In this episode of The Purposeful Banker, Alex Habet and Tony Hernandez analyze key points from the February 2023 Market Update based Q2 PrecisionLender data and discuss how the high interest rate environment is affecting commercial lending.
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[Blog] Commercial Loan Pricing Update (February 2023)
[Blog] Waking the Sleeping Giant of Deposit Pricing Strategy
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[Podcast] Bank Stress and Uncertainty in the Digital Age
Transcript
Alex Habet
Hi, and welcome to The Purposeful Banker, the leading commercial banking podcast brought to you by Q2 PrecisionLender, where we discuss the big topics on the minds of today's best bankers. I'm your host, Alex Habet.
The intention with the episode today is to keep it short and sweet, although I would like to pick up where we left off in our discussion last time, when Dallas came on to offer his view on what was going on in the news. That's where we talked about all the signals that we collectively missed as industry watchers, things like the pitfalls of concentration or specialization, the implications of technology's role in the new banking crisis, and whether or not what was ultimately engineered as a solution, constitutes a bailout. If you haven't caught that episode, I highly recommend it. It's worth a listen. Dallas continues to deliver the goods.
But we're not going to rehash any of that today, at least not directly. It's still a little bit too early to get a read on how the news has impacted what's going on in the market, but we are at a precipice of at least understanding on the eve of what happened in the big major news events and the bank failures that we all observed. We're now preparing to see what the fallout will be. In other words, the numbers here didn't bear any of the news that has since been dominating in the news.
So, today, we're drawing that line in the sand, that benchmark that we will compare as new batches of information come up. To help us do all that, of course, everybody knows who we would ask to come back. This person needs no introduction. Welcome back, Doc, Tony Hernandez, the Deal Doctor. How's it going, sir?
Tony Hernandez
Thank you, Alex. Thanks for having me again.
Alex Habet
Well, look, there's been a lot going on. I'm sure you've been following yourself. I mean, I know you have; we've been talking about it a lot offline. But look, the dust is somewhat settling. I don't know if anyone will really admit that, but it feels that way. At least we're not anticipating the complete unknown the way we were a few weeks ago. We're now at least at a moment, I think, collectively, where we're trying to see, well, what's the impact of this? There's going to be some long-term implications. I don't know what that's going to look like. I think we've just got to let that part unfold. But specifically, as was discussed in the introduction of the show, we have a really good idea of what activity looked like.
We do these regular updates. Anna-Fay posts the blog monthly on our website that discusses this, and so it was timely that the most recent report went out, which goes right up until, I think, the week before everything started going down. But we don't always cover these monthly updates on this show. This one is particularly important, though, because it's not impacted at all by the string of events. And so it's going to be an interesting way to monitor, to the extent that there is a measurable impact, where we can see the pockets of change.
I guess, real quick, before we dig into the report, because we invited you here for your expertise to help disseminate some of that for the audience, where do you think you're going to see ... Gut reaction. It's OK if you don't have one. In your opinion, how do you think the industry is going to ride? Do you think it's going to start to feel business as usual pretty quick? Obviously, the same issues that were present with a higher rate environment, all those things are obviously going to still be there. But do you think the acute impact of what's happened in the news ... do you think there's going to be an impact to the activity in the coming months?
Tony Hernandez
I think it's going to be just part of the bigger cloud of storminess that we may have foreseen in the past. I think last year some others were calling it, that there was a big storm coming, and then it dissipated. But as we continue to go on, there continues to be moments of friction that really prevent us from having high growth, achieving the NIM or whatever targets that we might have. This certainly just adds that much more to that uncertainty. So I don't think that, as a whole, it's going to be the thing that sinks us, but definitely contributing toward, again, not perhaps achieving the growth or the targets that we might have embarked when we kicked off 2023.
Alex Habet
I have a question for you, as someone who speaks to our clients every day, and I've asked you this before. I don't recall specifically about what last time, but in this time, have you gotten some different phone call types from your clients based on what's happened in the news?
Tony Hernandez
I have not, but I know that some of my peers have. It runs the gamut of a concern of, is there inaction or action, should they be concerned because that's not what their peers are doing, toward just a passing comment that, "Hey, our institution as a whole, it's OK. We have pockets of industry concentration." Where the clients are calling concerned of whether they're at risk of being walked out, etc., to the complete opposite, where some of our clients saw the disruption and they say, "Hey, this is a perfect time for us to scoop up some new clients." All over the place, so much so that it's really hard for me to tell you ... It's been this flavor versus this other. It's ran the entire gamut, from anxiety to opportunity, to like a non-event.
