There are vast opportunities for community banks to differentiate themselves from their competition and create substantial value-add. One technique that we and other banks are having success with is the use of forward commercial loan commitments. This is a structure where your bank locks in loan terms that may start in the future. Forward periods range up to 24 months and average about 13 months. CenterState also uses this forward lock and commitment technique to win larger and better borrower relationships, attract new customers and increase profitability. Knowing when and how to use “forwards” can be a valuable tool for many community banks.
5 Ways To Apply The Forward Loan Commitment
There is some interesting and profitable application of forward loan commitments that community banks may use in today's market. We have written about some of these techniques, but there are some more that we want to share.
The Standard Rate Lock: More banks than ever are using forward loan commitments to accommodate standard closing and due diligence steps such as title, appraisal and loan documentation. The advantage is that the borrower gets to lock the rate prior to the loan’s closing thereby removing payment uncertainty. This technique is often used where there is a long time to closing. Because the yield curve is so flat, the true cost of the forward is only about one basis point per month for the forward period, but the bank can charge substantially more for the privilege of that forward.
Single Close Construction Loans: Banks are using forward term loan commitments to offer single-close construction through perm financing. This technique can increase the profitability of the relationship by maintaining the stabilized and longer, term facility. But this application also prevents competition from national banks after the construction and stabilization.
Bringing Customers From Other Banks: A few banks that we work with have also used forwards to create a hybrid structure to poach customers from other banks. This particular application involves offering a customer a new loan where the initial period mirrors the pricing on the original loan at the previous bank. The bank builds a forward which is typically the more profitable portion of the loan for the bank. This allows the customer to retain the economics of their original loan and still make the switch to a new lender.
Forward Starting Refinance: Another interesting forward technique that we see community banks deploy is locking in an existing customer on a new loan without refinancing the existing loan. The forward loan commitment starts after the existing loan is set to terminate. Thus, the customer continues paying off the old loan until maturity and then refinances the loan with your bank. Again, the remaining economics is retained by the customer, but the bank builts additional term, fees or spread on the backend.
To accommodate A customer’s rate view: The most interesting technique in today’s market is to forward rate lock loans by appealing to borrower’s fear and greed at the same time and take advantage of market volatility. We do not think that community banks speculating on interest rates, but there are natural dips in the market where community bank lenders can make a substantial profit by providing good advice, and the forward loan rate lock can be a tremendous tool. The graph below shows 10-year rates for the last six months. Just when some customers thought that they missed their opportunity to lock in low rates, the last month has witnessed a 25bps dip in long-term rates. This is where lenders approach existing customers and prospects to show them an excellent opportunity to obtain financing at rates that some thought would not come back. Unfortunately, lenders and borrowers cannot make a decision on the loan on the spot, but the forward rate lock allows borrower and lender to lock the rate and take a few weeks or months to get through the necessary due diligence and documentation.
Some bankers may argue that the current dip is transitory and may not repeat – but we disagree. Interest rates, liquidity, and capital are volatile and the ups and downs of the market create opportunities will always present themselves. There will be another run-up in rates, and then another dip and the cycle will repeat itself. It is important for a banker to be ready to take advantage of such passing opportunities with a forward rate lock tool to commit the borrower on the spot and not let the specific opportunity fade with the passage of time.
The only caveat to all of these forward rate lock techniques and tools is that community banks must not take an undue risk without compensation. At CenterState, we have developed all of the above techniques without taking the interest rate and funding risks. There are many ways to hedge the unwanted risk, and every bank should develop its own set of tools.
While commercial banking is a relatively simple business model, there are some novel and interesting tools that community banks should possess to maintain a competitive advantage, but still stay in their banking lane. We do not believe that community banks should act like hedge funds, but the forward commercial lock is a simple and powerful tool that can create value for the borrower, protect the bank, create substantial service, differentiate the banker and be very profitable for the bank. Many community banks are well advised to investigate how they can develop such a product for their local market.
Submitted by Chris Nichols on December 06, 2018