Correspondent Blog

The biggest surprise for bank managers using risk-adjusted return on capital (RAROC) loan pricing models is the low return on equity (ROE) on smaller, shorter, and lower-credit quality commercial loans.  Those ROEs tend to subtract substantial value from the bank and show negative returns – sometimes in the negative double digits.  However, one aspect that…

Optionality is defined as a state in which choice or discretion is allowed. In finance, optionality is an asset (has value) for the person who can exercise the option, while the person who gave the option has the liability.  Selling options for above their value can be a profitable business for banks and brokers, but…

Most borrowers are implicitly expressing a view that interest rates will be lower in the future than the current market expectation. This view is reflected by a sharp decrease in the average contractual loan commitment term at community banks and an increase in floating vs. fixed rate structures. Borrowers are choosing short-term financing in anticipation…

In last week’s article (here), we discussed why category and geographic diversification may be unfeasible for many community banks.  We concluded that after a community bank sets limits on loan categories, the added benefit of geographic or loan category diversification is nullified.  We discussed three main reasons why community bank diversification by geography and loan…

We estimate that the average contractual loan commitment for term credit at community banks has decreased from just under five years in 2022 to just under three years currently. The primary reason for this shift is not a change in borrowers’ business models or banks’ preference for repricing term loans, but rather, borrowers’ decision to…

In our previous articles (here and here and here) we discussed some of the drivers of commercial relationship profitability. In this article, we consider and define relationship banking and how relationship banking can increase commercial loan profitability. What is Relationship Banking We define relationship banking as a model focused on a consultative banking approach.  Bankers…

In two previous articles (here and here) we discussed how loan size and loan term affect the profitability of commercial loans.  We continue this theme of major drivers of loan and bank profitability and discuss the importance of cross-selling and upselling, and its impact on bank performance.  In this article, we consider the common features…

In a previous article (HERE), we discussed several factors that drive loan and bank profitability. We covered in detail how and why community banks can increase loan size to improve return on assets (ROA) /return on equity (ROE).  In this article, we will consider how and why loan term is a significant driver of profitability…

Several measurable factors drive loan (and, by extension, bank) profitability, including loan size, credit quality, term, cross-sell, and upsell.  In this article, we will consider how and why loan size is one of the most significant drivers of profitability for community banks and what community banks can do to improve performance. Relationship Between Loan Size…

Since our last update on pricing and credit HERE, commercial loan pricing trends for the first quarter of 2024 continue to be driven by the perceived increase in credit risk, tighter credit supply and banks’ need for wider margins. This article provides an update on pricing trends driven by our Loan Command aggregated community bank data and…

Community bankers need to practice realistic loan pricing discipline. However, we need to understand the meaning of pricing discipline and its effect on community bank performance. In this article, we would like to define loan pricing discipline and cover bid, why it matters, and demonstrate how most community banks currently are not using loan pricing…

A typical current strategy for community banks when originating commercial real estate loans is to offer floating-rate loans or shorter-term adjustable structures.  Borrowers are waiting for the Fed to lower short-term interest rates, hopefully translating into a refinancing opportunity for the borrower at a lower loan rate.  Unfortunately, this strategy has all the underpinnings of…