Since early March, we’ve posted regular updates on the commercial loan pricing markets, based on what we’ve seen when examining the PrecisionLender dataset. We look at several popular metrics and point out areas in which there have been noteworthy changes.
Given that the commercial banking industry largely slows down in the second half of December, we’re pivoting away from our usual market update format and instead will be reviewing what we’ve see in commercial banking throughout the course of 2020.
When the pandemic delivered a shock to the banking system in mid-March, commercial loan pricing activity changed quickly, responding to shifts in borrower demands, the 150 basis point (bps) decline in interest rates, and the onset of PPP.
In this piece we’ll take a look at how that response unfolded over the next nine months. Some of the outcomes we found in the data confirmed previous assumptions about how banks would act, but other findings did not conform to expectations.
Reminder: If you’d like to see our previous loan pricing market updates, you can find them here. And if you have questions about the metrics we track, please reach out us at to email@example.com.
NOTE: PrecisionLender’s data reflects actual commercial opportunities priced (loans, deposits, and other fee-based business) by more than 150 banks in the United States, ranging in size from small community banks to top 10 U.S. institutions. In addition to their variance in size, these banks are also geographically diverse, with borrowers in all 50 states.
Volume Slowed at Year’s End
After spiking in March – and then plummeting in April when PPP loans not priced via PrecisionLender dominated bank activity – commercial pricing volume climbed steadily until, by September, it had largely returned to pre-pandemic levels.
It has since dropped back in the fourth quarter. We examined the potential impact of seasonality by looking at Q4 2019 vs. Q4 2020 but found the data to be inconclusive.
Priced Commercial Loan Volume, Weekly Average
Spreads Improved Across the Board
As we’ve shown in previous updates, LIBOR and Prime spreads both jumped up early in the pandemic and then fluctuated only slightly within narrow ranges. Both stayed approximately 25 bps higher than pre-pandemic levels.
We also took a look at fixed rate spreads and found a similar story. Though these spreads fell a bit from their Q3 heights (as funding indexes increased – more on that later), they still remained ~ 40 bps higher than pre-pandemic levels.
Across the board those spread increases reflect one of the common 2020 themes we found in the data: Yield and NIM protection.
Little Change in Rate Types and Maturities
With all the uncertainly that came with the pandemic, the initial expectation was that commercial lending would see a shift away from fixed rate loans, or at least a drop in the length of those deals.
Instead, neither occurred in 2020. Fixed rate loans remained 42-45% of the overall mix throughout the year. Meanwhile maturities on those deals – as well as on floating rate loans – didn’t shift significantly either. Fixed rate maturities remained in a tight range of 71-77 months, while floating rate maturities were 34-39 months.
Rate Type Mix
Yield Curve Did Not Remain Flat
Early in 2020 bankers were dealing with an inverted yield curve, which then essentially flattened in the first weeks of the pandemic. But beginning in May – using the 3-Month LIBOR Swap Curve as a proxy – we began to see a shift on rates longer than 36 months. Using snapshots from June 30, Sept. 30 and Dec. 15, we found that, while increases were modest at the 60-month point (just 10 bps up from their lowest points), the curve steepened from there. The 360-month point increased 47 points during the second half of 2020, reducing the gap to its Jan. 31 counterpart to just 35 bps.
3-Month LIBOR Swap
Three Distinct Coupon Levels Emerged
Prior to the pandemic, there was little to distinguish the coupon rates for fixed-rate deals and LIBOR-based floating rate deals. But that shifted significantly, beginning in mid-March. While fixed-rate coupons remained steady at around the 3.50% mark, LIBOR dropped down to around 2.70%, tracking the decrease in the index and increase in spread. Similarly, Prime coupons dropped in lock step with the decrease in the index and increase in spread. The 100 bps gap between LIBOR and Prime coupons in December is essentially the same as the gap between them back in January.
Coupon Rate Trend
Fixed-Rate NIM Expanded …
The aforementioned steady coupon rate for fixed-rate loans resulted in NIM expansion in 2020, as yields have stayed consistent during the pandemic, while funding costs have dropped. It should be noted, though, that the recent uptick in funding costs led to a 9-point drop in NIM, down from 2.73% in September to 2.64%.
Fixed-Rate NIM Composition
… As Did Floating-Rate NIM
Floating-rate NIMs have measured between 300-330 bps since April. That expansion of 30-60 bps since March has been driven by higher spreads to index (as noted earlier), consistently low COF, and a general relaxing of term liquidity premiums in the second half of 2020.
Floating-Rate NIM Composition
Floors Became a Popular, Effective Tool
Some Risk Mitigation Tools Used, Others Ignored
In addition to rate floors, there were several other options available to commercial bankers seeking to mitigate risk during the pandemic. Interestingly, some of them did not appear to be used by banks when examining pricing results.
For example, for loans that include a loan-to-value measure (about 80% of the loans priced in the PrecisionLender database), the average LTV hovered around 69% all year long. Fee incidence didn’t budge either, staying in a narrow 3-percent range all year. Target ROES – which might have been expected to rise alongside growing risk concerns – did not, remaining around 18.1% throughout 2020. However, expanded margins meant that targets were reached more frequently during the pandemic (68%) than before (54%).
The one mitigation measure that banks did seem to take was to require more capital (chart below). Economic capital rose from 6.6% to 7.1% in the second half of 2020, while regulatory capital increased from 9.7% to 10.5%.
Essentially, banks shouldered the burden of risk mitigation. Rather than asking the borrowers to contribute more mitigation in the pricing conversation, bankers instead worked to protect yields and expand margins during COVID compared to pre-pandemic levels.
Capital as % of Average Loan Balance
We started these market updates back in March, as a way of keeping commercial bankers up to date with what we were seeing in our pricing data. Due to their popularity, we intend to keep producing these updates in 2021. If there is anything you’d like to know about what they’re seeing, please send along your questions to firstname.lastname@example.org.