In a previous article [here] we discussed why community banks need product managers to ensure that financial products and services are effectively developed, launched, and managed to meet customers’ evolving needs and the bank’s risk and profitability goals.  In this article, we provide a concrete example of how product management in lending might work. Our example will be to incorporate a loan-level hedging platform to drive product innovation. We have seen hundreds of community banks introduce this product with minimal cost for excellent short and long-term results.

Product Management in Lending – The Strategy of a Loan-Level Hedging Program 

The goal of product management in lending strategy is to create value versus your competition in credit. The basic premise of bank product management is having the right strategy, using the right tactic, in the right channel, for the right product, at the right time, for the right customer, and having it serviced by the right employees.

Having a hedging program opens a wide array of benefits versus the competition all for the benefit of your customers and shareholders.

The reason that loan-level hedging makes a good fit for many community banks is as follows:

  • Loan level hedging increases life-time value of a customer by extending loan duration, increases cross-sell opportunities, and may attract liquid borrowers who may have both funding and deposit product needs.
  • Community banks may not need to hire new product or risk managers, since loan hedges are an addition to an existing product – a commercial mortgage. This makes the product easier and faster to implement.
  • The product is appropriate for longer-term credit commitments because it mitigates both borrower and lender risk, creating certainty of payments for the borrower and stable margins for the lender.
  • The product is an effective way for community banks to generate more non-interest income which is an important profit driver for most banks.
  • Not all customers are the right fit for the product. However, borrowers who want a long-term relationship with the bank, have multiple financing needs, and a need for multiple banking products are both profitable and a good fit for loan hedging.
  • The best aspect of a loan hedging program is that the sales team is already in place at the community bank – the commercial relationship manager or lender. The product also makes the relationship manager more profitable by offering more value to the borrower.

Building a Product Team: For community banks adopting loan-level hedging, the team should include the following managers: a) chief lending officer as the product manager or product champion, b) chief credit officer or chief risk officer as the product risk manager, c) existing marketing team to handle branding, positioning, advertising, and marketing, d) loan operations to handle billing and payments, and e) if a bank has an existing profitability analyst, that analyst should be administering fund transfer pricing, RAROC profitability, and loan and deposit level margins. A loan-level hedging product is an adjunct to what banks already manage – commercial mortgages, making the product easier to implement and manage.

Understanding and Establishing the Product: Many community banks are facing competition from larger banks that already offer loan-level hedging.  Therefore, many banks will use the product defensibly to retain existing customers.  However, responding and pricing to competition is not always an optimal strategy.  Community banks should understand the cost, risk, and reward of loan hedging when setting pricing and targeting customers.  Community banks must understand what problem a loan hedge is solving for the borrower, what value proposition the bank is offering relative to competitors (ease of use, ease of maintenance, options for borrowers), the added risk to the customer, and what alternatives are available to the customer.

Developing A Strategy: Community banks will want to position loan-level hedging to take advantage of the competition, reach some risk or revenue objectives, or achieve some other goals for the bank.  We have seen community banks use the following strategies effectively for loan-level hedging:

  • We have seen community banks label their commercial mortgage/hedge as “Turnkey Construction Loan.” Where the bank offers a single closing construction with permanent take-out financing, where pricing is fixed at inception. This offers the borrower reduced pricing risk, but also offers the community bank a longer and more profitable credit facility.
  • Other community banks target cash-rich businesses with commercial loans/hedges and offer zero-cost closing. The bank pays for appraisal, title work, and other reasonable closing costs through the hedge fee generated by the product.  Depending on the structure, the average closing costs paid by the bank represent only 10 to 25% of the total hedge fees that the community bank can generate from the product.
  • Our favorite strategy, deployed by a few banks in the market, is to position the commercial loan/hedge as balance sheet financing versus project financing. For example, a community bank may call the product “XYZ Bank Portable Financing.”  The ability to move the loan from collateral to collateral, creates substantial value to some borrowers whose business model requires cycling different projects or business, but the consistent theme is that the borrower wants a long-term relationship with the bank.  The strategy creates higher loan revenues for the bank (in the form of net interest margin (NIM) and fees), higher future upsell business, and opportunities for cross-selling other bank products.

Marketing Plan: If the product is used strictly defensively, a marketing plan may not be required.  However, if the product is aimed at winning new business, or proactively converting existing clients, then management needs to create a direction and application for a loan/hedge product.  We have seen community banks with expertise in manufacturing, fishing, government contracting, and veterinary practices all utilize the loan/hedge product to retain existing business and win new business by applying the product to existing and well-known customer segments.

Sales Communication and Training:  All banks should want to avoid reputational risk associated with a new or more nuanced product, and this is especially the case with loan-level hedging.  The sales team (commercial relationship managers and lenders) must be given upfront, ongoing, and customer-facing support to be able to identify appropriate prospects, explain the product, and establish suitability (both the lender and borrower must agree on the product fit).  This is where simplicity of the product is key. A well-defined agreement is better than nebulous documents, concise is better than voluminous, and ongoing simple customer maintenance is better than asking borrowers to get involved in derivative accounting.

Support Model:  Every product must have customer support, and banks either need to develop the support inhouse or through a trusted vendor.  Proper internal training, external training content, and outsourced vendor support are key to establishing an effective and profitable loan/hedging product.

Risk Management:  Every product has risk that must be managed, and not using a product comes with its own set of risks.  The CCO or CRO must understand the additional risk and risk mitigation that a loan/hedge product introduces to the bank’s balance sheet.  The most essential elements that bank managers must appreciate with the product is trust and reputational risk.  If the product is not explainable to the borrower, and if the borrower does not understand the risks associated, then it should not be sold.  The mitigant is that often the loan/hedge product can be tailored to the borrower’s timeline and structure, to offset or reduce risk to the customer by controlling terms, dollar amounts, or adding prepayment options.

Action Items

Increasing lifetime customer value, fee income and retention rates should be the goal of community banks when identifying new products. When it comes to product management in lending, growing and tracking profitability on a risk-adjusted basis is also a paramount goal. A loan-level hedging program, as an adjunct to a commercial mortgage, may be just the right product for community banks that are seeking to achieve the above goals.








Tags: , , , Published: 06/25/24 by Chris Nichols