Just as commercial loan pricing volumes hit a nine-month high in March 2024, November data reveals continued surges and shifting market dynamics.
In November 2024, you're seeing a continued surge in commercial loan pricing volume, building on the trend since the beginning of the year. March 2024 marked a significant high with a score of 101 on the PrecisionLender index, the highest in nine months, and subsequent months have maintained this upward trajectory. SOFR-based floating-rate loans dominate larger deals, with a median loan amount of approximately $9.0 million, contrasting with fixed-rate loans at around $700,000. Fixed-rate spreads have increased, and banks are instituting higher minimum spreads and rate floors to maintain profitability amid rising interest rates. Funding costs have risen due to cash rate increases, impacting commercial loan pricing, while deposit rates have elevated costs for banks, particularly for community banks where non-interest-bearing deposits decreased from 52% to 42% from March 2023 to March 2024. For more detailed insights into these market dynamics and their implications, further analysis is essential.
In the first few months of 2024, commercial loan pricing volume has defied earlier expectations of a slowdown, instead showing a significant resurgence. Despite forecasts from fed surveys at the end of 2023 suggesting a decline in commercial lending, the actual data tells a different story. For the third consecutive month, pricing activity has bounced back to mid-2023 levels, reversing the late 2023 trend. March 2024, for instance, posted a 101 on the PrecisionLender index, marking the highest volume in the past nine months.
This expansion in pricing volume is driven by a combination of factors, including a robust pricing strategy and thorough competitive analysis. Regional and community banks have been particularly active, with Regional+ banks leading the charge in April 2024, contributing to the highest level of pricing activity in the past 10 months.
The data indicates that banks have been successful in increasing their loan pricing margins, partly due to a perceived increase in credit risk and tighter credit supply. The average SOFR-equivalent credit spread for loans in the first quarter of 2024 was approximately 2.55%, up from 2.44% in the previous quarter, reflecting banks' efforts to maintain profitability. This strategic approach to pricing, coupled with a detailed competitive analysis, has enabled banks to gain control over their market share and maintain profitability in a competitive environment.
When incorporating SOFR into commercial loan pricing, you must consider the dynamics of credit spread adjustments, which have seen significant changes. For instance, the use of credit adjustment spreads to compensate for the economic difference between LIBOR and SOFR has decreased, with only about 42% of new facilities including such adjustments in the first half of 2023, down from nearly 60% in the first half of 2022.
These adjustments, often negotiated and bespoke, impact market rates and can be reflected in various ways, such as adding a static spread (e.g., 10 basis points for one-month SOFR) or incorporating the spread into a higher overall margin.
The liquidity cost effects are also vital, as evidenced by the improvement in SOFR bid/offer spreads, which, although still wider than LIBOR spreads, have shown encouraging progress, particularly after the July 26, 2021, announcement that boosted SOFR trading.
As you move from LIBOR to SOFR for commercial loan pricing, determining the appropriate credit spread adjustments becomes essential. This shift is critical due to the inherent differences between LIBOR, a rate that includes a credit risk premium, and SOFR, a risk-free rate.
The Alternative Reference Rates Committee (ARRC) has recommended using the five-year historical median difference between LIBOR and SOFR, set on March 5, 2021, to determine these spreads. For instance, the recommended spreads are 11.448 basis points for one-month tenors, 26.161 basis points for three-month tenors, and 42.826 basis points for six-month tenors.
However, market dynamics have led to varying approaches in pricing strategies. Some commercial loan agreements incorporate a static spot spread based on the current LIBOR-SOFR spread, which can be considerably lower than the ARRC-recommended spreads. For example, the current spot spread for three-month LIBOR and Term SOFR is only about seven basis points, a gap that may not align with the ARRC's recommendations.
In practice, the use of credit spread adjustments is becoming more negotiated and bespoke. By the first half of 2023, only about 22% of facilities incorporated the ARRC-recommended historic spread adjustment levels, down from 50% in the first half of 2022. Many facilities now use a flat 10 basis points spread adjustment for Daily SOFR and SOFR with a one-month duration.
