RMA-SOCL: A Practical Guide to Pricing for Risk (Craig Poms)
A Practical Guide to Pricing for RiskCraig PomsEVP, Chief Delivery Officer
Introductions & HousekeepingCarl RydenCEOcryden@precisionlender.com980-297-7110Craig PomsEVP – Chief Delivery Officercpoms@precisionlender.com980.297.7103PrecisionLender provides world-classloan & deposit Pricing ManagementSolutions to financial institutions.Clients – ~143 banks with assets from $50 million to over $180 billion.Usage – ~3,600 lenders and managers pricing $6 billion in commercialloans each quarter and growing.Experience – Direct experience deploying pricing solutions to over 500financial institutions.Please – Questions and comments are ALWAYS welcome AT ANY TIME.
It is All About RiskAbsent an illegal or immoraluse of the funds, all we careabout is getting repaid asexpected.
Why don’t we think aboutpricing the same way?Shouldn’t we apply the samerisk assessment when weprice?
What we hear…“As long as we think we will get paid back, we will take almost anything.”“The good deals are so incredibly competitive. Sometimes I’m scared when we WIN.”“I’m not sure that we are appropriately incorporating risk into our pricing. ”
From one of our client CFO’s:“In my 35 years in banking, what I have found to be true is that youtend toWin the Most, What you Misprice the Worst.”
The Pricing DynamicWe have been talking pricing with banks formany years and here is how we have come tothink about Pricing:
profit from precision – compete with confidence TMOur View of the Pricing Dynamic…17CompetitionPricingPortfolioRelationshipRelationshipRelationshipProfitabilityGoalsPortfolio Needs / Relationship Awareness
ImpactPricing loans anddeposits is the mostsignificant thing banksdo every day.Pricing is at the center of whatyou can manage.It is where the rubber hits the road – where your strategymeets execution. It is the most important lever that youcan pull as it directly and tangible impacts:Wins – Pricing determines which deals you win, whichdeals you lose.Profit – Pricing determines how much you get paid onthose that you win.Type – Pricing determines what types of deals you win(asset quality, duration, risk, collateral, rate structure etc.)Quality – Pricing determines the quality of the resultingrelationship.
AnAn effective Pricing Management System should have:+Profitability Modeling:• Industry standard math• Fully incorporate risk• Price full opportunitiesOn-going Management:• Proactively manage relationships• Manage products over time• Create & manage rate sheets• Comprehensive pricing reportsMeasure & Monitoring:• Real-time dashboards• Continuous relationships ranking• Monitor published rate sheets+1 2 3The Fundamental Components
AnAn effective Pricing Management System must have:+The Critical ComponentsEase of Use / Actionable Results• Intelligently guides & suggests alternatives• Lenders immediately see what drives profit• Empowers lenders to winTrust & Transparency• Never a “Black Box”• Consistent with common sense• Engages credit, risk, finance and sales / lending
• A disciplined and objective methodology to set loan prices based on riskis a necessity. Many banks pay lip service to this requirement but toooften cite the need to match the competition as a reason not to abide byit.To be effective, loan pricing should take into account the entirecustomer relationship, the loan loss provision and cost of risk, an equityallocation, the duration of the credit and its funding cost, and the riskrating of the credit.A secondary benefit to a disciplined approach to loanpricing based on objective factors is that it provides a solid defense fromcharges of unfair or discriminatory pricing in small business lending.• American Banker: Community Banks Must Stay Disciplined as C&I Lending Surges, Claude A. Hanley, Jr. and John R. Barrickman, MAR 5, 20133:00pm ET
Best Practices• A Proactive Approach to Pricing• Pricing used as a tool, in the moment, to Win More Deals• Pricing Used as a tool to build the kind of portfolio that you want to manage• Give lenders better knowledge of different pricing options• Lenders pricing the wayYou want them to• Improve cross-selling of deposits and other products• Understand the value of your existing relationships
Bad Practices• Pricing to the competition• Using spread as an indicator of price• Inconsistent pricing from loan to loan or lender to lender• Not understanding the value of your existing relationships
Not All Margin is Created EqualThe danger of reaching for yield:- You can create immediate margin by going out longer on the yield curvewith lower rated loans.- However, this will cost you over time in terms of increased loan losses, raterisk and capital requirements.
ImpactPricing today determines yourportfolio of tomorrow.Pricing with a Pricing Management System helps:Grow Your Portfolio – Empowering your lenders to winmore of the best deals in your market.Increase Profitability – Knowing what drives theprofitability on each deal and accurately comparing therisk-adjusted profitability of all new Pricing Opportunities.Strengthen Relationships – Empowering your lenders tofocus on the exact needs of each borrower and instantlyhand-crafting options that meets your borrower’s needsand meets or exceeds your profitability targets.Compete with Confidence – Consistently explore pricingalternatives that appropriately incorporate all aspects ofrisk is a powerful competitive weapon.Pricing helps you win and keep your best relationships
In Summary- Pricing is the most important thing you do- Pricing in terms of risk-adjusted ROE targets is critical- Pricing needs to be a discipline