Alex Habet
It's interesting, you get the anxiety and opportunity mix. I've certainly observed that, as well. OK, let's talk about this market update from Anna-Fay. Again, for those of you who don't catch it, you can go to our website. It's available there every month. It's a great read; it's a great way to tap into the vast amount of market data that we have and just get the TLDR, the insights from that. Tony, let's start with one of my favorite places to look at first, it's a very fundamental spot, is what does supply and demand look like for the credit market out there?
Tony Hernandez
Right. We'll keep it high level, like you mentioned, Alex. It's been an interesting first quarter, and like you mentioned, it's not the full quarter, it's the first two months right up to the eve, where we saw demand for loans wane for the first time, or at least in a while. On the flip side, on the supply side, we also saw some of our FIs get more strategic on the kind of assets that they wanted based on target ROE and how they funded themselves. We know that there were some stories about all that due to the imbalance of the loan demand combined with the rising cost of deposits, that our financial institutions got more judicious on what loans that were funded versus what they didn't.
Having experienced a similar crunch, but triggered by a different set of circumstances, it's, what do you do when you have an outsized demand, even though it's waning and you're no longer able to meet it? It goes back to, hey, it takes a village. It's going to take you, the banker, it's going to take good communication to your client, good communication up the chain, whether it's through market executive due to risk, or all others on how you're going to continue to support your clients. I think that if you, as an individual, you feel backed into a corner, or somebody that's managing that book of assets, I think that ongoing communication will help in how you make those decisions on what loans you fund and which ones you don't.
Alex Habet
Right, right.
Tony Hernandez
I think that with that imbalance, very curious to see where pricing goes on this. I think you mentioned in the past that we don't have a magic eight-ball to really tell us where pricing is going to go, whether it's pushed up because of the tightening that we're seeing, or if it reduces because the demand for loans slows down a bit, so that that imbalance catches up a little bit.
Alex Habet
Yeah, that's the big wild card. I think you said it best. It's going to be one of my next reads, where I'm going to see, well, how have the volumes been affected by the news? But then again, on that imbalance, and at least trying to pinpoint down how it manifests itself as part of the rate landscape. Shifting specifically to rate structures, Anna-Fay has been also tracking the share of what are the most popular rates or how are the most favored rates structures evolving? Is there an update that's worth mentioning, at least on the mix there?
Tony Hernandez
Sure. I think for those of us that have either listened to you and I here, or read that report, no surprise there, SOFR remains resilient, the spreads remain resilient, excuse me, which points to bankers' resilience and effectiveness on passing on cost as appropriate. Prime sprints, on the other hand, have been taken downward steadily, and the overall mix of fixed rate exposures versus floating continues to show the preference for fixed. It's continued to turn down, not hovering right around 30%. Now, don't quote me on this, but I believe that in one of the very first episodes that we looked at that concentration of fixed rate debt was in circa of the mid-30s, right? I don't want to say 35, 36 or 37 in the case that I'm wrong, but it was around that vicinity.
Alex Habet
Yeah, no, I recall that.
Tony Hernandez
So, to see that come down, and again, that story of SOFR continuing to really be the replacement for LIBOR, and where bankers are kind of flexing their strength and protecting them, has been fascinating. So that decrease of, call it five basis points and fixed, and what's happening with Prime, now shows SOFR again being the most popular, with a 42% concentration, and if I'm not mistaken, probably their high-water mark on what we've been tracking there. So, just again, highlighting what I just covered.
Alex Habet
That's presumably expected, given as rates go, the attraction to fixed rate goes down, it's getting expensive and more and more expensive, so that checks out. So, I guess SOFR was lucky that the adoption went pretty well early on, and now, it's just full steam ahead, having its moment as well, as it just becomes normal part of course. So, all expected stuff. That's great. Anything else that you would point to, perhaps on how are coupons trending?
