RMA-SOCL: A Practical Guide to Pricing for Risk (Craig Poms)

A Practical Guide to Pricing for Risk

Craig Poms EVP, Chief Delivery Officer

Introductions & Housekeeping

Carl RydenCEO

cryden@precisionlender.com980-297-7110

Craig PomsEVP – Chief Delivery Officercpoms@precisionlender.com

980.297.7103

PrecisionLender provides world-class loan & deposit Pricing

Management Solutions 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 commercial loans each quarter and growing.

Experience – Direct experience deploying pricing solutions to over 500 financial institutions.

Please – Questions and comments are ALWAYS welcome AT ANY TIME.

It is All About Risk

Absent an illegal or immoral use of the funds,

all we care about is getting repaid as

expected.

Why don’t we think about pricing the same way?

Shouldn’t we apply the same risk assessment

when we price?

We would like to propose a name change

RAMA

The Risk Acquisition and Management

Association

It is as much about how we Acquire Risk as it is about how

we Manage Risk

Isn’t this how we make money?

Risk Acquisition is not just about Marketing and Sales

It is also about how we use Pricing in the Risk Acquisition

Process

Using Pricing to proactively acquire and manage risk is sorely missing in most

banks today

How Do You Price Today?

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 you tend to

Win the Most, What you Misprice the Worst.”

How Would You Like to Price?

What we hear…

“You want to be a price maker, not a price taker.”

“You can’t bring emotion into pricing. The pricing has to have structure.”

What should drive our pricing?

The Pricing Dynamic TM

The Pricing Dynamic

We have been talking pricing with banks for many years and here is how we have come to think about Pricing:

profit from precision – compete with confidence TM

Our View of the Pricing Dynamic…

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Competition

Pricing

Portfolio

Relationship

Relationship

Relationship

Profitability Goals

Portfolio Needs / Relationship Awareness

Impact

Pricing loans and deposits is the most significant thing banks do every day.

Pricing is at the center of what you can manage.

It is where the rubber hits the road – where your strategy meets execution. It is the most important lever that you can pull as it directly and tangible impacts:

Wins – Pricing determines which deals you win, which deals you lose.

Profit – Pricing determines how much you get paid on those 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 resulting relationship.

Pricing Environment

Today’s Concerns

#1: Low point in the rate cycle

Today’s Concerns

#2: When rates will rise

Today’s Concerns

#3: BASEL III will increase Tier 1 capital requirements

#4: Capital is scarce

So What Can You Do?

Adopt a pricing system based upon risk-adjusted ROE targets

How is Pricing Used Today in Your Bank?

How is Pricing Used Today in Your Bank?

Is it reactive to the competition?- You don’t match the competition

in their assessment of credit risk, then why match their assessment of pricing risk?

How Should Pricing Be Used Today in Your Bank?

Is it used proactively to build the portfolio that you want to live

with in terms of both interest rate risk and credit risk.

How Do You Factor In Risk Today?

Can you accurately adjust pricing for: Credit Risk? Interest Rate Risk?

Collateral Risk? Guarantees?

How Do You Factor In Risk Today?

Can you quantify the effect on your rate for:

Credit Risk? Interest Rate Risk?

Collateral Risk? Guarantees?

What About Accounting for Relationships?

Can you quantify the Strategic Value of your Relationship?

Multiple loan facilities Deposit accounts

Other fee based business

Pricing Management System

AnAn effective Pricing Management System should have:

+Profitability Modeling:• Industry standard math• Fully incorporate risk• Price full opportunities

On-going Management:• Proactively manage relationships• Manage products over time• Create & manage rate sheets• Comprehensive pricing reports

Measure & Monitoring:• Real-time dashboards• Continuous relationships ranking• Monitor published rate sheets

+1 2 3

The Fundamental Components

AnAn effective Pricing Management System must have:

+

The Critical Components

Ease of Use / Actionable Results• Intelligently guides & suggests alternatives• Lenders immediately see what drives profit• Empowers lenders to win

Trust & 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 risk is a necessity. Many banks pay lip service to this requirement but too often cite the need to match the competition as a reason not to abide by it. To be effective, loan pricing should take into account the entire customer relationship, the loan loss provision and cost of risk, an equity allocation, the duration of the credit and its funding cost, and the risk rating of the credit. A secondary benefit to a disciplined approach to loan pricing based on objective factors is that it provides a solid defense from charges 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, 2013 3:00pm 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 way You 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 Equal

The danger of reaching for yield:

- You can create immediate margin by going out longer on the yield curve with lower rated loans.

- However, this will cost you over time in terms of increased loan losses, rate risk and capital requirements.

Let’s See the Pricing Dynamic in Action…

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Impact

Pricing today determines your portfolio of tomorrow.

Pricing with a Pricing Management System helps:

Grow Your Portfolio – Empowering your lenders to win more of the best deals in your market.

Increase Profitability – Knowing what drives the profitability on each deal and accurately comparing the risk-adjusted profitability of all new Pricing Opportunities.

Strengthen Relationships – Empowering your lenders to focus on the exact needs of each borrower and instantly hand-crafting options that meets your borrower’s needs and meets or exceeds your profitability targets.

Compete with Confidence – Consistently explore pricing alternatives that appropriately incorporate all aspects of risk 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

THANK YOU

blog.precisionlender.com

Craig PomsEVP – Chief Delivery Officercpoms@precisionlender.com

980.297.7103

Carl RydenCEO

cryden@precisionlender.com980.297.7110