In two articles in the past few weeks (here and here), we discussed how the “higher-for-longer” interest rate environment will affect the community bank sector – continued increase in the cost of funds (COF), steady yields on loans, and a decrease in net interest margin (NIM) will put severe pressure on ROE for new loan originations.  Community banks must improve the performance of their existing portfolio.  For the average community bank, the top quartile of profitable customers comprises over 100% of the bank’s profits, and the bottom quartile is highly unprofitable. In a low-growth business environment, community banks must focus on retaining, extending, and protecting their most profitable relationships, augmenting profitability on the average relationships, and actively shedding those relationships that cannot be converted to profitability.  A community bank may increase ROE substantially by using internal refinancing strategies to secure its top relationships that provide cross-sell opportunities, efficiencies, fee income, and growth opportunities. These “tactical loan refinancings” are a method for banks to manage credit risk and profitability.

This article discusses the practical steps bankers must take to identify, prioritize, contact, and refinance existing relationships.  Most lenders and managers have focused and developed their skills centered around acquiring new business, not mining existing portfolios.  We have developed and used a set of procedures, data mining techniques, and template borrower correspondences that we would like to share with our readers.

The Economics of Tactical Loan Refinancings

It costs the average community bank between $6k and $26k to book a new commercial loan but only about $2k to modify or amend an existing one.  The difference between a new and existing credit (all else equal) is 5.1% in ROE.  Stated another way, a bank is 5.1% ROE ahead on the same loan by not losing the credit to a competitor.  Further, the average community bank’s loan-to-core deposit ratio is 92%, so any new loan will be priced at the incremental cost of funding (between 4% and 5%) vs. the bank’s lower average cost of funding (approximately 2.00%).   When banks are “loaned up,” the cost of garnering new commercial loans is high.

Community banks that can decrease commercial loan prepayment speeds and extend the duration of their most profitable clients may be able to increase the loan portfolio ROE by hundreds of basis points.  There is no other way to achieve such a sizeable incremental return on a loan portfolio without much investment.

Practical Steps of Tactical Loan Refinancings

Here are the steps that we take to identify internal tactical loan refinancings.  First, we take a loan schedule extract from our core system, and we look for the following criteria:

  • Loans over a specific size. Typically, at SouthState Bank, we concentrate on commercial relationships or loans over $1mm, but every bank will have its size cutoff.  Loans under $500k are not as contested, are typically less profitable, and we do not have the resources to allocate this strategy to all relationships.
  • We identify loans that are in the top 25% of our profitability. Banks that cannot measure ROE for each relationship can use a subjective test.

After identifying the set of loans based on the above criteria, we want to identify variables that increase the likelihood of the customer refinancing.  We have generally identified the following variables:

  • Any dissatisfaction specified by the client.
  • Loans that mature within the next one to three years.
  • Clients that are paying above-market rates.
  • Borrowers with no or weak prepayment penalties.
  • Customers with loan structures that do not match their asset-liability position (long-term assets financed with shorter-term liabilities).
  • Borrowers with low switching costs (no treasury management, wealth management, or investment management services).
  • Customers with only one product with the bank or low service usage.

With existing borrowers, lenders have an advantage in knowing the borrower’s business; we have the customer’s financial information, and lenders can discern if any amendment or add-on business can benefit from a quick closing.  Our Excel template that identifies the target relationships for this exercise is available for review below.


Template for Tactical Loan RefinancingsBlog – SSB ARC Fee Portfolio – TEMPLATE

Borrower Communication – Get Our Sample Letter

To retain the relationship, we approach the client and offer modifications that reflect the current interest rate environment beyond the borrower’s existing loan maturity or better reflect the client’s current business needs.  The modification strategy can be achieved with a simplified change in terms or loan modification agreement.  The entire set of documents may be as short as four to six pages.  Banks have also provided this strategy without fees depending on circumstances and market competition.  We forgive prepayment penalties and can roll in the costs of any yield maintenance provision into new loan terms.  We can also allow the borrower to maintain their remaining term at the existing rate and structure forward rate lock pricing.

We approach clients using a sample letter, which is available for review below.

Sample Letter for Tactical Loan Refinancings

Blog – Refi – SSB Sample Proposal Letter

When it comes to tactical loan refinancings, our intent in approaching the borrower is to retain their business and extend their commitment to us.  However, we position our efforts as follows:

  • We made a preemptive effort to review our customer’s services with us.
  • We provide options to the customer that position us as a trusted advisor.
  • We are delivering current market information to the client. It could be that interest rates are rising, real estate cap rates have fallen, or alternative refinancing options may be more limited in the future.  The message to the borrower must be genuine and an objective market representation.


In the last ten years, most lenders and managers have focused and developed their skills centered around acquiring new business.  However, the next few years may offer lenders an opportunity to impact clients and the bank by refinancing existing credit relationships.  Lenders must act as trusted financial advisors to their customers; not every borrower will be a suitable candidate.  To be a compelling proposition, the internal refinancing or extension must be a win-win for the lender and the borrower.


Tags: , , Published: 10/09/23 by Chris Nichols