Do you measure a relationship by the size of the assets under management? Or do you focus on the profitability of the relationship? Most banks do a good job of tracking assets under management, but understanding the profitability is not as easy. You must first define what profitability even means in this conversation. 

• Total Expected Profitability - The profitability analysis your bank built back when your won the relationship.
• Historical Profitability – Looking back look at what the relationship has delivered to this point.  We can think of this as the Historical Profitability.
• Strategic Value - The value of future business payments that have not yet been received. (More on this below.)

These three examples are just a few of the possible definitions available. There are so many ways to define profitability that the conversation can become muddled and progress can grind to a halt. We’ve seen many high priority projects fall apart because management didn’t take the time to define what profitability means to them. 

The argument for using Strategic Value

At PrecisionLender, we typically think of relationship value in the context of an opportunity to win, or possibly lose, something of value. What future business might be lost if we let the competition steal away a piece of an existing relationship?  Therefore, we recommend focusing on the value of future business payments that have not yet been received – i.e., the “Strategic Value.”

Another way to think about Strategic Value is to imagine the value that your competition sees.  Assume your customer is talking to another bank and has told them everything. They know about the rates you are receiving, the structure of your loans and the deposits associated with this relationship. There’s nothing they do not know. In this context, it’s easy to see that they could never steal away the payments that you have received to this point, but they can certainly steal away they payments yet to be made.

• What value does your competitor see in those future payments?
• How will they use that value against you?  

Measuring your bank’s relationships through the eyes of your competition can help you identify areas where you are most exposed.

Which relationships deserve my immediate attention?

The textbook answer here is, “All of them.” But in the real world of limited time and resources, ​your RMs should start with renewals. Renewals are a time when borrowers like to rate shop. Getting ahead of this shopping event can prevent some last-minute surprises. Identify the relationships that have something renewing in the next 3-6 months, then determine which renewals belong to relationships with high Strategic Value. 

Let’s look at two different relationships that both have a $1MM LOC coming up for renewal. Assume both relationships contain what we’ll call “average or normal” risk.

• Relationship A - $25MM of total loan activity spread across a couple of CRE loans, this LOC and several smaller C&I deals. You have their operating account, which also generates meaningful income.
• Relationship B - $10MM of total loan activity spread across a similar mix of products. You also have their operating account, which generates a similar amount of income.

On the surface, Relationship A may seem like the more valuable relationship, since it has a larger amount of assets under management. But we haven’t discussed the pricing of those assets yet.

• Relationship A strong-armed their RM at every step of the process. Their loans were priced very aggressively, and they forced the bank to lock those rates in for longer terms. As rates have risen, margins have been compressed. 
• Relationship B, on the other hand, appreciated the bank’s guidance and expertise. They chose adjustable rate loans that allowed them to take advantage of the lower rate environment. But as rates have risen, the bank has been able to manage the interest rate risk. The future earnings from this relationship continue to deliver a healthy NIM.

By using the Strategic Value approach, your RMs would understand the value the competition sees in the smaller relationship, due to its more profitable pricing structure. Even though Relationship A will threaten to take their business elsewhere, the RM should have the confidence to demand a premium when renewing their LOC. Other banks will not have the ability to match the rates that were locked in during the lower rate environment. 

The approach on Relationship B however, might be different. Knowing that they offer meaningful value to a courting bank, your RM might consider a more aggressive offer to keep them happy and safe with your bank. An offer to engage in meaningful pricing discussions before the renewal date may allow the RM to lock in pricing before they talk to another bank, as well as build trust and goodwill.

I’ve identified an exposed relationship … now what?

While performing these types of relationship reviews, you ‘ll likely find a relationship that is ripe for the taking. Before hitting the panic button, consider the true position of the relationship.

• Have they been a rate shopper in the past?
• What other business do you have that makes them “sticky”?
• Have you seen any signs that suggest they may be talking to another banker?

Don’t forget that your RMs’ customers do see value in their knowledge and expertise. (If they don’t then your bank has issues that go well beyond what we’re covering in this blog post.) They aren’t always willing to trade that for a quarter-point in rate. 

For the sake of this conversation however, assume the threat is real. A risk vs. reward analysis seems appropriate here. Your RMs should begin by having a conversation with the customer. What do they feel is fair? What would they offer in trade for the more aggressive pricing? 

• Could your bank win their deposit relationship?
• Do they have other needs your RM could help solve?

If the RM were to offer them what they ask, and get something of value in return, what’s the result?  Did they lose profitability or gain it? They should run a scenario that compares the current profitability to the new proposal.  How bad does it hurt? Or does it even hurt at all?

Next RMs should review the rest of the relationship. Assume they lose the loan that is being renewed. How does that affect the relationship’s overall value? Is there anything else that another bank might consider attractive? How bad would it hurt if your bank lost the most valuable pieces of the relationship? Could losing this particular loan be the trigger that leads to the eventual loss of the entire relationship?

By comparing what needs to be done and what could be lost, your RMs get a much better understanding of the price they’re willing to pay to keep the business. In many cases, banks have seen that sacrificing $400 or $500 of profitability on a renewal can save tens of thousands of dollars across the rest of the relationship. 

Where have my customers fallen short?

Your RMs spend most of their professional life focused on the promises they’ve made and how they can deliver on them. But what about the promises that have been made to the RMs and your bank?

Consider a very common scenario. The RM agreed to price an operating LOC fairly aggressively, because their customer promised to transfer their cash management services over to your bank. A year has passed and it’s time to renew the pricing on the LOC. Your RM builds a quick pricing scenario and sees that maintaining the same spread on this LOC will result in the same undesirable return. In addition, a review of the relationship shows that the cash management services never came to be.

How do your RMs handle this situation? Did they even remember that the additional fee-income was promised? 

Getting your RMs to regularly asking those questions about their relationship is a significant step. But once they get in that habit, you need to be sure your bank is set up to provide them the answers they need, in a timely fashion.

PrecisionLender has helped sales leaders at more than 200 banks worldwide provide their RMs with this critical contextual information. Click on the button below to learn how your bank can better understand its relationships.