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By: John Robertson I began this blog series asking the question “How can banks offer such low rates?” Exploring the relationship of pricing in an environment where we have a normalized. I outlined a simplistic view of loan pricing as: + Interest Income + Non-Interest Income Cost of Funds Non-Interest Expense Risk Expense = Income before Tax Along those lines, I outlined how perplexing it is to think at some of these current levels, banks could possibly make any money. I suggested these offerings must be lost leaders with the anticipation of more business in the future or possibly, additional deposits to maintain a hold on the relationship over time. Or, I shudder to think, banks could be short funding the loans with the excess cash on their balance sheets. I did stumble across another possibility while proving out an old theory which was very revealing. The old theory stated by a professor many years ago was “Margins will continue to narrow…. Forever”. We’ve certainly seen that in the consumer world. In pursuit of proof to this theory I went to the trusty UBPR and looked at the net interest margin results from 2011 until today for two peer groups (insured commercial banks from $300 million to $1 billion and insured commercial banks greater the $3 billion). What I found was, in fact, margins have narrowed anywhere from 10 to 20 basis points for those two groups during that span even though non-interest expense stayed relatively flat. Not wanting to stop there, I started looking at one of the biggest players individually and found an interesting difference in their C&I portfolio. Their non-interest expense number was comparable to the others as well as their cost of funds but the swing component was non-interest income.  One line item on the UPBR’s income statement is Overhead (i.e. non-interest expense) minus non-interest income (NII). This bank had a strategic advantage when pricing there loans due to their fee income generation capabilities. They are not just looking at spread but contribution as well to ensure they meet their stated goals. So why do banks hesitate to ask for a fee if a customer wants a certain rate? Someone seems to have figured it out. Your thoughts?

By: Mike Horrocks I am at the Risk Management Association’s annual conference in DC and I feel like I am back to where my banking career began.  One of the key topics here is how important the Risk Rating Grade is and what impact that right or wrong Risk Rating Grade can have on the bank. It is amazing to me how a risk rating is often a shot in the dark at some institutions or can even vary on the training of one risk manager to another.  For example, you could have a commercial credit with fantastic debt service coverage and have it tied to a terrible piece of collateral and that risk rating grade will range anywhere from prime type credit (cash flow is king and the loan will never default – so why concern ourselves with collateral) to low, subprime (do we really want that kind of collateral dragging us down or in our OREO portfolio?), to anywhere in between. Banks need to define the attributes of a risk rating grade and consistently apply that grade.  The failure of doing that will lead to having that poor risk rating grade impact ALLL calculations (with either an over allocation or not enough) and then that will roll into the loan pricing (making you more costly or not enough to match for the risk). The other thing I hear consistently is that we don’t have the right solutions or resources to complete a project like this.  Fortunately there is help.  A bank should never feel like they should try to do this alone.  I recall how it was an all hands on deck when I first started out to make sure we were getting the right loan grading and loan pricing in place at the first super-regional bank I worked at – and that was without all the compliance pressure of today. So take a pause and look at your loan grading approach – is it passing or failing your needs? If it is not passing, take some time to read up on the topic, perhaps find a tutor (or business partner you can trust) and form a study group of your best bankers.   This is one grade that needs to be at the top of the class.  Looking forward to more from RMA 2014!

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