Tony Hernandez
The last thing on there across all type data shows that continue to trend higher. Again, to our first comment that the banks are effective in passing on that cost of borrowing with fixed rate being the laggard there, maybe just a timing of when pricing is presented to actually closing, and again, pointing us to toward why the preference in floating rate structures, given that if you're charging, call it 300 basis points over SOFR, regardless of where SOFR's at, you're going to get 300 basis points on the contractual spread versus a potential mismatch on fixed rate structures if you don't lock, if there's a gap in your process of locking into custom funds, before actual closing. So, that might be part of the issue there, but overall, I think the sensitivity of those rates.
Alex Habet
So, it wouldn't be a great market update episode if I didn't at least talk about deposits, just even for a moment.
Tony Hernandez
Yeah.
Alex Habet
It's everybody's favorite topic these days, and the Deal Doctor's here to also talk about deposits. So Doc, with the rising coupons and those costs being passed back to the bank's customers, is that driven mainly by the rising cost of deposits? Are there other factors at play?
Tony Hernandez
Sure. Just kind of big picture, those large month-over-month increases that continue to tick up, if you look at deposits back in January 2022 to today, or to January rather, there was an uptick of 80 basis points. Whereas, February compared to January, it was a 15 basis point uptick in deposits.
Alex Habet
So, that's just this year, you're saying in just ...
Tony Hernandez
It took a year to get to 80 basis points, it took a month to get to 15. So again, we don't have the magic eight-ball to say that it's going to continue at a 50 basis point increment, but just how much ground it covered in one month could lead or points toward that. Yes, it is that the internal pressure or how financial institutions organically fund themselves has to be reflected in the cost of funds, combined with the broader rate environment, that we find our ourselves in.
Alex Habet
Interesting. That's a pretty big ramp up there, in a month, that you're spotlighting. So, that's going to be another interest ... A really interesting data point to look at.
Tony Hernandez
If there's one that we put a pin in, Alex, I think it's this one.
Alex Habet
It's probably this one. Yeah. So, I take back what I said before, about looking at volumes first, but what this does to supply demand, who cares about that? We're going to look at this one. I think everyone's going to be fixated. OK.
Tony Hernandez
But one, and you might have been doing this by perhaps a plug to our good friend, Andy Heusel, on a blog post.
Alex Habet
Yep. Yep. I definitely would check that out, as well, I think that just went up this past week. So, we're beginning of April now, so it's fresh, hot off the presses. You can go on the website and check out a blog post about how to think about deposit pricing strategies broadly. It's a great read, as well, and hopefully, one day we can have him on here to discuss that in greater detail.
Tony Hernandez
Absolutely.
Alex Habet
Just to recap real quick, because I promised that this would be a short and sweet episode, I really wanted to keep it focused on just the update itself. We haven't done one in a few months, and this is an important one. So, on the eve of the crisis, we observed loan demand slowing down, credit standards are tightening, spreads are by and large steady, although coupons are trending higher, we're seeing a continued decrease in fixed rate structures, relative to other structures, and we have fast rising deposit costs, which are now really fast. So, that's where we stand on the eve.
My advice to everyone out there is to tune in to see how we're going to be tracking against this data, when fresh batches come out. We're expecting our first new batch, I think any week now. And, to the extent that the numbers are moving as fast as we think, we might have the Deal Doctor come back and do a quick update to the ... lightning round update to the market that we're doing right now. So, check back soon as we unpack all the action with the Deal Doctor. Tony, Deal Doc, thank you very much for coming back on the show today. Any last words?
Tony Hernandez
Yeah, it goes back to one of the first conversations that we had, Alex. Lay out all options, leave no stone unturned, and be there for your clients, whether, what's the sensitivity? Is it interest rates from the loan side? Is it that they feel that they're not getting commeasure payment on the deposit side? Is it that you are not asking for a closing fee? Try out all the options, and within there, you're going to find the winning combination that allows you to support your clients and allows you to serve your institution.
Alex Habet
Once again, sage advice from the Deal Doctor. Thank you so much again for joining today, and we look forward to having you as always, back on the show again.
Tony Hernandez
Thanks, Alex.
Alex Habet
Alright, that's it for this week's episode of The Purposeful Banker. If you want to catch more episodes, please subscribe to the show, wherever you'd like to listen to podcasts, including Apple, Spotify, Stitcher, and iHeartRadio. If you have a moment to spare, let us know what you think in the comments. You can also head over to Q2.com to learn more about the company behind the content. Until next time, this is Alex Habet, and you've been listening to The Purposeful Banker.
