Despite changes in the market and in the borrower’s risk profile, it’s common for many banks to simply roll over existing pricing when it comes to loan renewals. Our Performance Optimization Program delivers the data-driven pricing guidance you need to optimize pricing and fee incidence in the context of the current market. This case study examines the steps that one of our clients took to successfully re-price the majority of their renewals last year with the help of our Performance Optimization Program.
During our analysis of the bank’s portfolio, we found that new originations carried significantly higher spreads and fee incidence than their renewal book of business. Since a high percentage of the bank’s loan volume each year comes from renewals, we worked with the bank to implement a new data-driven process for renewing credits.
After taking into account the bank’s volume and non-credit revenue objectives, the Performance Optimization Program found that the bank had missed out on a 32 basis point revenue opportunity. The bank could have captured this opportunity if they had repriced the prior year’s renewals according to our local market spread and fee levels.
Our client bank, like many banks, handled renewals very differently from new loan originations, not only from a credit review and approval perspective, but also in terms of pricing approvals. We noticed two principle impacts:
- While some cursory due diligence was performed around the borrower’s credit risk, pricing was typically not re-assessed in the context of that new risk assessment. Consequently, the bank had a fairly flat risk-return curve on their renewal book of business, failing to increase pricing on deteriorating credits while occasionally conceding on spreads and fees in order to retain more profitable relationships.
- The bank had failed to capitalize on several pricing and fee opportunities that had either been missed at origination or because market conditions had changed – opportunities that they were capitalizing on with new originations.
The Performance Optimization Program team worked with the bank to design a renewal repricing process. This contained several key aspects and deliverables:
- Bankers should approach every borrower three to six months prior to their renewal event. Research from the Performance Optimization Program has shown that the earlier a borrower is approached to discuss pricing, the more likely it is that a positive re-pricing will occur. Borrowers have much more leverage when that discussion takes place two weeks before the renewal, as the bank is focused on retaining the business rather than forcing the borrower into default. Borrowers approached more than three months before maturity have an average of 25 basis points higher pricing than borrowers approached less than a month before maturity.
- Relationship managers were re-trained on Performance Optimization Program Renewal Reports that present each upcoming renewal opportunity alongside spread and fee targets. We also designed management reports to monitor how well each relationship manager captured the opportunities presented to them, and coached relationship managers on what questions to ask themselves when reading the reports: Has credit quality deteriorated? Is there a significant non-credit or deposit business with this borrower? What assurances of non-credit or deposit business were discussed at origination, and have those materialized?
- We coached relationship managers on how to use Performance Optimization Program insights to position pricing as being in the context of the market. Relationship managers are now coached to begin each client negotiation with a discussion of the change in market conditions, rather than as a judgement against the borrower or a change in business practices. They are also coached to position upfront fees as more of an administrative pass-through cost, and unused fees as a pass-through on regulatory charges. With confidence in the market levels, relationship managers were encouraged to ask clients for a last look before moving the business with the goal of getting some increase even if not to the target levels.
- Finally, the bank instituted a pricing approval process similar to new loans for all renewals. By requiring management sign-off for every variation, the bank sought to create additional motivation for relationship managers around renewal re-pricing.
So what were the key takeaways? In the first year of this initiative alone, the bank was able to capitalize on roughly one-fourth of the opportunity identified – Just over eight basis points of their renewal loan volume for the deal. The primary drivers of this improvement were:
- Increased upfront and unused fee incidence.
- Higher pricing on 56% of credits with a credit downgrade, and even on 50% of credits with no credit risk migration.
- Implementing spread and fee guidance on deal characteristics as determined by the market, where none existed previously.
With reinforcement of these new procedures, the bank is positioned to capture even more of the opportunity over time.
The Performance Optimization Program is a data-driven solution that helps banks maximize risk-adjusted revenue, while also taking into account their broader total relationship profitability, volume, market share, and customer satisfaction objectives. Learn more.