Lending & Credit Risk Loan Pricing

Funding Loan Growth: How to Set Your Institution Up for Success

Kylee Wooten

December 13, 2019

Read Time: 0 min

Key Takeaways

To grow your FI, you must support the growth with proper funding.
Relationship pricing leverages your customer base and cross-sells products for a larger share of the deposit wallet.
Bundling accounts can make a loan more attractive for both the institution and the borrower.

Supporting loan growth

You can’t just plant a seed in the ground and expect to have a plant the next day. There are several factors you have to consider in order for it to develop, from planting it in the proper soil and getting the right amount of light, to watering it and fertilizing it correctly. Similarly, growing your financial institution’s loans is more than just a goal. It takes a significant amount of care and consideration to ensure that loan growth can be supported, including having the funds to do so.

Core deposits play an important role in providing funding for financial institutions’ loan growth. Because of this, relationship pricing can be an essential approach to acquiring funds for loan growth.

Relationship pricing

Too often, loan officers will simply “price by the seat of their pants” and match competitor pricing, rather than strategically model their loan pricing to determine what the loan will do to the institution’s bottom line. To avoid this inconsistent, “wild west” mentality on rates and returns and create a more reliable process with more money to lend out, then institutions must strategically price to earn a specific loan return on equity (ROE) and/or return on assets (ROA). Relationship pricing, for example, is a pricing framework that is determined based on an individual’s overall financial picture, rather than determining pricing on a product-by-product basis. This pricing strategy can help institutions gain insight on the relative value of the relationship by “calculating the value of bringing in deposit accounts with loans, or the potential to discount loans when multiple loan types are originated with a single borrower,” explains Darryl Mataya, Senior Advisor at Abrigo.

Relationship pricing leverages the customer base your institution already has and cross-sells products to garner a larger share of the deposit wallet. This strategy also requires the institution to consider what the entire relationship is worth to them. How much is your bank or credit union willing to spend in order to acquire the purchase of a new product, such as a loan? How much would you discount the price?

At face value, an offer your bank or credit union provides on a loan in order to win the deal might not seem like it is in the best financial interests of the institution. However, a financial institution can strategically leverage relationship pricing and add core deposit accounts to make the loan more lucrative for the bank or credit union.

Influence accurate decisions, improve assumptions used in asset liability models, and increase loan growth organically.

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How to bundle accounts

Let’s imagine that your institution has a goal of hitting 10% ROE and 1% ROA, and it has a customer seeking a 5/20 balloon commercial real estate loan of $1,200,000. After pricing the loan to be competitive in the market, assigning credit risk value, and adding up annual service fees, the ROE falls short of the 10% goal at 4.85% and the ROA is just shy of the 1% target at 0.97%.

But by bundling and pricing additional accounts strategically, the institution can improve those returns. For example, perhaps you are able to sell the customer an additional $100,000 line of credit at the prime rate, plus 25 basis points (bp), with an expected average balance of $50,000 and a 50bp servicing cost. The relationship return would be determined by creating an income statement over a horizon.

The combined return in this example would improve to 5.30% ROE and 1.06% ROA. You could continue, taking into account the value that adding a business checking account or money market deposit account would add to the overall return on the relationship. In this scenario, doing so would mean that the value of each of the additional products could help the financial institution exceed its ROA target (hitting 1.22%) and fall just shy of the ROE goal (achieving 7.63%) on the entire relationship.

While the initial commercial real estate loan by itself didn’t seem to be the best deal for the bank or credit union, coupling it strategically with the additional accounts made it significantly more attractive for the institution because of the return on the entire relationship.

From incentives to cold calling, there are numerous ways that peers implement relationship pricing to ensure they are getting the funding that they need. No matter the strategy your institution leverages, it must evaluate and measure its success. To determine if your institution’s strategy is working, ask the following questions:

What is my market share trend?
Are average balances growing?
What share of customer balances do we have?
Are accounts growing?

Once you have a good handle on your institution's strategy by answering the questions above, make sure you have that strong relationship lending practice in place at your institution. Having those practices engrained in your lenders will make it easier to evaluate funding and whether certain loans will be worth the investment long term. Growth is hard to come by in this competitive market, but don't make it harder on yourself. Be smart with the loans and relationships you are chasing, and the growth will come.

Additional resources, download Abrigo’s latest whitepaper, “Maximizing Your Financial Institution’s Cross-Selling Potential,” or watch the webinar, “Loan Pricing: A Key Driver of Success.”
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