In this tutorial Commercial Bank Revenue Model: Loan Projections, you’ll learn about the key revenue drivers for a commercial bank, with a focus on how to project its loan portfolio based on GDP growth, market share, and addressable loan market sizes.
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Table of Contents:
1:46: Overview of Revenue for a Bank
6:47: The Step-by-Step Process to Project Loan Growth
15:06: Calculating and Checking the Loan Size in Each Segment
19:39: Recap and Summary
For pure-play commercial banks, the vast majority of their revenue will come from “Net Interest Income”: Interest Income on Loans, less Interest Expense paid on Deposits, Debt, and Other Funding Sources.
KEY QUESTION #1: What will the bank’s Loans and Deposits be?
KEY QUESTION #2: What will the bank’s Interest Rates Earned and Paid Be?
Interest rates are a whole separate topic, and Deposits and Funding Sources are usually linked to Loans, so we’re going to focus on the key drivers behind Loans and Loan Growth here.
More so than with “normal companies,” commercial banks’ fortunes are heavily linked to the overall economy.
Higher GDP growth results in more transactions – more buying and selling – and to more borrowing by both consumers and businesses.
A healthy bank will tend to grow its loans more quickly than the GDP growth rate – credit expansion leads economic expansion.
So the first key driver of Loan Growth is GDP growth.
Some banks might sell more effectively, might offer more favorable terms for lenders, or might have different lending standards, so market share also plays a role (this is key driver #2).
The Step-by-Step Process to Project a Bank’s Loan Portfolio
Step #1: Determine the sizes of a bank’s markets (e.g., Mortgages, Auto Loans, and Credit Cards) to calculate its market share(s).
Step #2: Make each market a percentage of the country’s GDP.
Step #3: Project how the country’s GDP changes in the future.
Step #4: Project the bank’s market share in each segment and forecast each loan market as a percentage of the country’s GDP.
Step #5: Calculate the Loan Size in each segment with GDP * Loan Market Size as a % of GDP * Bank’s Market Share.
Steps 1 & 2: Sizing the Loan Markets
Possible Sources: Bank’s IPO Prospectus, Industry Reports (UK – De Montfort Group), Bank’s Interim/Annual Reports or Earnings Calls, Equity Research…
If you can’t find data on loan market sizes, make it less granular and look at Total Loans in the country instead and calculate the bank’s market share there.
The goal is to get a rough sense of whether the bank’s market share is rising or declining over time.
Step 3: Projecting GDP Growth
You can find any country’s nominal GDP via sources like Wikipedia, Statista, the IMF/World Bank, etc.
For the projections, you can consult with similar sources, but you should also consider different cases and think about what happens if growth continues as expected, what happens if it goes above expectations, and what happens if there’s a recession followed by a recovery.
Step 4: Projecting Future Market Share and Addressable Loan Market Sizes
Approach #1: Follow and extend historical trends (If the bank is losing/gaining market share, continue that; otherwise, keep it steady).
Approach #2: Speak with people in the market, such as real estate brokers and new homeowners, and see if you can discern trends from them (“channel checks”).
Approach #3: Look for outside sources such as equity research and buy-side research and see what they’re saying.
Step 5: Calculating the Loan Size in Each Segment
Loan Size = Nominal GDP * Loan Market Size as % of GDP * Bank’s Market Share
The harder part is checking your numbers afterward – Do the estimates seem reasonable? Do they accurately reflect different outcomes?
You often want the Base or Upside Case to be close to equity research/consensus/management estimates.
And the Downside Case should be real (e.g., 2009-style recession) – negative GDP growth, not just 1% growth rather than 2%.