In our previous blog (HERE), we discussed the three primary criteria that banks should consider in choosing an appropriate index to price commercial loans. We concluded that, for the time being, LIBOR (surprisingly) was a superior index for community banks to use because of its high correlation to community banks’ cost of funding (better than Prime or US Treasury). We also discussed why LIBOR is a more flexible loan index for community banks becau
Tag: Loan Pricing
Mispricing of small balance loans is the major problem facing our industry and is a drag on many banks. It is difficult to make a $50,000 loan profitable. Let’s consider a typical small business commercial loan example: a five-year loan for equipment with a 1% origination fee. To make a 15% risk-adjusted return on equity, a banker must price this loan at a minimum of a 7.75% spread using direct costs and assuming average credit. That is a thick spread and not only could make your bank less competitive but also potentially increases the risk.
Profitability is the degree to which an activity yields profit or financial gain. While this concept is simple to understand, in reviewing a bank’s financial statements where profitability can be easily measured for past performance, bankers often don’t measure the profitability of a loan at inception and certainly not with the same level of certainty.
Credit is always changing and we watch a variety of markers such as corporate bond credit spreads, vacancy rates, net effective rents and many others in order to help us understand credit. Three of those important credit metrics are the probability of default (POD) by industry, the rate of change of that POD and the volatility of credit of each industry. We just got fourth-quarter forward-looking, through cycle probabilities of default in driven by PayNet and have run our analytics.
In a recent blog (HERE), we reviewed and analyzed commercial mortgage loans originated in 2017, and we identified some strategies that community banks could deploy immediately in 2018 to increase their return on assets (ROA).
In 2010, Paul the octopus was tasked with predicting the outcomes of the World Cup. At feeding time, Paul was presented with two different glass boxes that contained his food each representing one of the teams. To Paul’s credit, he was on a roll as he correctly predicted the outcome of all eight German soccer matches leading up to the final. However, instead of having abnormally strong psychic or predictive prowess, the little cephalopod was just lucky. There was a 1 in 256 chance that Paul would correctly divine the outcome of each German match, and he nailed it.
There has been much discussion lately about the flattening of the yield curve. Some economists and analysts believe that the yield curve could invert in 2018. Much of this discussion has been focused on trading strategies and the relationship between the shape of the yield curve and the strength of the economy. However, the flattening of the yield curve has real consequences for community banks and their loan portfolios. If the yield curve does continue to flatten in 2018, the dominant loan structure for community banks will be challenged.
Context is defined as the circumstances that form the setting for an event, statement, or idea, and in terms of which it can be fully understood and assessed. Some numbers are difficult to understand without proper context.
Community bankers are currently paying close attention to commercial loan pricing given near-record tight credit spreads and increasing interest rate risk. The vast majority of commercial loans in the market are priced to an index plus a credit spread. Determining the appropriate credit spread that will win the business and provide sufficient return to the lender is a key element of RAROC (risk adjusted return on capital) analysis. However, the underlying index to
We recently received a call from a frustrated banker attempting to retain an existing borrower. By way of background, the borrower approached our banker 11 months ago asking for a construction through perm loan. The proceeds were used to construct an owner-occupied industrial and distribution center.