Declining Interest Rates and Pricing Loans

Overview

Based on current loan pricing assumptions, there has been a dramatic decline in market interest rates which has resulted in a drop in interest rates for new loans. This is especially true for fixed rate and adjustable rate types with an initial fixed period of 3 to 7 years.

For example, from mid-November 2018 until mid-August 2019, the five-year point on the 3 Month LIBOR-Swap curve has seen a decline of about 1.75%. This implies that a five-year fixed rate loan made at 6% late last year, could be originated at about 4.25% as of mid to late August. A number of our clients have expressed concern about the implied low rates for loans with 3-7 year terms and have questioned what can be done within PrecisionLender to result in a higher interest rate on loans with these maturities.

We would urge caution in making any dramatic changes to assumptions in PrecisionLender and to consult with other areas of the bank, especially Treasury and Asset Liability Committees. This is to ensure pricing actions don’t conflict with possible hedging actions that these areas may be initiating.

Below are assumption changes that can be made to result in a higher interest rate requirement:

Increase the ROE Target on Select Products

This increases the ROE for all maturities and will result in a higher suggested rate for all terms. Although it depends on the assumptions, each 1% increase in target ROE leads to about 10 basis points higher rate, assuming no other changes.

Increase the ROE Target on Selective Products but only for Selective Durations 

This is similar to the suggestion above but would only affect loans with certain maturity terms. The Admin will take the same actions as outlined above, but will now click 'Add Target Adjustments'. Below is an example of using this option for loans with terms of 36 to 84 months.

Add Rate Adjustments to the Funding Curve

Whether the bank is using an FHLB curve or the 3-month LIBOR-Swap curve, adjustments can be made to the entire curve or particular maturities. Note that once these adjustments are made, they will remain until changed. Do not make edits and forget. It's very important to actively update as needed. To accomplish this, navigate to the Administration section. In the ‘Regions & Users’ area, select the Funding Packages section and then open the Funding Package you wish to add adjustments to.

Liquidity Curve Adjustment

If your bank uses a “Raw” funding curve like the 3-month LIBOR Swap, upward adjustments can be made to the Liquidity Curve to result in higher rates. Follow the same steps as outlined in above, but go to the Liquidity Adjustments section (see example below). Note: make sure you save your changes.

Floor Rate

On Floating and Adjustable rate loans (only during the adjustment period), the Administrator can set a default floor rate. This is accomplished by taking the same actions as outlined above, but then going to the Allowable Rate Types section (see example below). Note: the Relationship Manager or Lender can override this floor and the bank needs to ensure that the floor language is included in any loan documentation.

Andi Builder

Finally, if you have the Andi Builder, the bank can create a skill to remind the Lenders not to price below specific interest rates based on the term and type of loan.