to decline soon. All of these are common reasons to consider locking in loans at rates below prime. But let’s not forget about the increased cost of funding these loans. Banks that have a disciplined pricing model can easily calculate the profitability impact of today’s environment. This should include a profitability analysis of the full customer relationship and not just loan profits. Decisions to offer commercial loans at rates less than prime should be based on sound pricing analytics. LoanPricingPRO® Scenarios Two years ago, the average commercial customer typically had loans with rates 40-60 bps over prime as well as significant non-interest-bearing deposit balances. The value given to these deposits through a funds transfer pricing process allowed for very competitive pricing on the loan. The example below shows a floating rate loan priced at prime with profitability slightly below the target. But, after adding the compensating non-interest-bearing deposit, the full customer relationship return on equity exceeds the bank’s minimum target levels. June 2021 — Floating rate loan at prime and large non-interest bearing deposit. Fast forward to today. If this loan has been renewed or replaced at a “prime minus” rate, the relationship may still be profitable if the cost of those same deposits hasn’t increased by more than the change in market rates. But, if the rate paid on those deposits has increased substantially or if they have moved to a high-yield CD or money market account, then the value of these deposits has fallen, and they are no longer providing support for a lower loan rate. In this case, the loan rate needs to have a much higher “prime plus” rate to compensate for the higher deposit cost. Current environment — Floating rate loan at prime minus 100 bps and large NIB DDA. Current environment — Floating rate loan at prime plus 100 bps with high-cost deposit. 10 West Virginia Banker
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