What We're Seeing In the Commercial Lending Market 3/27

March 27, 2020 Jim Young

To keep you up to date on what's happening in the commercial lending market, we're increasing the frequency of the Purposeful Banker podcast. We'll review PrecisionLender's data on several key metrics - NIM, volume, spreads, etc - and talk about the latest developments in a rapidly changing situation. 

(Note: This was recorded on Tuesday, March 24)


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Jim Young:
Hi, and welcome to The Purposeful Banker, the podcast brought to you by PrecisionLender, where we discuss the big topics on the minds of today's best bankers. I'm Jim Young, director of content at PrecisionLender, and I'm joined again by Dallas Wells, our EVP of strategy.

I know the last time we came to you we said that we thought it might be a while before you hear from us again on the podcast because things were so uncertain. We just weren't sure when this would come back into the flow of things. And actually, what we ended up doing is the opposite. We decided let's try to put these out a little more often, trying to stay as close as we can to timely given that things are changing so much. We want to try to give you guys as much information about what we're seeing and hearing to help you out.

Having said that, because it's a podcast and we're recording this one on Tuesday, March 24th, and we're going to try to get this edited and out as soon as we can, we ask for a little bit of patience. Probably some of the things we talk about might have shifted by the time ...

Between the recording and when it actually shows up on your feed. But we'll, again, try to be as timely and as helpful as possible.

Having said that, Dallas, thanks again for coming on the podcast.

All right. Let's start off with ... For this week's show, we wanted to go into what we're seeing, basically, in the commercial loan pricing market. Some of you who follow us on our social media accounts and who have gotten our emails as well have seen that we've done these market updates the past two weeks. Dallas, can you give a little bit of the thinking on why we're producing these and maybe a little bit of why these are ... There's a lot of stuff coming out right now ... Why we felt like this should be something that commercial bankers should take a look at.

Dallas Wells:
Yeah. Basically, the world changed overnight. The bilateral commercial loan market is something that tends to move pretty slow and steady, so even when there's rate changes those are rarely a big surprise and you can see the trends ... See those coming and then slowly digest them and it's these nice, smooth curves in everything that happens with the market. Volume up and down, rates up and down, it's fairly fluid and, again fairly smooth.

In the same logic of upping the frequency of the podcast, it just feels like so much is happening in such a short time span right now. You go a week and you get to Friday afternoon, you look back and you're like, "My gosh, that felt like it was a year long and we're only through five days." There's a lot of dislocation and changes in the market happening on lots of different variables and all at once. And so, we've started getting lots of questions from bankers, from our clients and from prospects that we talk to regularly. They're asking that simple question of what does the market look like now? And I think there's also the almost whispering, what's everybody else doing? Are we doing something outlandish? Is what we're doing reasonable? And there's some comfort in following the crowd a little bit. But also, just knowing where is the market because this is a market that's hard to see into. By the time you get data, it may be months old, which in an environment like this is, again, going to feel like years or decades old.

We started producing this just to get a regular look for what's different. Are we returning to normalcy? Are we not? Are there interesting trends peaking out of there? Mostly, we're just regurgitating the data. There's a little bit of analysis that goes with it. We're getting those out early in the week. And then anything interesting that pops out of that or follow along questions that come from that from bankers, we'll do a little bit deeper dive into that. Maybe we can talk about a couple of those things today.

Jim Young:
Yeah. And you mentioned about ... We definitely use FDIC data in some of the reports and that's one of the things we've done in the past, but this isn't something like that. Some of this stuff is not stuff that banks have to report elsewhere and it's also stuff that we are looking at daily and then producing these things weekly. Can you talk a little bit about the data source that allows us to have a view into some things that you can't see elsewhere and to also have that view on a day-to-day basis rather than a quarter-to-quarter basis?

Dallas Wells:
Sure. There's over 150 banks that use PrecisionLender as their primary pricing and negotiation platform. All of their commercial loan volume flows across our platform in the form of what we call opportunities. Those are deals that are being structured and negotiated out in the marketplace. That ranges in size from small community banks to some of the biggest global banks. The annual volume current run rates just north of two trillion dollars, so it's a pretty good, diverse data set and it's kind of a real-time look at what discussions are bankers having with real, live borrowers?

All that data goes into what we call a sanitized database, which means before our analysts can touch it, it's scrubbed of any identifying information. We see deals and deal structure. We don't know who they're to, we don't know which bank they're from, but you can start to find a signal in there of what's happening in the marketplace, so that's what we thought would be useful to share.

Jim Young:
Okay. Putting together the first one of these ... And again, as everyone who listens to this knows, I am not a banker. But even for the layman such as I, this jumped off the page to me immediately and that was the volume spike that we saw in a number ... Amount of money being priced, et cetera, in the first couple of weeks of March. Went down a little bit this last week, but still numbers for the first three weeks of March considerably higher than the previous two months of this year. Can you talk a little bit about that spike and what you think caused it?

Dallas Wells:
Yeah. It was meaningful enough change in volume that it wasn't our ... To put it in my friendly terms, it wasn't our banking nerds that spotted it; it was our engineering and data nerds that spotted it. Our platform runs entirely in the cloud, so the engineers that do the feeding and care of that system started asking some questions of, "Hey, guys, what's happening? Because volume is through the roof right now." And actually, we're looking at this week-to-week to smooth out some of the noise. There were a couple days in there that were just massive volume; just number of deals and the amount of activity on the platform.

To put that in some real context, as we got to the first week of March, volume spiked from where it was the week before. And the week before was just a pretty standard week, right in line with where it's been year to date. That first week in March it was up 59% from where it was the week before. And when you see it on the chart, it's such an outlier. It looks really strange on the chart. And we thought, well, that was weird. Maybe it was just a one time thing. When we looked at it the next week, it was even higher. And then in the most recent week, it leveled off a little bit but still way elevated above normal levels.

The kind of spooky thing ... I say spooky just because it was reminiscent of some of the stuff that happened in the financial crisis back in '08 and '09 ... Is we would have these giant record-setting volume days and then I would ask the folks who were watching that volume the next day, "Hey, what's it look like today?" And they're like, "It's crickets. It's really quiet today." Almost day-to-day changes, which is unusual in this market. This is not like the equity market where there's daily news that gets ... And there's these instantaneous little transactions that happen. These are deals that get put together over weeks and months.

So, for there to be that kind of activity change day-to-day has been a little unusual and really interesting. And so, we've been trying to talk to the banks about what's driving that. I think a lot of it is when you see rate changes as drastic as they've been ... We're talking ... At the short end of the curve, you're looking at the Fed doing two emergency rate cuts in a very short time span. And then the long end of the curve has had to adjust to that. And so, you've seen within a weeks time these 40, 50 basis point moves and rates that have just been super steady and stable for years.

You see a combination of borrowers coming back and saying, "Hey, the world is different from what we talked about three days ago." So basically, everything you've done in the last week, month, maybe even quarter ... These deals that have been in motion, it changed enough that the borrowers came back and said, "Hey, I think that's different now." And you have a lot of bankers doing the same thing ... Of deals that didn't quite go or didn't quite work or you missed out on it to the competition. Then you go, "Wait, I want to recheck that because now maybe it works." And now we get to re-trade that thing and try it again. It's not necessarily that more deals are happening, just that every deal that was already in motion has to have been adjusted and so we take a new, fresh look at it in this new environment. We'll see how that sustains and if it takes volatility to keep it in place or if that's our new normal for a little while.

Jim Young:
Do you think ... Is it possible also ... If I'm running and I'm thinking more small business sort of thing, I read the tea leaves and I say, "Hey, if things are going the way they are in terms of social distancing or even shelter-in-place and that sort of thing, my business is going to be hurting for a while and I'm going to need, essentially, a loan to make sure I can bridge through the next three to six months. I better go ahead and grab this right now," basically. It almost felt to me like maybe both sides were motivated at that point. Bankers are motivated to go ahead and make some of these deals and people are motivated to come to them and say, "I could use a loan right now."

Dallas Wells:
Yeah, you're absolutely right. And that kind of proactive approach is what feels a little different about this go-around from the last big volatile crisis that we had, which is that banks are dealing from a position of strength. What that means is that you do actually see ... Of course, you see borrowers coming in. And there's actually been some pretty, what I think, are neat, feel good stories of people saying, "Hey, I need 50 thousand dollars so that I can make payroll and I can send my folks home but still make sure they get a paycheck, too." Businesses wanting to do the right thing and banks being in a good enough position to be able to accommodate those things and give friendly terms and structures to make that happen.

And also, bankers learning that waiting for someone to come to you with a problem and say, "By the way, I'm dead broke and have been for two months," and you're now at the bank of the line, that's the wrong approach. They're trying to be proactive about businesses that they know could struggle a little bit and say, "Hey, how can we help you with some liquidity right now to get through what we hope is a very temporary issue?" And then you can come out healthy on the other side instead of getting yourself in a really bad position just from a liquidity crunch. Coming both directions and it's absolutely new business and re-looking at everything that was in the works.

Jim Young:
What about rate-type shifts? That sort of thing? Is it situation where, again, people are saying, "Hey, at this point I want to lock in on something fixed rate," because everything's shifting? What are we seeing those numbers?

Dallas Wells:
Interesting things happen, again, with volatility like this. There's two sides of the coin. Number one is rates move down to record lows and so there's some incentive for borrowers to want to lock in a low rate for a long time. Get it while the getting's good. Also, in times of uncertainty, let's lock down what my debt service is going to be. Now I know what that outflow is every month and I can plan around it. But the flip side of that is as short-term rates go almost to zero, some of that floating rate deck gets really, really cheap. There's some incentive go to both ways. We didn't really know what to expect when we looked at this; which way might be winning out there.

For comparison's sake, we're comparing what's happening in March to what was happening in January. January's what we're using as our baseline. It was business as usual. There was Coronavirus stuff in the news but it wasn't really impacting the markets yet. If you look at our trend lines, they were pretty stable for the months preceding that. We use that as the baseline and we compare it to March. What we're seeing is more fixed rate structures and fewer variable rate structures. Fixed rate structures were 41% of the share in January. They're now tracking at about 46% and growing. That can come from both sides. It can come from borrowers requesting it, it can also come from banks saying, "Let's help some of these potential credit risks again get stable and lock in something that is affordable and matches their cash flows."

Either way, it looks like fixed rate seems to be the structure of choice in this environment.

Jim Young:
But meanwhile, on the floating rate side of things and that's where they give ... One month LIBOR was the one that really seemed to ... Took a significant drop from 28% to 21% of the mix while prime-based floating basically stayed the same. What does that mean or how do you interpret that?

Dallas Wells:
There's two things happening there. One is just the fundamentals of the index, itself. Prime is higher, right? So we won't necessarily see the same, nominal rate relief and outgoing debt service relief because it kind of has a built-in floor just because it is three percent above the Fed funds rate. That's part of it.

The other part of that is that ... Just the different nature of borrowers who tend to do prime-based borrowing versus LIBOR. Prime ... And again, this is not an across the board truism, but it's on average the truth. Prime tends to be your smaller borrowers and LIBOR tends to be larger, and therefore, usually more sophisticated borrowers. They end to, number one, have somebody whose like ... It's their job to manage such things. And so, they will try to play that arbitrage between fixed or floating and what best matches the business' current environment and they have the size to be able to push on the bank for those and get those things done.

What we're seeing is larger borrowers pushing for, hey, I want to move away from LIBOR-based floating rate debt and towards fixed rate stuff while I can do so. And then a lot of the smaller borrowers are just take what they can get and the terms that they've always gotten are the ones that they will continue to get.

Jim Young:
Okay. Going on the checklist here of the big things to check on, with all the rate volatility, how has that translated to NIM and then what has that meant across the various loan structures?

Dallas Wells:
This data can get a little noisy when you try to look at it week-to-week. I would say that one of the things we're cautioning banks when we talk about this stuff is don't read too much into small changes; that basically, they can be within the noise level of the week-to-week fluctuations. We tried to plot these back a little ways before ... Back into the stable world and see are some of these changes outliers from normal fluctuations? And what's interesting is there was a fair amount of change in the spreads or what we're calling margins on fixed rate structures.

Just to be clear on how we're measuring this, we're not taking the bank financial statement accounting view of it, which would be interest income minus the bank's average cost of funds. Instead, we're looking at deal by deal the marginal cost to find that deal. It's matched funding or risk adjusted margin. It takes the term into account.

What we say is, as you would expect, as rates came done, yields came down on loans so the rates being charged came down. And in the first couple weeks of March, the funding costs came down by like amounts. And in fact, actually came down enough faster that there was actually a little pop in margins on fixed rate loans where there was this temporary blip up in margins. The question from banks when we first looked at that was, was that some kind of risk premium already showing up in the marketplace? What it looks like from the most recent week is maybe not. It's hard to tell yet until we see a few more weeks of definitive trends because those margins actually came back down the most recent week we looked at.

What happened is that even though yields came down a little farther, the funding costs actually popped up. That was ... If you think back to what's happened in the rate markets over the last couple weeks, 10-year treasuries at the really volatile part of that got down as low as below 50 basis points; below half a point for 10-year treasury rates. Those are now, as we speak today, just north of 85 basis points, I think. They've been up above one percent over the last week. So, still a lot of volatility in there and what you're seeing is the rates came way down and then they came back up. You're seeing the shape of the yield curve move all over the place, which is unusual and it's causing some of the noise in there. And I think that's where bankers just have to be aware of how those costs play in to how they're structuring these deals and try to use a sanity check on some of these things.

For those PrecisionLender clients, if you're seeing things that you don't expect as you're putting these deals together, let us know and we can talk through what's causing some of that and some adjustments you can make to maybe smooth out some of that volatility if you want to remove a little bit of that noise.

Jim Young:
Yeah, it was interesting with all that stuff because it was kind of wild to see, wow, cost of funds plummeted and then they bounced back up and all these sort of things happened. And then we took a look at, basically, the overall March NIM versus January and it was basically roughly the same-

Dallas Wells:

Jim Young:
At that point. Okay.

