Each year, PrecisionLender partners with The Kafafian Group (TKG) to review and update the PrecisionLender platform’s default recommendations for loan origination and servicing costs as well as deposit servicing costs and fees. Using TKG’s 2017 industry analysis as the basis, we have developed an updated set of recommended default values on costs, which we describe below.
Note that the scope of these changes only relate to servicing and origination costs for loans and deposits products within the PrecisionLender platform. It does not address other assumptions related to credit capital and annual loss inputs, collateral, facility rating, guarantee recovery rates, funding costs or Target ROEs. Any questions or assistance needed on these other key assumptions or the contents of this article should be directed to your Client Success Manager (CSM) or to our Support team at firstname.lastname@example.org.
Changes in 2018
Increases and Decreases
Most of the changes this year are minor in nature. We continued to use the same structure we introduced two years ago. Commercial Installment (C&I) origination and Commercial Real Estate servicing saw the most significant upward movement this year. There were a few additional minor increases in some other products. However, there were a few cases, based on our data set, in which the levels declined. The information we received showed a continuation of the strong lending trend evident in last year's data. The increase in the lending base allowed the fixed or indirect cost component to be spread further, for a net per unit decrease. This partially offset the increase in expenses due to inflation, salary growth, and compliance costs.
Marginal Costs Method
In our 2016 article on this topic, we discussed the difference between the "Fully Absorbed" method and the "Marginal Costs" method. Fully absorbed includes both direct (loan officers’ salaries, benefits for credit analysts, etc.) and indirect (accounting expenses, electric utility charges and general marketing, etc.) costs. We use marginal costs, in which the direct costs are accounted for, but only a portion of the indirect costs are included. We prefer this method because loan and deposit pricing is based on making the right marginal economic decision for the next loan or deposit.
We will provide, however, both the PrecisionLender recommendation that uses the marginal cost method as well as the TKG fully-absorbed median for their clients. A more detailed description of the methodology we used can be found in the 2016 article.
General Overhead Expenses
The general overhead expenses (i.e. - the senior executive group’s total compensation, general marketing expenses, and various accounting functions like regulatory reporting) have been about 20.6% of total cost, compared to 19.7% last year, based on the TKG data. Based on our methodology, we continue to use an assumption on loan origination that about 53% of the total cost is marginal direct cost. We used a slightly higher figure for Commercial Real Estate loans. However, on the servicing side we continue to remove only the general overhead expense. Thus, the PL recommendations are modifications of the TKG figures (Modified TKG).
It is important to note that the TKG information generally provides us with information on commercial loans of about $500,000-$750,000. The levels in the other categories are based on PL assumptions.
New Loan Recommendations
This downloadable appendix shows tables with our latest recommendations for both loans and deposits. The appendix also shows a comparison between PL's 2018 and 2017 recommendations - though in most cases the changes are minor. The table below provides PrecisionLender's new recommendations for the $500,000-$750,000 balance for various products.
The two tables in this section show the TKG fully-loaded information, which is the basis for the table above and the tables in the appendix. This section shows the comparison between their most recent report for 2018 and the data used last year.
The data above is the median for a sample of about 30 banks and thrifts. These institutions have a median asset size of about $1.3 billion and are mostly located on the East Coast, particularly the mid-Atlantic region. The average efficiency ratio for these institutions is 64.45%. They also have a loan-to-deposit ratio of about 97.0%. As such, for banks in lower cost areas, or those with low efficiency ratios, the default amounts shown might be higher than the bank’s actual experience. However, for institutions in high cost areas or with a high efficiency ratios, these costs may be too low.
We use a similar number of banks each year, but the included institutions vary slightly as clients of TKG are acquired by other banks and leave and new banks become customers. As such, an exact comparison of the median TKG data each year on a “same stores” basis is not possible.
New Methods to Account for Costs in PrecisionLender
PrecisionLender continues to offer more options to account for costs in its platform. In addition to listing costs per tier, in 2016 we introduced the ability to set costs as a percentage of the loan amount or average balance (for servicing), or a combination of all the options. In 2017 we introduced the ability to set servicing costs as a percentage of revenue (Net Net Interest Income in the PrecisionLender platform). These can be separate or combined (i.e. a set dollar plus a percent of loan amount).
In the past, a loan with a committed amount of $499,999 would show a higher ROE than one at $500,002, because the origination and servicing expense could be considerably higher for the latter loan. Using a percentage of the loan amount in addition to a set dollar can smooth out these discrepancies.
In the appendix we have included an alternative to the standard tables that accounts for this situation.
Based on the data, we made some minor increases in the servicing costs for commercial and consumer DDA. While the TKG data showed some other changes, we felt these were not material enough for us to make modifications to the other categories.
Changing to the New Defaults
Please note each client must take specific actions to adopt and implement these new 2018 default assumptions. They do not happen automatically, and no assumptions will change without a client's prior approval. To see the method to facilitate implementing these changes, visit this article on our support site. Note: Only the bank's PrecisionLender administrator can make these changes.
A few of our clients have developed their own costs for origination and servicing, based on their banks’ internal operations. We continue to believe this represents the best information to use in the PrecisionLender platform when available. While the default assumptions that have been discussed are reasonable for many institutions, they do not represent any one institution by type or size. For greater detail on the method used to determine these defaults please read this article.
If you have any questions or comment please contact us at 980-297-7100 or support.precisionlender.com.