Are my Pricing Conversations Aligned with my Banks Overall Strategy?

PrecisionLender recommends clients review reporting region(s) at least annually to ensure key assumptions remain calibrated to the bank’s specific strategies. Specifically, inputs related to capital allocation methods, marginal tax rate, tax exempt loan structures, funding and liquidity, and cap/floor risk are addressed.

In addition, within your reporting regions you may choose to apply your selections across your entire bank or customize them across regions (if applicable).

Collectively, this assumption set has a large impact on the banker inputs that drive ROE results on loans and deposits. Below, you’ll find our latest recommendations, as well as commentary as to why we’ve chosen them.

 

In this Article

 

Default Reporting Regions

Configuration Option Latest Recommendation Comments
General    
Visible Return on Capital Types: Net Income / ROA / ROE Selected metrics will display as options in the metric dropdown found in the Relationship Impact Summary footer and Scenario Builder screen (see The
Opportunity Screen).
Default Return on Capital Type: ROE This default metric will be pre-selected in metric dropdown found in the Relationship Impact Summary footer and Scenario Builder screen (see The
Opportunity Screen).
Federal Tax Rate: - Use Marginal Tax Rate
State Tax Rate: - Use Marginal Tax Rate
Effective Tax Rate: Automatically Calculated Blend of Federal and State
Tax Effective Yield
Calculations
   
Use Bank Tax Effective Yield Adjustment Factors Not checked This disallowance will be 100% of the interest expense unless the obligation is deemed to be "Bank Qualified". That factor is reduced to 20% for all Bank
Qualified obligations.
Non-Bank Qualified Interest Disallowance
Factor:
100%  
Bank Qualified
Disallowance Factor:
20%  
Custom Non-Bank Qualified ID Factor: 0% This allows you to use different Non- Bank Qualified disallowance factors for different products within the same
region.
Tax Exempt Cost of
Funds
   
Tax Exempt Cost of Funds Option: Marginal Loan Cost of Funds Other options include a point on the funding curve and the bank’s overall cost of funds. PL recommends Marginal Loan Cost of Funds because the funding cost is aligned particularly to the Tax Exempt Loan being priced. The overall cost of funds is an historical weighted average cost and does not align with incremental funding costs. The point on the funding curve is incremental but does not match the cash flow and maturity features of the Tax exempt.
    loan being priced. Marginal loan COF is a conservative and best practice approach.
Funding Package
Assumptions
   
Funding Curve Family for Fixed Rate Spread Lock: Treasury The Funding Curve Family used in calculating the Spread Lock on a fixed rate loan.
Funding Cost Option: Do Not Include Capital in
Funding
Blog post explaining recommendation
Funding Packages Your preference The set of funding assumptions that will be used to price a loan. (See Funding Packages)
Unused Line Opportunity
Cost
   
Unused Line Opportunity Cost Option: Point on Funding Curve In order to account for the opportunity cost associated with committed, but unfunded assets (such as lines of credit), this selection allows banks to elect whether a user defined cost of funds or a market driven cost of funds is appropriate to apply to the unfunded balance cited above. PL recommends “Point on the Funding Curve” because this market driven rate moves with all funding curve rates and remains “current”. The user defined rate must/should be updated frequently. When unused Line Cost rate is selected, neither of the 2 inputs below are required.
Transfer Duration: 1 The opportunity cost is commonly determined using a rate associated with a corresponding duration along the funding curve. When “Point on Funding Curve” is selected, the “Transfer Duration” month becomes a second input requirement. This assumption guides which month duration on the funding curve is appropriate for the unfunded balance. PL recommends a 1 month transfer duration because lines of credit are typically floating rate and are funded with 1 month COF. Other durations options can range from 3 to 12 month. The Transfer duration option should match the funding cost duration point for the asset. The unfunded portion will be matched for
    funding purposes to a like point on the
fully adjusted funding curve as the funded portion.
Liquidity Factor: 10% This business rule assumption asks “what % of the unfunded amount should I prepare to fund?”. PL recommends 10% of the unfunded amount.
Earnings on Capital    
Earning Factor: 0% Some banks prefer to treat loans as if they are 100% funded by liabilities (i.e. borrowed funds). The related equity capital allocation is presumed to be invested for a risk free / low risk return with the associated income credited back to the calculation of the loan profit.
The ability to apply an earnings credit factor on capital will only be available if the funding cost option of ‘Do Not
Include Capital in Funding’ is selected. If a factor of greater than 0% is entered it represents the annual interest rate that will be applied to average equity of the opportunity to generate an , ‘Earnings on Capital’ dollar amount as a revenue line item on an opportunity’s Financial Statement. PL recommends 0% because the solution is not explicitly calculating the cost of average equity. It is not best practice to employ capital revenue and not employ capital cost. As a result, PL suggest no “Earnings on Capital” is necessary. The Return on Capital metric is complete.
Capital: Maximum of Regulatory and Economic Capital Provides the ability to select which type of capital will be used for calculating the monthly capital requirement for the opportunity. PL recommends the “maximum of Regulatory and Economic Capital” to ensure no opportunity is undercapitalized. This conservative approach assures that highest quality deals carry a minimum capital level and that poorer quality deals carry capital commensurate with their risk. Other options include either Regulatory capital or Economic capital individually which can lead to undercapitalized results and overstated returns in certain cases.
Cap & Floor Options    
Caps/Floors Approach: Black76  
Maximum Cap Duration: 60  
Volatility Estimates Enabled - Published monthly Recommended Volatility Estimates
Fees    
Fee Amortization
Method
Amortized Fees  

 

To learn more about setting up regions, click here.


Default Funding Package

Configuration Option Latest Recommendation Comments
Funding Package
Assumptions
   
Name: Your preference What this Funding Package will be called
throughout PrecisionLender
Funding Curve: FHLB-Composite for US See Funding Curve Options
Funding Curve
Interpolation:
Monotone Convex See Interpolation Methods
Funding Curve
Adjustments
Your preference Allows you to add adjustments, to the
entire curve or for specific durations
Liquidity Adjustments Enabled – Published 2x a
month
Recommended Liquidity Curve

 

To learn more about setting up funding packages, click here.