Effective pricing strategies must consider these adjustments to manage credit risk and maintain competitive loan pricing. This involves thorough risk profiling and continuous monitoring of market conditions to guarantee that your lending practices remain economically viable and compliant with regulatory guidelines.
The shift from LIBOR to SOFR has marked implications for market rates, particularly in how credit spread adjustments influence borrowing costs. As you navigate this change, it's vital to understand the dynamics of SOFR spread adjustments and their impact on market volatility and economic indicators.
The SOFR-equivalent credit spread has seen notable changes, with the average spread for loans in the first quarter of 2024 standing at approximately 2.55%, an increase from 2.44% in the previous quarter. This rise is partly driven by the perceived increase in credit risk and banks' need for wider margins to counter higher costs of funds and interest rate sensitivity.
Market volatility has been exacerbated by the shift from LIBOR to SOFR, with the difference between the two rates sometimes widening greatly, such as during the 2008 financial crisis when the gap reached up to 100 basis points. Currently, the spot spread for three-month LIBOR and Term SOFR is around seven basis points, but the ARRC-recommended spread based on the five-year historical median is considerably higher, affecting borrowing costs and lender-borrower negotiations.
As economic indicators suggest tighter credit supply and increasing deposit costs, banks are instituting higher minimum spreads, fixed rates, and rate floors. This environment of rising market rates and volatility underscores the need for precise credit spread adjustments to maintain fair borrowing costs and mitigate risk.
The shift from LIBOR to SOFR has significant implications for liquidity costs, particularly in how SOFR spread dynamics influence banking operations. As you navigate this change, it's vital to understand the impact on your liquidity management and funding strategies.
The average SOFR-equivalent credit spread for loans in the first quarter of 2024 is approximately 2.55%, an increase of 11 basis points from the previous quarter. This rise reflects broader market conditions, including tighter credit supply and banks' need for wider margins. The difference between LIBOR and SOFR, historically around 100 basis points during market disruptions, is currently much narrower, with the spot spread for three-month LIBOR and Term SOFR being only about seven basis points.
In managing liquidity, you must consider the sensitivity of SOFR to supply and demand conditions in Treasury markets. For instance, SOFR can spike around quarter-ends due to banks' balance sheet management under regulatory requirements, such as the Basel III leverage ratio. These fluctuations can affect your funding strategies, making it essential to monitor and adjust based on real-time market data. By doing so, you can optimize your liquidity management and mitigate potential risks associated with SOFR spread dynamics.
In the context of commercial loan pricing, you have observed a notable increase in fixed-rate spreads, particularly in the recent months. For instance, in September 2024, fixed-rate spreads rose by 28 basis points, driven by bankers maintaining higher coupons despite falling funding costs, which increased from 6.07% to 6.18%.
This trend is significant because, although market rates have dropped, such as the Fed's 50-basis point rate cut in September 2024, banks have managed to keep fixed-rate coupons higher, thereby enhancing their net interest margins (NIM). Specifically, the fixed-rate NIM average for 2024 has risen to 2.12%, with the September mark being the highest recorded since September 2021 at 2.35%.
This dynamic highlights banks' strategic pricing adjustments to maintain profitability amidst changing market conditions, reflecting their ability to adapt and optimize loan pricing in response to monetary policy shifts.
As interest rates rise, you're likely to see an increase in the spreads on fixed-rate loans, a trend that benefits banks in several key ways. In the first quarter of 2024, the average SOFR-equivalent credit spread for loans increased to approximately 2.55%, up from 2.44% in the previous quarter. This rise is particularly notable for fixed-rate loans, which saw spreads increase by 7 basis points in March 2024, according to PrecisionLender data.
This increase in fixed-rate spreads is part of a broader strategy by banks to enhance margins. Banks have instituted higher minimum spreads, higher fixed rates, and rate floors to counter the higher cost of funds and interest rate sensitivity. For instance, fixed-rate strategies have become more disciplined, with banks showing better control over fixed-rate pricing, especially in sectors like medical loans, which saw significant pricing increases due to reduced volatility.
