Commercial Loan Pricing Pitfalls for Bank Executives
Commercial Loan Pricing
Navigating the common pitfalls of commercial loan pricing are hazardous. Here are a few of the danger zones that you should avoid.
A better credit forces a banker into a thinner spread; however, are you properly managing the balance between credit and the net interest margin? This is not a straightforward, linear relationship. Credits that are above 1.50 debt server coverage (DSC) are insensitive to credit loss. The fine details begin to matter with a DSC between 1.20 and 1.50.
Larger loans are usually more profitable because of the fixed origination cost of all loans. This is especially true for small community banks with an average loan size under US $500,000. Minimize this level of loan as much as possible in order to increase profitability.
Manage Key Relationships
Many loans lose money based on the risk profile and the costs of administration. These loans are best looked at as a loss leader, not an endpoint. The main drivers of income that you look to maximize based on the relationships that you develop through loans are cross-selling and fee income.
Terms Count – But Not in the Way You Think
Long-term loans may seem like more of a hassle, but loans reach their pinnacle of profitability on the day they are repaid. The farther off that day, the more time the loan has to accrue value.
Please contact us if you need help with your next commercial loan pricing model. Our experts have experience in a wide variety of commercial industries across various economic and geographic landscapes