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Commercial loan pricing model: Spread-based or ROA?

Commercial loan pricing model:  Spread-based or ROA?

Commercial loan pricing model

The commercial loan pricing market is complicated.  Competition for loans is increasing, and competition for quality loans is increasing at what seems to be an exponential rate.  Determining what will work best as a commercial loan pricing model is important, as it allows for reduced complication in the structure of commercial loan pricing models, without simplifying the process past the point of absurdity.

First, it must be determined if spread-based pricing or return on asset (henceforth ROA) pricing will be used in the loan model.  Spread-based pricing is tempting, of course—it is easy for the bank to calculate, and it almost always provides a more positive outlook for the future.  ROA pricing is different, because it requires a clear look at risk and a more dynamic loan pricing model overall.  However, in the long run, ROA pricing may reduce the bank’s risk and provide both the bank and potential loan buyers with more significant stability.
Research suggest that switching to ROA pricing models has led to banks becoming more aggressive for higher quality loans, while reliance on spread-based pricing makes institutions more voraciously competitive for lower quality loans.

In an ideal world, of course, an institution wants to be competitive at the highest quality loans to increase net profit margins over time.  New market research suggests that a reliance on ROA pricing models allows for a more competitive edge and more freedom for lenders in the high quality loans market.  The market is always changing, and The Hurdle Group, Inc. strives to help investors make good decisions about the structure and future of their commercial loan pricing models and strategies.

Contact us for more information about commercial loan pricing.

Alan Lee