Repricing and Refinancing a Lucrative Deal [Podcast]

January 30, 2018 Maria Abbe

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If it's lucrative, the competition is going to want it and they're going to have the ammunition to go after it.

In this episode, Jim Young sits down with George Neal to discuss why you would want reprice your best deal. 

   

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Podcast Transcript

Jim Young: Hi, and welcome to the Purposeful Banker, the podcast brought to you by PrecisionLender, where we discuss the big topics on the minds of today's best bankers. I'm your host Jim Young, director of communications at PrecisionLender. Today I'm joined by George Neal, our EVP of analytics here at PrecisionLender. But we're actually going to be asking him to put on his old well worn banker's hat and talk about when and why you should consider repricing a lucrative deal.
 
George, thanks for coming on the show.
 
George Neal: Certainly. I've been in banking, or prior to joining PrecisionLender anyway, I was in banking for more than 20 years. In that capacity, I worked in analytics, credit policy, working with both consumer and commercial credit facilities. More recently, I've had the opportunity to work with a great team here at PrecisionLender. We work with more than 200 banks, priced more than a trillion dollars worth of loans and my team is responsible for driving value out of that data that gets generated and returning that value back to our customers.
 
Jim Young: All right. So then I think you passed the initial test, we'll let you continue on in the podcast here. And I'll start off with the obvious question here. If I already have a lucrative deal, why would I want to reprice it or to put it in terminology that my mom in South Carolina might use, why fix something that ain't broke?
 
George Neal: Well, you first have to consider if you're talking about a deal that is so lucrative that it's drawing your attention to it, I would argue that it is broken. And it is broken for a couple of reasons. First of all, if you were to try to pick the most shiny red pickable apple in a bank that your competition is going to come up and grab, it's probably that deal. If it's that lucrative your competition is going to be drawn to it and they're going to have ammunition to take that relationship away from you.
 
Secondly, even if they don't take it away, there's a level of inherent reputational risk that comes with maintaining what to your customer is going to look like as a one sided deal. Remember, unfortunately, as consumers and as customers in the commercial market, memories are relatively short term. Very few people think about well, this deal was fair when I made it. They think about is this deal fair to me right now and if it isn't whose fault is that. And very few people are willing to say it's mine when they can say it's the banks.
 
Jim Young: And also they could also then saying, could I get a more fair deal somewhere else basically.
 
George Neal: I don't think they even have to say that. I think people are going to come to them and tell them that that is the case.
 
Jim Young: All right. Let's just say though for the sake of this thought experiment that your customer actually isn't really mad about the current deal, maybe they're not paying close enough attention, they're doing pretty well elsewhere and they're not that focused on it. Maybe the competition isn't that, is there still a reason that I should consider repricing that deal?
 
George Neal: There is, and we'll start kind of with the most academically supportable one. If you can say that the long term value of repricing that deal is better than the current value of the highly lucrative structure you have, there's certainly a reason to look at repricing. And that can manifest through any of a number of ways. If it enhances your ability to cross-sell, to get noncredit products for example. Let's say that through restructuring this very lucrative loan we're able to gain some Treasury revenue or we're able to gain additional deposit base or whatever is driving your NCR, your non credit revenue, that may very well justify letting go of a little bit of that interest margin or a little bit of that lucrative nature of the deal.
 
When I say it's the most academically supportable, net present value of one relationship over net present value of another relationship, all CFOs are going to like that and basically in banking we deal with a lot of these kinds of things.
 
On the other hand, you also have this kind of a femoral concept that you know what the long term value is of a deal. A lot of banks will call that into question. My argument or case back to that is, that is the fundamental job of your relationship manager. When your relationship manager properly focuses on building a right relationship with your customers. When they're building the kind of relationship that builds long term value and brand equity for your bank, they have a very clear view of what the long term value of that relationship could be. If they don't, perhaps they need a little bit more market experience or something else but most of the great relationship managers that I've had the privilege of working with are very good at that, the view that as their core competency. Their job is to understand that relationship and know where it can and should go.
 
Jim Young: Is that enough then to to push back when you get the argument of look, I'd rather, this is profitable, this is good now, I'd rather have that certainty rather than the hope or anticipation of greater profitability later?
 
George Neal: In most cases for what I think are very good relationship banks in the commercial market, yeah, that's enough, that should be enough. We trust our relationship managers to do the right things for our banks, to do the right things for our customers and we should have faith in them when they come to us and say I understand that this deal is highly profitable but this company, this customer, this relationship is going to develop in a beautiful way and we need to support them and to support this relationship and make sure that we're viewed as a great partner and a great organization to work with.
 
There is another piece of this however. We here at PrecisionLender talk about a thing called strategic ROE. And I think that that comes into play here in a very strong way. Strategic ROE in PrecisionLender speak is the return that the market would expect or the market value of this loan right now. And one of the problems that we can easily find ourselves in as banks is you say okay, I know what the profitability of this deal is. You're talking about a funds transfer priced profitability. That's all inside baseball, right? No one in the client space understands RFTP. Our competition doesn't care what our internal funds transfer price is. They care what the value of the deal is on the street today, and if we're overpriced that carries with it a problem.
 
So, is there a reason to go out and say, yes, you should look at repricing these deals even though you don't have a whole lot of belief in the future value of the developed relationship? Yeah, there is and that is that these are going to draw competition. It's easy to see where these relationships are overpriced, they're out of market, they're going to cost you. They're going to cost your reputation, they're going to cost you time on your relationship managers, you're going to throw away all the equity you've spent building that relationship and you're going to burn brand equity.
 
As a bank, we never want to be in the position where we're only rewarding squeaky wheels and we get that reputation out on the street. You don't want to be the bank where your customers know that the way to get repricing is to threaten to leave. That damages your brand, it damages your ability to operate in the market and it doesn't build brand loyalty.
 
