Renewal Spreads Are Narrowing Even When Credit Quality Is Stable

Recently we decided to take a closer look at commercial credit renewal pricing trends. We'll be sharing those findings in our upcoming webinar, but today we wanted to focus two particular charts that got our attention. They show that, when it comes time to renew commercial credits, some bankers are ignoring what the credit quality of the deal is telling them – or are even doing the opposite.

Even without any significant change in credit quality – at least not enough to trigger a rating change – banks are proactively reducing spreads on a considerable volume of renewals.   

Analysis reflects floating rate credits which were renewed between January 2018 and February 2019 with no change in risk rating. Analysis excludes short-term extensions of six months or less and credits rated Special Mention or weaker. Repricing incidence includes cases where the pricing adjustments were triggered by grid pricing. Figures are weighted by outstandings.

More than 20% of credits under $5 million and more than one-third of deals over $5 million saw thinner margins on their renewals over the past year. Why?

The declines coincide with an erosion in origination spreads and suggest that banks are either:

  1. Taking a defensive posture to minimize the risk of runoff; or 
  2. Lowering spreads in response to a direct competitive threat. 

Also, in some cases, particularly on the larger renewals, the narrower spreads may have been triggered by grid pricing, where the improvement in financials was not enough to affect an upgrade in the credit rating.

Want to learn more about our findings? Check out our latest report on commercial renewal market best practices.


Weaker PDs Are Actually Leading to Thinner Spreads 

The magnitude of the pricing adjustments varies across the market. On smaller renewals (commitments under $5 million), deals repriced downward had margins shaved by an average of 41 bps, while those repriced upward experienced increases just north of a half-point. By contrast, larger renewals averaged much more moderate adjustments, ranging from 16 bps to 27 bps.  

Notably, the pricing reductions were not limited to the strongest-quality borrowers. Rather, average probability of default (PD) was actually comparable, to slightly weaker, on the deals that were repriced lower. 

*Analysis reflects floating rate credits which were renewed between January 2018 and February 2019 with no change in risk rating. Analysis excludes short-term extensions of six months or less, credits rated Special Mention or weaker, and renewals which were rolled over at existing pricing levels.  Repricing incidence includes cases where the pricing adjustments were triggered by grid pricing.  Figures are weighted by outstandings. 

Some may feel the difference in the average PD on deals with spread increases vs. spread decreases is not significant. Regardless, at a minimum this chart shows that banks are not focusing pricing reductions on their highest quality deals. 

See how Union Bank & Trust does risk-based pricing right ››

 

 

 

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