A concept that is commonly misunderstood by those that are new to the lending and banking industries, is the difference between loan origination skills versus credit management skills – what should be the balance? As seasoned bankers and lenders well know, both of these skills are necessary to achieve successful portfolio management, but the terms are not equal in importance and can not be used interchangeably.
Understanding the Importance of Credit Management Skills
Credit management is certainly an important part of the lending process. To successfully manage your institution’s loan portfolio, it is prudent to conduct a thorough credit analysis that includes credit history and prior loan history before a loan is granted.
Institutions that grant too many loans that default lose profit potential and jeopardize the long-term stability of the bank. This is why determining creditworthiness and capacity to repay the loan are important factors in whether or not to grant loan approval, and are an important part of credit management. Learning how to balance a loan portfolio with the right mix of credit grades is also an important part of developing this skill, as doing so helps to spread out the risk so that lenders can potentially minimize the number of loans that ultimately default, while also not missing out on the ability to profit from lucrative loans to applicants with less than stellar credit.
In general, commercial loans have greater potential for both profit and successful repayment as a commercial enterprise generally has more sources of income that the applicant can draw upon, and are generally for an exponentially larger amount than a residential or consumer loan.
How Data From Credit Analysis Feeds Into the Loan Pricing Model
Some of the data that is collected during the credit analysis process does feed into a loan pricing model that is used to determine the best price for a given loan. The use of a loan pricing model and setting the actual terms and price of a loan are the primary components of loan origination skills.
Why Loan Origination Skills Determine the Profitability and Survival of Your Bank
Excellent loan origination skills are necessary to maximize profit, increase long-term stability, and meet the demands of ever-increasing government regulation. It is not an exaggeration to say that loan origination skills can have a greater impact on your bank’s profitability and survival than credit management skills.
The reason for this is because, no matter how safe a particular loan, or even a package of loans, might seem in terms of credit risk, this means nothing if the lender is not able to make the loan at a profitable price for the bank.
A Real-Life Example of Credit Management vs. Loan Origination Skills
An excellent example of the importance of both credit management and loan origination skills can be found in the recently released 2015 First Quarter report by the TCF Financial Corporation.
The credit quality of the debts that the company held in the first quarter improved due to the sale of previously issued bad and troubled debt. The funds from this sale was used to increase the number and amount of new loans that the group held on its balance sheet.
By using solid origination skills for the new loans, the group was able to increase its loan and lease balances, which enabled the lender to improve its financial results despite the drag on its performance that was created by delinquencies and charge-offs.
Essentially, superior loan origination skills helped the lender overcome the effect of prior poor credit management decisions. This is a common result for lenders throughout the country that adopt loan pricing models that help their bank reach it’s goals. A bank’s profitability often comes down to the ability to set the optimum price for a loan.
Determining the price and terms of a loan is a complex process. The lender must be able to efficiently price loans to recover origination fees and servicing costs while meeting profit goals and demonstrating to regulators that a consistent methodology for loan pricing is used throughout the entire loan portfolio.
Our PULPS Loan Pricing Model takes all of the guesswork and hassle out of determining the optimum price for your organization’s commercial loans. Contact us today to learn more about how we can help you gain an edge over your competition and maximize your profit while making it easier to meet federal requirements.