By contrast, if you have the opportunity to come out there and say, look, you don't have to threaten to leave. I see that this is out of line. I can make this right for you. That builds the kind of credibility that can't be bought at the time of initial pricing. Everybody when they're initially pricing a loan is going to do their best to make the deal work, but to make the relationship work, to make the long term bond between the bank and the client successful, that's hard equity to buy. But a simple transaction where you say, hey look, I realize this is out of line with the market, let's fix it, sometimes that's all it takes.
 
Jim Young: That's really an interesting way of putting it because I think the two examples in my own personal life, one is my insurance company to which I'm tremendously loyal and literally today I was telling someone you really should try, have you looked with these guys because they send me unprompted almost every year as long as I've been driving pretty well, you know, I get a rebate check. And it's hey, look, the market shifted while, in between, because I pay twice a year and in between the market shifted and actually you didn't need to be paying that much. That's tremendous. Do I have any idea if it what their rates are compared to everyone else? No and I don't care.
 
George Neal: I don't think that banks have to come back and refund money to their clients, no one's expecting that but the ability to say, hey look, we realize we're out of market, perhaps you've been out of market a little while. So you reap some benefit from that. Be honest about it. We realized you're out of market. We're going to take a look at this relationship and see if we can do something for you. That builds the kind of brand equity that we need as banks given all the competition that's coming in from other banks, non financial institutions, financial innovations locally and globally. Our space is being inundated in many cases because banks aren't as trusted as they once were.
 
Jim Young: Right. And on the not trusted part of it when it comes to various, you know, a lot of times, I don't want to pick on cable companies but sometimes that's one of the ones that TV packages, it's, oh well, you just got to threaten to leave and I got this much knocked off and it's like ... Again, with your hypothetical bank customer, they have talked to their other colleagues and friends who are also customers at banks and say if that's the case, it's not just hey, I went and I was a squeaky wheel and I got it knocked off, it's sort of they could have been charging me less all along but waited until then and that's again, bad for your brand.
 
George Neal: Exactly. And at the end of the day what do we have? We've said it before, effectively we're dealing with money, it's a commoditized product. Yes, we all have different products, different structures etc. But the one thing that a bank has that other banks in its neighborhood don't is its brand. You have to defend it.
 
Jim Young: You made a compelling case here. Now if you are the CLO at my hypothetical bank, the first bank of Jim Young, how would you turn these ideas about repricing lucrative deals into reality? If I'm a bank and I haven't been doing this sort of thing before, what's kind of the steps that I should take to build this into a, as a regular process?
 
George Neal: I would start by saying that simply having a loan on the portfolio isn't enough. Of course all the banks take a look at the risk that's inherent on the portfolio but very few of them or not all of them, not very few, but not all of them look past the risk into the profitability and say I need to look at excessive profitability too and understand where I'm finding out of band profitability and what that means for this relationship.
 
So the first step I think is identifying those relationships that have loans that are mispriced to the current market and making certain that the strategy you have for that relationship corresponds to the strategy you have for that loan. Now, in many cases you'll find yes, I have a very lucrative loan the because I've taken a loss leaders in other places, I've earned that out. Great, that's in line with your strategy. Keep that long, don't let that go.
 
But if you find that you're in a situation where the market has moved and left you in an overly advantageous position with your customer, right, the ability to go back to that customer and say hey look, we're taking a look at this, we know what the market has done, that the market has moved. We believe that we can expand this opportunity and reprice this loan for you. That's a tremendous proactive act. It builds credibility, it builds confidence, faith, it builds brand. And those things are genuinely valuable.
 
So my first step is identify them. Figure out some way. We use strategic ROE which is effectively what's the street value of this deal. You can use whatever methods that you like and then the next step is when you identify those outliers at whatever level you think that outlier might be, align it to a relationship strategy. If it lines up, do nothing. If it doesn't, take the right action.
 
Jim Young: Would you also add in there that you got to have and you talked about it a little bit before, you've got to have relationship managers in place that you trust to be able to make some of those calls about where the direction of those relationships is going to go.
 
George Neal: Absolutely. It is effectively impossible simply looking at the numbers to predict the long term growth or shrink of a relationship over a period of five, 10 years. And these are the kind of time horizons that I think banks have to look at.
 
I work with a brilliant group of data scientist. I feel privileged every day to see their brilliance in action as they work through trying to identify can we do this. Can I say based on just the numbers how this relationship is going to grow? And the answer is to some extent but not nearly as well as someone who's in communication with that business partner, knows how their business is doing, knows the direction they're going to take. Are they going to zig left, or are they going to zag right? The numbers aren't necessarily going to tell you that but your relationship manager should know. And if we've empowered them properly, if we trust the people that we work with and we have the right people in place to make binding decisions, then the place where the decision needs to reside is pretty obvious.
 
Jim Young: All right. Well, that'll do it for us today. George, thanks so much for coming on the podcast and sharing your expertise.
 
George Neal: As always, it's a pleasure, Jim.
 
Jim Young: And thanks for listening. If you'd like to learn more visit our resource page at precisionlender.com. If you like what you've been hearing make sure to subscribe to the feed in iTunes, SoundCloud, Google Play or Stitcher. We love to get ratings and feedback on any of those platforms. Until next time, this has been Jim Young for George Neal and you've been listening to The Purposeful Banker.
 
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About the Author

Maria Abbe

As a Content Manager here at PrecisionLender, Maria develops the messaging, stories and content pieces for prospects and current clients – showing them the value in PrecisionLender. Her passion for serving others is evident as she leads the volunteer program here at PrecisionLender. Maria’s ability to be organized and constructive, along with her ability to be practical makes her an exceptional addition to our team.

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