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Point Your Loss Leader
in a New Direction

The reality for many financial institutions is that middle-market lending is their loss leader. In an extremely competitive and fast changing economy, opportunities that don’t require substantial, long-term capital commitments are far more attractive—and easier to sell to senior management. 

Writers like Ronald Kahn agree, "Spurred by higher than expected reserve requirements from the Office of the Comptroller of the Currency (OCC) and portfolio losses, many cash flow lenders have decided that lending to the middle market is not profitable." (Making Cash Flow Lending Profitable, Ronald A. Kahn, Susan W. Wilson and Alysia V. Tan Mar 18, 2002.,  http://www.ventureeconomics.com/buy/
protected/ZZZDHUMUMYC.html  

Leveraging Loss Leaders Benefits the Firm

Banking institutions use a variety of tools to leverage the loss leader to gain profitability for their firm. According to CFO Magazine, "Living with Mega banks," June 1, 2001, financial institutions are more favorably disposed if a corporate client also commits to other services like cash management or letters of credit and foreign exchange forward contracts, as well as custodial fees for holding collateral in various countries."

Pointing Your Loss Leader on the Path to Profitability

In addition to satisfying your client and benefits to your firm, you can point your loss leader in a new direction. Here are two popular approaches that we have learned to make middle market lending more profitable:

Loan Re-Pricing. "Rational pricing—meaning pricing that is in line with perceived risk—has been a critical component in this down market for lending institutions as they continue to evaluate the benefits of lending," says Ioana Barza, Loan Pricing Corporation, in the May 2002 issue of CapitalEyes. As shown in Exhibit #4, (full text and exhibits from Barza’s article, http://www.fleetcapital.com/resources/
capeyes/article.php?a=05-02-91), risk-adjusted returns continued to come up in the middle-market in the first quarter, based on debt to EBITDA parameters. With higher stakes resulting from economic uncertainty, many lenders lament that the loss (real or potential) relative to the reward is imbalanced. In many segments of the loan market, the loan is not profitable as a stand-alone product. 

One-Stop Shopping. In her article, Barza goes on to say, "This scrutiny has resulted in a push for more rational, risk-adjusted pricing on transactions, but also in more evaluation of overall relationship returns, including non-credit income, which remains essential to the overall profitability calculation. ‘We bid on the 401K plan and other ancillary business because if it’s not there, it will be hard for us to sign onto the deal,’ one lender says."

In other words, offer "one-stop shopping" within your corporate loan group by developing additional products—and outsourcing services, such as debt financing, you prefer not to perform in-house—to achieve continued reliance on your financial institution. The end result is retention of long-term clients, and, potentially, fee income by partnering with client advisory groups who guide them through short-term.