Most Risk Based Loan Pricing Schemes are a Delusion

Could you use CostPro Suite- Loan Pricing Tool more effectively?

Would you benefit from improved yields on your loans?

Are you preparing your loan rates for a rising rate environment?


Related web seminar on this topic:

Loan Pricing Tool Basics

June 27 • 2018

11 am PT • 12 pm MT

1 pm CT • 2 pm ET


Studies prove that a credit union can enjoy significantly higher loan revenues by engaging in effective risk based loan pricing (RBL) practices. Sadly, because of poor processes, relatively few credit unions really reach their loan revenue potential. TCT Risk Solutions, LLC (TCT) provides empirical methodologies that assure client credit unions maintain the precise balance between risk and maximum profitability.

There are fundamental reasons credit unions should engage in RBL and provide loans to less-than-prime borrowers

· Far too many credit unions subsidize loan programs through fee income

· Lending primarily to high credit score borrowers results in low or non-existent margins

· NCUA encourages risk based loan pricing – Guidance Letter 174

· More cross sell opportunities

· Effective RBL programs can boost ROA by 35 to 70 basis points

There are three common methods to engage in “risk based loan pricing” – the first two are delusions

1. Copy or undercut the competition or “best guess” – this is the easiest and most dangerous method to price any product

· Few banks or credit unions have the same clientele demographics, same reserves, same expenses, etc. to justify pricing generally by watching the competition

2. Tiered pricing - assumes a base rate and then stair steps in equal steps for “levels of risk”

· Results in imprecise costs and rates – subsidizes some borrowers at the expense of others

3. Empirical risk based loan pricing – a statistically validated pricing system

· Focuses on maximizing loan revenue in relation to loan type and individual borrower risk

· Contingent on:

  • Precise identification of all expenses by loan type and borrowers’ credit scores
  • Setting rates accounting for expenses: (a) assigned to types of loans; (b) according to credit grade risks and (c) accounting for interest rate risk in payment terms
  • Periodic back testing to assure the pricing model is accurate and effective

An empirically-derived RBL model will have the following features and benefits:

· Uses statistically validated methods for establishing pricing structures for each loan type and risk grade.

· Uses a credit union’s unique expense structure (broken out by loan type and borrower risk grade) including (a) costs of generating loans, (b) cost of funds, (c) cost of collecting loans, and (d) cost of charge offs. The model then factors in these costs to generate interest rate recommendations for each loan type and risk grade

· Creates a foundation for establishing loan policies and procedures

· Allows a credit union to reach the precise balance between risk and optimum revenues

· Assures one class of borrower or loan type is not subsidizing another

· Provides empirically based recommendations for drafting Concentration Risk policy

· Allows a credit union’s management to perform “what if” loan pricing exercises to determine profitability outcomes under different rate scenarios by loan type and risk grade

· Undergoes a statistical validation (back testing) process at least once per year

TCT’s empirically-derived RBL model is the one of the most effective loan pricing tools available

TCT provides one of the most effective Risk Based Loan Pricing tools available in the financial industry. TCT’s RBL has been recognized and endorsed not only by credit union executives but by state and federal regulatory agencies as well. Pricing loans and running simulations is made easier for credit union managers using TCT’s proven, interactive RBL model.