The Covid-19 pandemic has decimated the US economy, and the recovery may take longer than initially suspected. However, currently, community banks have an opportunity to identify and win or retain longer-term, credit-worthy relationships at better credit spreads. There are also substantial challenges facing the entire banking industry.
Based on our observations, we estimate that somewhere between 20% and 25% of community banks have adopted a policy requiring minimum yield or credit spreads for their newly originated commercial loans. The strategy requiring minimum commercial credit spreads may be well-intentioned, but the results for banks may be less than optimal.
For the majority of bankers, maintaining or increasing net interest margin (NIM) is the single most significant focus today. The shape of the yield curve and lower rates have caused NIM compression across the board and have hurt bank equity performance. While we are not big fans of managing bank performance using NIM as it doesn’t take into account risk and cost, it is one of the most common performance metrics used in banking.
One thing that is underappreciated in our industry is the difference between loan structure risk versus credit risk. While these are intertwined, the two risks are different as we will explore.
At this juncture of the credit cycle, community banks must be judicious in the way they source, structure and book commercial loans. Competition is stiff, and every banker is trying to outsmart and out-compete multiple lenders vying for the same customer. Unfortunately, negotiating terms and pricing on a commercial loan feels a little like entering a bazaar wher
Net interest margin (NIM) is one of the most over-utilized metrics in banking. As we have pointed out in the past, if you include all the failed banks over the last ten years, the statistic is about 20% predictive of underperformance. Thus, if you manage your bank trying to get the largest NIM possible, you are likely to produce less profit, not more. Of course, all things being equal you want wider NIM loans than not, but all things are rarely equal.
Funds transfer pricing (FTP) has been an important tool for financial institutions for several decades. The methodology was introduced to banks in the early 1980s to help allocate corporate costs among business lines. Since then, the mechanism has been central to also helping allocate risk among business units. For instance, if your bank has interest rate sensitivity, what portion of the risk is driven by fee lines (f.e. mortgages), loans and deposits. In this article, we look at the concepts of FTP and detail how banks can use the methodology to better manage risk.
Last month, right after lunch, the borrower came into the bank to close his company’s owner-occupied commercial loan for $5mm – it happened to be March 21st. The borrower closed the loan, locked in a 4.50% rate for 10-years, shook hands, smiled and walked out the door. The Chief Lender and the CFO walked over to the business development officer and congratulated him on a job well done. High-fives ensued, and everyone was happy. Should they be? The Bank just lost $238k in one day, and the worst part is, no one knew the difference except the borrower.
Loan pricing is both an art and a science. While there are three primary ways to price bank products, one methodology is consistently used by top performing banks. Since we talk and see the pricing at hundreds of banks each month about loan pricing and we monitor credit risk, cost and non-bank competition in every state, we have a unique vantage point to see what works and what doesn’t when it comes to banking profitable commercial customers.
Loan spreads for C&I and CRE loans decreased slightly in February of this year from a month earlier, and they contracted further in March. We expect that spreads will continue to contract throughout the remainder of the year. The primary driver of declining loan spreads is the tax changes that passed into law at the end of last year. The vast majority of lending institutions have benefited from an approximately 30% reduction in their tax rate (or a reduction in the tax rate of the pass-through entity). The interesting question is this:
