A Loan Strategy Given Lower Rates

Increasing Lending Profitability

Many industry analysts are increasingly gloomy on the banking industry, trimming expectations for net interest margin, interest income, and total profits. With long-term interest rates declining within a whisker of the lowest level in history, many analysts are reducing their forecast of banking profits by up to 10% through 2020 or 2021. However, we would like to share a current proven strategy for community banks to make the best of the current interest rate environment, lock-in their best clients, increase cross-sell opportunities, and actually increase margins. 


Interest Rate Dips


US long-term interest rates were within a rounding error of their lowest level in history last week (the 10-year hedge rate touching 1.36%).  The graph below shows rates from 1987 to the present.  Lower long-term rates cannot be sugar-coated and will have a negative impact on net interest margin, net interest income, and earnings per share for most banks. 


10 Year Swap Rate shown at historic lows


However, despite the pioneering work of the Japanese and European central banks that have sunk interest rates to zero and below, that is not the base case in the US.  Neither economists nor the market expects long-term interest rates to approach the X-axis in this country.  In this rate environment, the unconventional community banks currently have an excellent opportunity to win high credit-quality clients for life, create cross-sell opportunities, effectively eliminate their best clients from competitive pressures, and increase credit margin.

The Strategy

At CenterState Bank, we are using the recent dip in rates to secure better quality relationships, differentiate our brand from the competition, mitigate poaching risk from competitors and generate higher (yes, higher) spreads for the bank.


The strategy is simple.  Most borrowers see the recent dip in interest rates as an opportunity to refinance their existing loans. Any loan booked in the last five years, which is the majority of many bank’s loan portfolios, can now be refinanced at a lower rate and for longer-term.  We identify prospects that have long-term banking needs (a customer that has financing needs for a few years is typically not a real relationship account) and offer those customers what the market has delivered – low rates and longer-term commitments at the same price as short-term credits. With interest rates low and the yield curve flat, we can offer five to 20-year financing that can be anywhere from 50 to 200bps lower than their current rate depending on when the borrower booked the credit.

Here are the benefits to the bank:


Better Credit: Locking in customers at lower rates is attractive to customers but also stabilizes our credit facility at a stronger cash flow coverage.


Greater Customer Retention: We lock in clients with prepayment provisions so that they do not refinance if rates drop further.  The prepayment protection extends our relationship, and, more importantly, gives us the ability to mitigate our interest rate risk if rates rise (through hedging, CD matching or FHLB advances – any of these techniques may work for various banks at a certain point of the business cycle).


Enhanced Cross-Sell: With a five to 20-year commitment between a borrower and our bank, we now can go to work to cross-sell our most profitable product – DDAs.  When customers lock in very low rates, for a long term, with prepayment provisions on the loan, the majority of positive cash flow ends up at the bank as deposits rather than as principal reduction on the loan.


Advisory Positioning: By locking in low rates for longer, we manage to position the bank as a trusted advisor to finance the borrower’s balance sheet rather than pieces of collateral (real estate is just inventory that borrowers buy and sell frequently).  We want the borrower to view our credit commitment as fungible financing for the borrower’s balance sheet.  Otherwise, we are perceived as the lowest cost provider and a transactional lender.  We work with borrowers to transfer credit or substitute collateral for the full commitment life of the loan to create a holistic banking solution.


Wider Credit Margins: Most importantly, we are actually increasing our credit margins.  Borrowers understand that interest rates are lower, but do not track precise levels.  While the 10-year Treasury and the 10-year swap rate yields may be down by 200bps from their highs of 2019, we offer slightly wider spreads but still deliver some of the interest rate decreases to the borrower.  The borrower obtains a low rate loan, but we increase our net interest margin (NIM) in the process.  We have witnessed banks increasing their loan margin by 15 to 20bps (passing the remaining decrease in interest rate to the borrower).


Defensive Protection: Another exciting aspect of the strategy is that it can be used on existing clients of the bank, regardless of the remaining loan commitment term.  Here, being proactive helps our bank.  If our existing loan has no prepayment protection, our client is at risk of leaving for another bank that is deploying this very strategy.  By proactively approaching our current customers and offering them an opportunity to save 50 to 200bps on their loan rate, and, assuming they have not yet been approached by other lenders, we can increase our margin even more than 15 to 20bps.  When proactively approaching current clients, banks are able to gain 25 to 50bps in additional margin.




Sometimes being unconventional can help community banks succeed.  While the market has soured on banking, there are still good opportunities for community banks to retain, or even expand, margin, add good credit quality customers, increase cross-sell opportunities and still deliver what customers want.  Sometimes when the market delivers buckets of sour fruit, banks just need to make ample amounts of lemonade.