Tag: Loan Pricing

The Biggest Mistake In Commercial Loan Pricing

Bank loan pricing

We estimate that 90% of all banks in the country do not have a commercial loan pricing model that adjusts for credit risk, shape of the yield curve, acquisition costs, maintenance costs or relationship revenue.  However, banks do not need to purchase a loan pricing model to eliminate the biggest mistake commonly committed today on commercial loan pricing.  The solution involves paying attention to the market, obtaining current market intelligence (which is widely available) and applying common sense when using pric

Are Banks Charging Enough For Their Loan Risk?

The Strategy Of Credit Risk

Bankers are lamenting the current ridiculous low loan spreads and questioning if they are getting appropriately compensated for the risk that they are taking with their capital.  This brings up the question - Are banks getting compensated for all of the risks that they take for extending credit?  Our resolute answer is - no, bankers rarely get sufficient revenue for the risks that they take in lending.

Taking Loans Away From The Competition – Tactic 2

Increasing Loan Competitiveness

A couple of weeks ago we discussed how quantitative banks can win more loan business by going after the two ends of the credit spectrum(usually Grade 2 and Grade 5 loans) that most community banks misprice (HERE). In that article, we show how banks that utilize a credit model have a distinct advantage against banks that don’t leverage a model particularly vulnerable in losing high-quality (Grade 2-type) borrowers.

Your Loan Portfolio’s Private Parts

Quantifying Lending and Credit Risk

Three weeks ago we gave bankers a quick way to translate commercial real estate portfolios into a common rating using simplified methodology (HERE) in order to quickly access their portfolio or a portfolio for purchase. We received many comments from bankers wanting to know more of a detailed approach to accessing credit by loan type and wanting to know how C&I fit into a ratings construct.

Understanding A Bank Loan’s Debt Service And Probability Of Default (2015)

Commercial Loan Probability of Default

Few banking school classes teach the finer points of loan structuring these days. This is a mistake as loan production is so competitive and spreads so thin that inexperienced lenders are at a distinct disadvantage. Last week, for example, we were discussing a loan here at CenterState and we determined the downside (stressed) case in a particular commercial real estate loan’s cash flows was a 0.8x debt service coverage ratio (DSCR). The question came up how much risk is that compared to a loan that cash flows at 1.25x stressed case?

Lessons and Pitfalls For Banks in Commercial Loan Pricing

Bank Commercial Loan Pricing Strategies

We estimate that roughly 15% of banks under $1B in assets currently use a loan pricing model (in-house or purchased).  For banks under $250mm in assets, that percentage is substantially smaller.  Furthermore, of banks under $1B, the percentage that uses a true RAROC model (risk-adjusted return on capital) is almost insignificant (we estimate that number to be less than 1%).

 

Harsh Realities of Commercial Lending

Loan Pricing Model

As we all know, things aren’t always as they appear.  In the classic image below on the left, the two horizontal lines are of equal length.  In the below image on the right, you can see both a young fashionable woman looking away and an old woman’s left profile (which one do you see?).  We won’t even get into the blue/black/gold/white dress debate. Similar illusions can be found in commercial lending.  

The LTV vs. Pricing For Commercial Real Estate (2015 Edition)

LTV and Loan Pricing

Loan pricing depends on many things including cash flow, geography, property type, tenant mix, lease structure, borrower, loan structure and leverage. While loan pricing is primarily driven off cash flows, banks spend an inordinate amount of time worrying about loan-to-value (LTV), but little time adjusting for pricing. Today, we look at the relationship between LTV and loan pricing using data from the month of March.

 

The Data

 

How Loan Size Impacted Market Pricing For January

Loan Profitability

Community banks often treat all sized loans the same when it comes to pricing. A $3 million loan is priced the same as a $700,000 loan. For banks that do this, keep in mind that they are not one, but two steps away from reality when it comes to superior bank performance. For starters, a larger loan is more profitable since a $10 million loan takes almost the same sales, marketing, underwriting and booking effort as a $1 million loan. As such, profitability is different.

The Impact Of Interest Rates on 2015 Credit Spreads

Credit Spread Predictions

When rates rise there are two main offsetting effects on the value of bank’s loans. On one hand, rising rates usually mean an improvement of both the general economy and of a particular sector. Not only is demand improving, but some sectors, consumer products for example, are more sensitive to improving economic conditions. On the other hand, rising interest rates is also is a result of a rise in the price level of inputs such as labor, raw materials and rents. Taxes are another area that, depending on industry, can be positively correlated to a rise in interest rates.

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