deal? The largest loan opportunities drive our net interest income — we can’t afford to leave winning or losing to chance. What should our interest rate be? For what term? Is there a fee involved? Is the rate fixed? Is the loan structured as a balloon or an adjustable? How should the adjustable portion of the loan be structured in terms of price and term? Loan pricing solutions have been used by the “mega banks” and large regional institutions for years, while community banks sometimes just “throw a dart” to determine what a borrower will pay. Size is a Driver of Profitability The three main factors that drive loan profitability are 1) the creditworthiness of the borrower, 2) the term of the loan and 3) the size of the loan. Most financial institutions focus on the first two factors but ignore the third. Worse, the third is often the driver that results in the biggest rate differentiation. Small-dollar loans are not nearly as profitable as larger loans because the costs associated with underwriting and servicing must be considered. Even when varying the costs based on the size of the loan, this dynamic is still true. The smallerdollar loans simply don’t produce enough dollars of net interest income to cover even the most modest operating costs. Does that mean we always have to price up smaller loans to achieve our profit targets? Of course not — not if we have a customer relationship that is profitable enough to carry the smaller loan. However, it then becomes critical for us to have an easy way for our lenders to have customer profitability data at their fingertips. Overpricing Your Most Profitable Customers and Underpricing the Least Profitable Most banks overprice their largest, most valuable customers and underprice their smaller, least profitable customers. This is a troubling prospect since, as a result, we end up giving the best deal to 34
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