Using pricing benchmarks, such as those provided by the AFS Pricing Dashboard, banks can optimize their loan pricing by dissecting market trends by key drivers like geographic region, deal size, and risk segment. This granular data helps banks set aspirational pricing targets and quantify the interest income opportunities of raising prices to market average levels.
The median loan amounts for fixed-rate loans are generally smaller, around $700,000, compared to SOFR-based floating-rate loans, which average around $9.0 million. This distinction suggests that fixed and SOFR structures are not interchangeable, especially in larger deals. Consequently, banks must carefully manage their fixed-rate loan portfolios to maximize profitability in a rising interest rate environment.
Guiding the impact of market rate drops on fixed-rate spread trends requires a keen understanding of the interplay between interest rates, credit risk, and bank pricing strategies. As the Federal Reserve eases interest rates, as seen in the 50-basis point rate cut at the September 18 Federal Open Market Committee meeting, bank loan yields are expected to decline. This reduction can lead to tighter credit spreads, which are already near historically tight levels at around 300 basis points.
The decrease in market rates can enhance market stability by encouraging borrowing and investment. However, the benefits are not evenly distributed; higher-rated issuers are likely to gain more from lower borrowing costs than lower-rated issuers with weak interest coverage ratios. For instance, a 200-basis-point reduction in SOFR could improve interest coverage ratios for higher-rated issuers, but only marginally improve the position of those with low starting coverage ratios.
In formulating investment strategies, it is essential to take into account these dynamics. Lower interest rates may reduce the profit from each loan, but they can also increase demand for loans, thereby boosting overall banking sector activity. Banks must balance their pricing strategies to maintain profitability while incentivizing borrowers, potentially using risk-based or relationship-based pricing models to optimize their net interest margin.
When you're dealing with commercial loans, especially those with adjustable rates, understanding coupon rate adjustments is essential. Coupon rate strategies are heavily influenced by market expectations and recent trends. As of the latest updates, floating coupon rates have remained largely static due to unchanged SOFR rates and spreads to SOFR and Prime since July[1.).
For fixed-rate coupons, there has been a notable shift. Prior to October 2023, fixed-rate coupons saw a rise, but subsequently declined. As of May 2024, the fixed-rate coupon stands at 6.77%, just 14 basis points higher than the July 2023 rate of 6.63% and markedly below the SOFR equivalent.
Adjustable-rate coupons have been more responsive to market changes, maintaining higher levels than fixed-rate coupons over the past 10 months. Since December, adjustable-rate coupons have increased by 37 basis points, while fixed-rate coupons have only increased by 10 basis points.
Community institutions have shown selectivity in their deals, with a higher priced coupon for ready-to-close loans compared to regional institutions. For SOFR-based loans, community institutions initially seek higher coupons but experience a 32 basis points drop upon closing, unlike regional institutions which see a modest 4 basis points increase. Understanding these adjustments helps you navigate the complex landscape of commercial loan pricing effectively.
The static nature of floating coupon rates and the recent fluctuations in fixed-rate coupons highlight the complex interplay of market forces in commercial loan pricing. As you navigate the current financial landscape, it's essential to understand the impact of cost of funds increases on your lending strategies.
Increases in the cash rate since early 2022 have substantially raised banks' funding costs. For instance, the cost of short-term debt and term deposits has increased by around the same amount as the cash rate, with term deposits seeing rate hikes similar to the cash rate.
In the first quarter of 2024, commercial loan pricing was driven by higher perceived credit risk, tighter credit supply, and banks' need for wider margins. This resulted in an 11 basis point increase in weighted loan pricing, with the average SOFR-equivalent credit spread rising to approximately 2.55% from 2.44% in the previous quarter.
