We are strong proponents that bankers should be focused on keeping loans instead of making loans. While it is true that banks make loans, originating a loan is an unprofitable business. Banks earn an acceptable return on capital by keeping loans, not by making them. We recently worked with a bank that kept, and increased a loan, without competition, and we want to explain how the bank was able to achieve this.

Why Making Loans is Unprofitable and Keeping Loans is Critical

Managers often stress the importance of relationship banking. Typically, this means that the longer lifetime value of a customer creates more revenue and profit, and the cross-sell and upsell opportunities improve, and a bank can obtain a larger share of wallet with longer relationships. However, at a very granular level, originating a loan creates negative ROE for the bank. It is expensive to originate a loan for the following reasons:

  • Bankers need to source multiple loan opportunities because the bank will lose some opportunities to competitors and decline some loans through underwriting.
  • Bankers will expand time and effort to court prospects, some of whom will never show the bank a loan opportunity.
  • Multiple bank employees need to underwrite loan opportunities, and management needs to review and approve the credit. The initial underwriting of a new client is often less efficient because sources of cash flow, business nuances and financials are not well known.
  • The bank will also spend scarce resources in the process of title work, documentation, onboarding, and initial due diligence to book a loan.
  • Winning a competitive bid for a loan means that the winner often showed the lowest price or loosest credit terms – not a recipe for long-term profits.
  • There are few new borrowers in the market and winning a client means poaching them from another financial institution. Even if that client is dissatisfied with their existing bank, poaching a client means offering competitive pricing.

Therefore, the bank’s strategy must be to increase retention and reduce loan churn. Longer loans are just more profitable, and the concept is shown in the graph below.

The importance of keeping loans.

Borrower Opportunity and 1031 Exchange

In 2022, a community bank offered a borrower a $4mm credit facility to construct a new car dealership. While this borrower was well known to the bank, the $4mm proposed credit facility doubled the bank’s exposure to this borrower. The borrower was in an expansion mode and was looking to aggressively grow the business.

Commercial loans are subject to amendments, collateral substitutions, cash-outs, and assumptions. But this borrower was especially active in the market and would not need the credit facility for longer than two to three years. The banker proposed a 20-year ARC loan knowing the possible changes in the loan’s life. The borrower bought in. But why?

The lender explained the flexible nature of the 20-year ARC loan and how it can benefit the borrower’s needs. The loan is structured to be assumable, assignable, and expandable to fit the borrower’s future expansion needs. This creates value for the borrower, allowing the bank to price with additional credit spread and keep more loans.

This year, borrower sold the car dealership financed by the $4mm credit facility in 2022 and is using a 1031 exchange to sell the existing car dealership and buy another larger property and increase the size of the business. That initial ARC loan has 17 years left to maturity. Instead of prepaying the ARC loan and collecting the prepayment fee, the borrower will increase the loan to a little over $8mm and retain the economics of the initially booked $4mm loan; the additional money will be priced at the current prevailing market rates with the same credit spread.

The following has been achieved in this strategy of keeping vs. making loans:

  • The borrower retains the bargain of a 20-year rate struck in 2022 (when rates were lower).
  • The bank increased loan balances to a profitable client and will generate additional hedge fees and loan origination fees.
  • The borrower did not go to other banks to obtain other loan offers. Other lenders may want this business and be willing to price lower or advance more money, but the borrower was interested in riding out the 17 years remaining on this credit facility.
  • It is likely that within the next 17 years this borrower will do another 1031 exchange, or transfer collateral or add money to the facility in some other way. This enhances the ability to keep this loan versus the need to make new loans.

Conclusion

Keeping loans is critical for a bank’s profitability. If the loan to finance long-term assets is worth making, it is worth making for the longest term acceptable to the borrower. Banks should also prefer longer term to allow the loan to amortize to decrease credit risk. The amortization of mortgage-style loans is small in the first five years and accelerates after five years on 20, 25, and 30-year amortizations. There is a vast difference between the strategy of making loans and keeping loans. The latter is the underpinning of relationship banking and creates value for both the borrower and the lender.

Tags: , , Published: 11/04/25 by Chris Nichols