PrecisionLender (PL) is providing revised origination and servicing cost standards for 2019. We have updated these recommendations annually for the last several years, and have again partnered with The Kafafian Group (TKG) to review and update these standard recommendations within the PL platform. Using TKG’s 2018 industry analysis as the foundation, PrecisionLender has developed an updated set of recommended standard values on costs, which we describe below.
A few of our clients have developed their own cost assumptions for origination and servicing, based on their banks’ internal operations. We continue to believe this represents the best information to use in the PL platform, when available. While the assumptions that are presented here are reasonable for many institutions, they do not represent any one institution by type or size.
Note: the scope of these standards relate to servicing and origination costs for loans and deposits products within the PL platform. They do not address other assumptions related to credit capital and annual loss inputs, collateral, facility rating, guarantee recovery rates, funding costs, or Target ROEs.
In this Article
- Marginal Costs Method
- Specific Details for 2019 from TKG
- Our Cost Structure
- Our Key Cost Changes Year Over Year
- 2019 Cost Assumptions Sample
- Cost Allocation Options Available in PrecisionLender
- Deposit Recommendations
- Changing to the New Cost Assumptions
- Implementing these Assumptions
- Potential Pricing Impact
Marginal Costs Method
PrecisionLender prefers the Marginal Cost method because loan and deposit pricing is based on making the right marginal economic decision for the next loan or deposit.
The TKG information is presented on a fully absorbed cost basis. PrecisionLender employs business rules to translate the TKG report information into estimated marginal costs for origination and servicing functions. From the TKG data, we use rules to determine the degree of:
- Direct costs—loan officers’ salaries, benefits, credit analysts,
- Indirect costs—accounting expenses, operations expenses, electric utility charges, general marketing expenses.
- Overhead costs—senior executive group compensation, and some selected functions.
Specific Details for 2019 from TKG
- Overhead costs represent about 20% of total expense.
- About 44% of origination costs are direct.
- About 8% of indirect costs flow into the marginal calculation.
- In sum, marginal cost is about 52% of total cost.
- The TKG sample size is approximately 24 institutions with median assets of $1.4 Their median efficiency ratio is 63.92% and median loan to deposit ratio is 98.46%.
- Please note that the TKG information generally provides us with information on commercial loans with average balances of $500,000 -$750,000 (The balance stratification level costs across the product set are based on PrecisionLender assumptions).
Our Cost Structure
PrecisionLender did not make any cost structure changes this year. We continue to use the same structure we introduced several years ago. Key components of this structure include:
- Channel definition to reflect the type of opportunity.
- The general origination distinction includes New Business vs Renewal or Multifacility.
- For construction loans, the channel distinction is Master Note vs Standard.
- For conversion loans, the conversion channel is available, which carries significantly lower costs than new business or renewal channels.
- The servicing distinctions include Standard vs Simple or MultiFacility
- Balance stratification levels, which were previously adjusted to $150,000, $500,000, $750,000 and $1M in 2016, following information from clients on authority levels.
- For a complete discussion, please see this article.
Our Key Cost Changes Year Over Year
- Commercial Installment (C&I) showed an approximate 10% decrease in origination costs and nearly unchanged servicing costs.
- Lines of credit posted a 19% increase in origination costs and 17% increase in servicing costs.
- CRE showed about 18% increase in origination costs and 5% decrease in servicing costs.
- Construction loans are little changed on the commercial side, but residential showed a 25% increase in origination costs.
2019 Cost Assumptions Sample
The Appendix shows tables with our latest recommendations for both loans and deposits. The Appendix also shows a comparison between PL’s 2019 and 2018 recommendations. The table below shows the cost changes between 2019 and 2018 for a single balance tranche and renewal/simple channel. Balance Tranche = $500,001 to $750,001.
Cost Allocation Options Available in PrecisionLender
The PrecisonLender platform offers several options for assigning origination and servicing costs to the accounts priced.
- Cost assumptions are assigned at the product level
- The solution stratifies costs by loan amount/balance
- In addition to listing costs per dollar tier, PrecisionLender offers the ability to set costs as a percentage of the loan amount for origination, or of the average loan balance for servicing, or a combination of all the options. This support article explains the steps.
- Servicing costs can also be set as a percentage of revenue (Net Interest Income in the PL platform). These can be separated or combined (i.e. a set dollar plus a percent of loan amount).
In the image above, 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. The Appendix includes an alternative to the standard tables to account for this situation.
Based on the TKG data, we made some minor changes in the servicing costs for various deposit products. We did not see enough material reasons to make changes to deposit capital, float and reserves, duration or annual fees. For specific details see the Deposits tab in the Appendix.
Changing to the New Cost Assumptions
Please note each client must take specific actions to adopt and implement these new 2019 standard cost assumptions. They do not happen automatically, and no assumptions will change without a client’s administrator implementing the changes.
PrecisionLender has published a how to guide to provide step by step instructions for making these changes.
Note: only the bank’s PL administrator can make these changes.
Implementing These Assumptions
Currently there is not an "easy button" that can be pushed to allow all of these new levels to be instantly placed in a client’s account. However this is something we are working to change.
In the meantime, you can use the "Replace With" functionality in product settings to update Origination and Servicing assumptions within in each product. For more information see Setting Up and Managing Origination and Servicing Channels.
For deposit products the number of modifications is much less than the origination and servicing channel values. However, these need to be changed individually. See Setting Up Deposit Products for steps on how to edit your deposit product assumptions.
Potential Pricing Impact
Changing to the new origination and servicing levels may result in a lower loan ROEs. Some institutions will expect their lenders to raise their pricing to achieve the same Target ROEs. This option may put the lender at a disadvantage in competitive markets. Others will adjust management’s expectations by lowering the Target ROE. Institutions may want to establish a few test loan types to determine the difference in ROEs under the recent and the newly-recommended defaults.