Many banks wait until the last possible period before renewing a loan. Waiting often invites competition, as other banks with loans out to that customer know exactly when other bank’s loans mature (hopefully you are capturing this information as well). To beat this problem, banks are smart to lock in renewals in advanced in order to minimize competition. Not only is a renewing loan likely a better credit risk (you have a payment history for starters), but banks can garner a larger spread making the risk-adjusted return more profitable.
Borrowers will pay for convenience as evidence by the chart on the left. Here, we tracked some 270 loans from a variety of community banks over the course of 2013 and looked at floating rates loans with maturities between five and ten years. We looked at closed new loans and compared them to similar credit loan renewals. All the loans were either on commercial real estate or to commercial borrowers. Debt service coverage was above 1.5 times in every case making these high quality borrowers with probabilities of default all less than 60bp.
While this is admittedly a small sample size and we do point out that while we tried to control for credit quality as best we could, loans are not a homogenous product and so some variation exists. However, what we found was that the data was fairly consistent and showed that over the course of 2013, renewals were priced at an average of 244bp compared to new loans that were originated at an average spread of 228bp.
Anecdotally, it seems that competition was introduced in less than 30% of the loan renewal cases compared to about 70% of the cases for new loan origination. This difference might explain some of the 16bp discrepancy between pricing in addition to renewing a loan with your current bank is more convenient than moving the relationship to a new bank.
One take away here is that banks may want to increase the time they renew loans to at least six months in advanced of maturity if not longer (we often suggest starting to have the conversation 18 months in advance) in order to reduce competition and enjoy a larger potential spread.
Submitted by Chris Nichols on November 05, 2013