Commercial lending at credit unions keeps growing; outstanding commercial loans reached $73 billion at the end of Q1 2019, up 33% since 2015. But lenders face adverse selection: their best-performing borrowers refinance early to cut costs, and struggling loans stay on the balance sheet. A refinance can also mean losing the relationship to another lender.
Banks often curb this with prepayment penalties. Federally chartered and most state-chartered credit unions are prohibited from charging them. Proven alternatives exist, yet few credit unions use them. One of the most interesting is grid-based pricing, used by commercial lenders for decades.
How grid-based pricing works
The borrower agrees upfront to pay one of several rates based on the loan’s current risk:
| Level | Rate | Covenant |
|---|---|---|
| Level 1 | Prime + 200 bps | DSCR-A |
| Level 2 | Prime + 300 bps | DSCR-B |
| Level 3 | Prime + 400 bps | DSCR-C |
The level depends on the business’s then-current financial performance, measured by Debt Service Coverage Ratio (DSCR), other financial covenants, or a combination. If DSCR improves, the rate resets lower; if it worsens, the rate rises.
Why it works for both sides
The credit union resets the rate to reflect current risk, reducing the chance a strong borrower refinances elsewhere, and is paid more if a borrower underperforms. The borrower gets a rate that matches its current performance, not just its expected performance at closing. It’s as if the borrower refinanced without the time and expense of a new loan, while the lender keeps the relationship without a competitive process.
Make it operational
The rules for setting the rate must be clearly defined and unambiguous. Credit unions also need technology that tracks effective rate changes, sends rate-change notifications and issues invoices at the right rate without heavy manual work. That often means modern commercial lending tools that support more flexible loans than traditional cores.