Early this year, we published our fifth annual State of Commercial Banking report, which uses Q2 PrecisionLender data to paint a picture of how banks are navigating fast-moving market dynamics. As we continue to look to the data to help us understand bank activity, February revealed several key points:
- Deal structure matters more now than as recently as October as a determinant of performance, and structures influence coupon rate, which is the primary indicator of borrower costs. We've seen significant separation of coupons across deal structures since October. SOFR has moved the most, tracking upward with the index and bankers' push toward maintaining spreads.
- Indicative fixed-rate structures via swap represent the low-cost alternative for the borrower. In February, the resultant bank-held SOFR floating rate instrument outperformed the fixed-rate alternative.
- The proxy funding curve jumped 50 bps month-over-month at the 60-month point, affecting fixed-rate structures.
- Overall deposit costs increased about 80 bps since January 2022 and posted a large upward move of 15 bps in February 2023 over the previous month. The overall mix includes the cost benefit of non-interest-bearing deposits. Meanwhile, interest-bearing deposits moved up approximately 25 bps month over month.
Volume Drops Slightly
We’ve moved the goal post for measurement to July 2022 from January 2022. As a reminder, July 2022 had gained about 15% over January 2022. The remainder of 2022 posted growth of approximately 20%, particularly October.
Turning to the new view, we see a downtick in February volume compared to January. Our conversations with bankers continue to reinforce these themes: fast-paced loan pipeline activity, loan demand beginning to outpace organic funding sources, emerging funding strategies from wholesale sources, and discussions on strategic target ROE differentiation in support of preferred asset classes (over others). At the same time, we've had discussions related to how borrower loan demand has "dried up." In light of recent bank closures, we took an early look at March activity, and the month-to-date pricing activity indicates an increase over February.
Priced Commercial Loan Volume, by Month, Indexed to July 2022 = 100
SOFR Preference Continues
SOFR continues to be on the high end of the range, showing bankers' tenacity with respect to resisting spread contraction.
Weighted Average Spread to SOFR
Prime spread decreased, giving up 7 bps from 20 to 13. The relatively high coupon rate on Prime-based structures, now pushing toward 8%, provides headwinds for bankers' ability to maintain or expand spreads on this index. Stated differently, Prime coupon is 75 bps over SOFR.
Weighted Average Spread to Prime
We have had questions about the mix of various SOFR indices being employed in pricing conversations. The pricing activity indicates bankers have clearly landed on SOFR one-month from the CME Term SOFR curve as the index of choice, representing 90% of SOFR priced loans. Meanwhile, the overall structural mix for pricing activity shows SOFR at 42%—a high-water mark—and fixed is down to 30%.
Balance Mix of SOFR Activity
Balance Mix by Rate Type
Indicative Fixed Swaps Still Offer Lowest Borrowing Cost
We last checked in on the comparative value of swap structures in November and, at the time, observed that the indicative borrower-facing fixed-rate coupon of 5.67% showed a discount to the pure fixed-rate alternative at 6.23%—56 bps variance. Now, in February 2023, we find the coupon discount continues at 5.80% for the swap structure versus 6.18% for the pure fixed-rate structure—38 bps discount. Some of this gain in the fixed swap rate comes from an increase in the spread to SOFR on swaps from 1.83% to 1.97% in February.
The indicative fixed-rate borrower-facing coupon continues to represent the lowest borrowing cost on average across common deal structures. Turning to the yield value, which considers both the amortized swap fee and net origination fee income amounts, we find that SOFR loans resulting from a swap have moved well past the pure fixed-rate structure in performance: 6.91% versus 6.41% in February. Both lag the SOFR structure with no swap at 7.39%.
Coupon Comparison, Fixed via Swap Versus SOFR
Yield Comparison, Fixed via Swap Versus SOFR
SOFR Coupons Distance From Other Rates
As recently as October, we were seeing convergence among coupon rates. There's been significant distancing since then, and SOFR structures have marched upward, tracking the change in index value. This view also reinforces the passing of costs onto the borrower. In the chart, it's clear to see that each structure now matters more to borrowers' costs as represented by the range coupon rates.
Coupon Rate by Month, Rolling Trend
Net Interest Margin
Fixed rate net interest margin dipped below the 200 bps mark, driven by the month-over-month 50 bps increase in funding costs. Adjustable structures continue to show better relative NIM performance from the bank's perspective at 2.56% than either SOFR or fixed.
Net Interest Margin by Month, Rolling Trend
Funding Curve Shifts Shape Again
A high-level view of Federal Home Loan Bank (FHLB) advance curve reveals two things happening: Key rates one-month and 60-month are up. These reference points affect the cost of funds for SOFR and fixed-rate structures, respectively. February added 50 bps to 60-month funding costs month-over-month and has a negative impact on the performance of fixed and some adjustable-rate structures. SOFR and Prime structures, on the other hand, saw about 10 bps month-over-month change in the one-month duration FHLB costs.
FHLB Curve, Selected Dates
Deposit Costs
Overall CD rates are up about 100 bps since September to about 2.00%. The Interest-bearing non-time group moved upward about 20 bps in February over January.
Interest-Bearing Non-Time Deposits Rate Paid
Time Deposits Rate Paid
Overall rate paid includes all aspects of mix—non-interest-bearing deposits, money market deposits, savings, and time deposits. Overall rate paid has increased about 80 bps since January 2022 and posts a large upward move in February 2023 over the previous month—15 bps. We will continue monitor deposit movement across the Q2 PrecisionLender client base.
Overall Deposits Rate Paid Percentage
Got Questions?
Our banking consultants and data scientists are combing through Q2 PrecisionLender pricing data every day. If there is anything you’d like to know about what they’re seeing, please send your questions to insights@q2.com.
About the Market Update
Since March 2020, we’ve posted regular updates on the commercial loan pricing markets based on what we’ve seen when examining the Q2 PrecisionLender dataset. We look at several popular metrics and point out areas in which there have been noteworthy changes.
Q2 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.
If you’d like to see our previous loan pricing market updates, you can find them here. If you have questions about metrics that have appeared in previous posts but not this latest one, please reach out to us at insights@q2.com.
