricing event in the next two years (that is approximately 21% of all their loans).  These national banks have strategies to retain existing clients, and community banks should likewise develop a plan.


Loan Ranking 


The Analysis


Community banks should decide how to decrease the risk of refinancing to a competitor.  Here are the steps that we take to identify these opportunities.  First, we take a loan tape from our core system, and we look for the following criteria:

  • Loans over a certain size.  Typically we concentrate on commercial relationships or loans over $500k, but every bank will have its own size cutoff.  Loans under $500k are not as contested, are typically less profitable, and we do not have resources to allocate this strategy to all relationships.
  • We identify loans that are in the top 50% of our profitability.  Banks that cannot measure ROE for each relationship can use a subjective test.

Next, we want to identify in the above subset of loans variables that increase the likelihood of the customer refinancing.  We have generally identified the following variables:

  1. Any dissatisfaction identified by the client.
  2. Loans that maturing within the next two years.
  3. Clients paying above-market rates or pre-tax reform spreads.
  4. Borrowers with no, or weak, prepayment penalties.
  5. Customers with loan structures that do not match their asset-liability position.
  6. Borrowers with low switching costs (no treasury management, wealth management or investment management services).
  7. Term loans with variable-rate structures.
  8. Customers with only one product with the bank, or low service usage.


As existing lenders, we have an advantage in knowing the borrower’s business well, we have the customer’s financial information, and any amendment or add-on business can benefit from a quick closing.


Loan Modification Strategy


To retain the relationship, we approach the client and offer modifications that reflect the current interest rate environment, or better reflect the client’s current business needs.  The modification strategy can be achieved with a simplified change in terms or loan modification agreement.  The entire set of documents may be as short as four to six pages.  We have also seen banks provide this strategy without fees depending on circumstances and market competition.  We forgive prepayment penalties, and we can roll in costs of any yield maintenance provision into new loan terms.  We can also allow the borrower to maintain their existing remaining term at the existing rate and structure step-up pricing. 


We approach clients using a sample letter (which you may download HERE). 


Our intention in approaching the client is to retain their business and extend their commitment to us.  However, we position our efforts as follows:

  • We took the preemptive effort to review our client’s services with us.
  • We are providing options to the client that positions us as the trusted advisor.
  • We are delivering current market information to the client – it could be that interest rates are rising, or cap rates have fallen and may rise shortly.




Identifying customers at risk of refinancing is one of the most efficient and productive ways for community banks to enhance ROE. The specific strategy of modifying existing loans to retain clients can enhance the loan’s return on equity by approximately 5%. Banks that can devote resources to modifying existing loans which may be in jeopardy of refinancing can gain significant profitability