Stop Competing on Rate!

Lenders, Beware of Competing on Rate…

Competing on rate is a race to the bottom, period. And pricing concessions early in the negotiation will both decrease overall profitability and cement expectations of future discounting.

But there’s good news: Clients generally only quibble over basis points in the absence of perceived value.

Here are seven levers that you as a business or commercial lender can pull to demonstrate expertise and to create value. These will help you steer the discussion away from loan pricing quickly and consistently.

1. Interest rate vs. interest cost

It tends to be that clients “anchor” on the all-in interest rate itself, since it’s easy to compare against proposals from your competitors. But rate alone doesn’t tell the whole story about the lifetime interest cost of that loan, which is what should matter most.

Lenders may wish to consider:

• Building and presenting an amortization schedule for the client.
• Discussing, modeling, and presenting creative credit structures to clearly show how the client might pay less total interest over the lifetime of the loan (even if the rate may be higher than a competitor). Some creative strategies include:
  • Cash sweeps to pay down principal if/when surplus cash is available.
  • Flexible prepayment options, if available. If not:
  • Consider multiple tranches (i.e., one fixed and one floating); floating rate loans generally have no early repayment restrictions.
  • Shorter amortizations.

2. Amortization period

Shortening the amortization period helps with more than just lifetime interest costs, too. 

Even though clients often want longer amortizations (to reduce near term cash requirements), there are many ways to think about amortization in terms of optimizing credit structure.

Lenders may wish to consider the following:

• All things being equal, a shorter amortization means the lender gets its funds back faster:
  • Adjudicators love this and it may help support an otherwise difficult approval.
  • It may also give you leverage to negotiate with the adjudication team elsewhere on something the client cares more about (i.e., security, covenants, etc.).
• A longer amortization means higher lifetime interest costs for the borrower, but lower monthly payments (if cash flow is tight):
  • If the client needs/wants a longer amortization they’ll probably have to “give” somewhere else (ie. guarantees, LTV, etc.).
  • But a longer amortization means higher lifetime interest income for the lender, which may allow you to wiggle on rate without sacrificing total interest income over the loan term.

3. Fees

While some clients hate fees, others understand that it’s the cost of accessing capital. Bankers must pinpoint and understand which levers are going to be meaningful to the client and then negotiate accordingly.

Remember, fees pay for the work that a banker does. Clients value their own time, and you as a lender should value yours, too! But sometimes you have to give a little…

Lenders may wish to consider:

• A higher interest rate can more than offset lower closing fees, but try not to concede on both!
• A lower upfront fee can also be offset by higher or more consistent maintenance fees (or annual review fees, etc.) in the future.
• Remember that you’re not just negotiating with your client, you’re probably negotiating with Risk and your VP, too:
  • If fees are within your discretion and you don’t need to escalate an exception, you may be able to retain leverage with your boss and/or adjudicator to negotiate other elements of the deal (or a different deal altogether in the future).
• It’s imperative that you understand your firm’s pricing model in order to negotiate effectively.

4. LTV (loan-to-value)

Clients tend to want higher LTVs. But they may not understand how that impacts lifetime interest cost, indirect security requirements, or other elements of the deal.

Lenders may wish to consider that:

• You can often “give” on pricing if a client is willing to “give” on LTV.
  • A lower LTV generally equates to a better-estimated recovery rate for the asset, and therefore a more favorable LGD (loss given default).
  • This should create a profitability buffer so you can reduce the interest rate without sacrificing profitability (which is measured on a risk-adjusted basis).
  • A lower LTV might support a smaller amount of indirect security (like guarantees).
• If a client insists on a higher LTV, they may have to bend somewhere else, like:
  • A shorter amortization.
  • Higher levels of indirect security.
  • More restrictive covenants.

5. Indirect security

Indirect security typically comes in the form of a guarantee. Owner operators usually HATE personal guarantees.

Lenders may wish to consider the following:

• If a client insists on minimizing their personal recourse, this may give you leverage elsewhere, including:
  • Negotiating a shorter amortization period, a lower LTV, or tighter covenants.
  • And if you can reduce or eliminate the guarantee, you can bet they won’t quibble on pricing or fees!
• Also, there are other types of indirect security than personal guarantees, like:
  • Corporate guarantees from related corporations (ie. holding companies with surplus assets).
  • Government guarantees from various agencies (like the SBA and the USDA in the United States), if they qualify. 

6. Collateral

Sometimes borrowers come to their lender looking for unsecured credit. Many owner-operators don’t understand that other tangible, unencumbered assets could actually serve as direct security for the proposed exposure.

Lenders may wish to consider that:

• Most firms have strict credit policies around unsecured lending, including:
  • Shorter amortizations, higher rates, and more indirect security.
• Always look for creative, non-standard solutions like:
  • Refinancing clear title PP&E, including CRE (commercial real estate) or sale-and-leaseback transactions on equipment assets.
  • Unencumbered assets in related companies that can be “ring fenced” using a corporate guarantee.
• The LGD on senior, secured credit is ALWAYS better than on unsecured credit, which gives you flexibility elsewhere in your loan structure.

7. Covenants

Loan covenants are a very useful way to align incentives between a lender and a borrower, but they can be sticking points in a negotiation.

Lenders may wish to consider:

• That negotiating on credit structure elements like covenants is a good way to steer the discussion away from the pricing.
• And covenants tend to give you some flexibility by:
  • Being able to reduce or eliminate guarantees.
  • Limiting or restricting potential problem behaviors (ie. excessive drawings) which generally means more stable future risk ratings (and pricing predictability).
  • If the borrower wants to avoid covenants, you may be able to negotiate a lower LTV or shorter amortization.
• But they’re not without drawbacks, too:
  • Covenants require monitoring and can be a headache for both you and your middle office.
  • Clients may have to provide additional or more frequent financial reporting, which can increase the risk of an inadvertent technical default.

The Bottom Line on Rate Competition

Pricing tends to be much less of a concern when you provide solid advice and tangible value to your clients and prospects.

And when you understand which of the above-noted levers is most meaningful to the borrower, you can tailor a creative credit structure that will satisfy both parties.

Be an advisor, not just a facilitator of transactions!

Additional Resources

Pitch Deck Essentials for Lenders Course

What is Credit?

Credit Analysis

See all commercial lending resources