Your funding strategies must adapt to these interest rate fluctuations. Banks have increased rates on interest-bearing deposits, with term deposits and certain at-call deposits reflecting these hikes. For example, rates on term deposits increased by about the same amount as the cash rate, contributing to higher overall funding costs.
As you adjust your pricing, consider that fixed-rate funding costs have continued their downward trend since May 2024, falling 93 basis points, while the all-in cost of funds for floating-rate loans dropped 30 basis points due to a 50 basis point drop in the SOFR index. These changes underscore the importance of dynamic funding strategies to mitigate the effects of increasing funding costs.
Increases in banks' funding costs, driven by higher interest rates, are prompting significant shifts in net interest margins. In the first quarter of 2024, the aggregate net interest margin (NIM) for Sixth District state member banks with less than $10 billion in total consolidated assets declined from 3.45 percent on December 31, 2023, to 3.39 percent on March 31, 2024. This decline is attributed to higher interest expense on interest-bearing accounts and increased wholesale funding costs, which rose from 2.16 percent to 2.62 percent over the same period.
Interest rate fluctuations have played an essential role in these shifts. While higher rates can initially support NIM by allowing banks to increase loan yields faster than deposit rates, sustained high rates can lead to increased funding costs and lower loan growth. For instance, US commercial bank loans grew by only 1.33 percent from December 31, 2023, to March 31, 2024, limiting the benefits of higher loan yields.
Banks are employing various loan pricing strategies to mitigate these effects. Risk-based pricing, relationship-based pricing, and dynamic pricing are being used to optimize margins. For example, the average SOFR-equivalent credit spread for loans in the first quarter of 2024 increased to approximately 2.55%, up from 2.44% in the previous quarter, as banks adjusted pricing to reflect perceived increases in credit risk and tighter credit supply. These strategies aim to balance the need for wider margins with the necessity of remaining competitive in a volatile interest rate environment.
Higher interest rates have driven up the costs of deposits, posing a vital challenge for banks. As of the first quarter of 2024, the incidence of non-interest-bearing deposits has declined considerably, from 52% to 42% for community banks and from 51% to 41% for regional and larger banks, between March 2023 and March 2024.
This shift towards interest-bearing deposits has heightened deposit competition and rate sensitivity. For instance, the correlation between deposit size and rate sensitivity is approximately 40%, indicating that about 40% of the interest rate sensitivity of an average deposit can be explained by its size. Smaller deposit balances, such as those around $5,000, are less interest rate sensitive compared to larger balances like $10,000, which can be highly volatile due to increased competition in this category.
Banks must carefully analyze their market dynamics to navigate this environment. In metro markets dominated by large banks like Chase, Bank of America, and Wells Fargo, deposit rate sensitivity tends to be lower. However, in rural markets or those with substantial presence of credit unions and banks like Ally or Capital One, deposit costs can be driven up due to higher rate sensitivity, requiring banks to offer rates 15 to 20 basis points above competitors to attract deposits. Understanding these nuances is essential for effective deposit pricing strategies.
In the November 2024 commercial loan and deposit pricing update, you've witnessed a landscape of robust expansion and nuanced shifts. Pricing volume has steadily climbed, surpassing expectations with each month in 2024 outpacing July/August 2023 levels. SOFR spreads have dropped, particularly in larger deals, by 10 basis points to 2.49%.
Fixed-rate spreads, however, have risen by 7 basis points, despite fixed-rate coupon rates increasing only marginally. Coupon rates for SOFR and Prime loans have adjusted, with SOFR coupons down 9 basis points and Prime coupons down 11 basis points.
The cost of funds has seen incremental increases, with a 17 basis points rise year-to-date for the Regional+ segment and a 9 basis points rise for the Community segment. Net interest margins are being influenced by a 3% increase in interest-bearing deposits, now making up 59% of the overall mix.
Deposit rates, particularly for interest-bearing accounts, have slowed in their month-over-month increases, but still reflect a significant year-to-date rise. These dynamics underscore the evolving market conditions and the ongoing adjustments in commercial lending and deposit pricing.