Dallas Wells:
Yeah. It was a roller coaster ride to get there but we ended where we started.

Jim Young:
Right. Exactly. How about swaps? What are we seeing?

Dallas Wells:
Yeah, so whenever there's volatility that shows up like this and then banks start to think about how do we hedge this? Are we ... especially with volumes spiking up, too, it's like you don't want to, with a big spike in volume, book a big chunk of your balance sheet through volatile times and end up with what might be a really weird set of instruments on your balance sheet.

We talk about rate volatility. As rates go way down to their low, you don't want that to be your high week of the decade in volume and you book a whole bunch of stuff at the very bottom that you got to live with for a while, then. What banks are looking at is there's an increased demand for fixed rate structures. We don't love levels down here, especially with that kind of volatility. It makes the finance and treasury folks not be able to sleep at night. So, how can we hedge that? We expected a pretty meaningful spike in structures using interest rate swaps, so back-to-back swaps. It moved from seven percent of the volume to 10%. Again, that doesn't seem like a big change but you're talking about a 50% increase in the number of swap structures out there.

And the other thing that's been interesting with that is that those swap rates that are being quoted out there, there's a lot less thumb on the scale in the swap markets than there is in the bilateral bank debt market. There's some negative swap rates out there. Even though bankers want to use some swaps, they go to actually price those with their provider or internally at their swap desk and there's a number with brackets around it that comes back and they're like, "Yeah, maybe not. Maybe I don't want to do that."

That will be interesting to watch, too, is how long are banks able to ... Especially if this trend continues, how long are banks able to withstand the really low, nominal level of rates? And in some cases, those things moving into negative territory? How do we handle that? And how does the liquid, transparent swap and corporate debt markets and syndicated loan markets ... Those things eventually ... Those things do show up in the bilateral markets. And it will just be interesting to see how long banks can wait before they have to face the music on some of those things.

Jim Young:
And then, rate floors. That was the big topic of conversation about a week ago as the recording of this podcast. And it's been ... We put out some pieces. You wrote one, Gita Thollesson wrote one. We've gotten some interesting feedback. A friend to the program wrote in and said very politely but in his view, "Why are we even asking this question right now? Asking whether you should use rate floors is saying should you get flood insurance after the flood has already come through?" Curious what you think about that part of it, the philosophical part of it, and then if you could, again, talk a little bit about what we've seen so far with rate floor usage.

Dallas Wells:
Yeah. First, to that question, of course it's going to feel late. You have your entire book and you're going to look at it and go, "Gosh, I wish we had floors on every deal on the books." But if we look back to lessons from, again, the last time that we were here, there was actually ... Bankers did learn their lesson. There's a lot more floors in place now than there were in 2007 before the bottom fell out then. With those floors in place I think you'll see margins hold up a little better.

But also, what bankers learned is that, again, there was that big volume spike then, too, as rates came down and the whole world had to re-price itself either just through contractual maturities or refinances or however it was coming. Huge prepay rates, huge refinance wave across every loan type. Making that decision today is still going to be useful and valuable and it will impact a bigger volume to your balance sheet than you probably expect.

We just looked back and this one ... Gita looked at the trends on it and she took it back to the beginning of 2019 to look at how often on variable rate loans are bankers putting floors in place? Floors of any kind. It was at 28% of those deals in the first quarter of '19 and it's been trending slowly up. In February of this year, it was at a third of deals, so 33%. So far in March, it's at 38%. A really big spike, again, there. Again, if you just look in terms of the change there, that's a meaningful change in a short amount of time. Bankers are saying, "Okay, now that you're coming back you want to reevaluate this deal at, again a zero rate world, which we thought we'd left behind. Now that it's back, we're going to need some floors in place."

I won't go too much into the weeds on any of that. We've got a couple pieces up. We'll link to those in the show notes. But lots of things to think about there. And again, let us know if we can help with that discussion. I think it's ... Like all financial instruments, if you put a floor in a deal there's trade-offs there and that thing has a value and a price and it also has downside risk. Make sure you think about both sides of that as you start putting those in place. But in general, is it the right answer? Yes, you should have some floors in place because seems like you can't go lower than zero, the rest of the world says you can. They've been in negative rates for quite a while.

Jim Young:
All right. Finally ... I think you touched on this a little bit already, but any changes yet or what are you seeing in terms of spreads?

Dallas Wells:
Yeah. If we go back and look at spreads on floating rate deals where you can take out a little bit of the noise of what's going on in the yield curve and you can look at that more in terms of true credit spreads, that data is a little noisy as you look at it week-to-week. Again, we took each week back from the beginning of the year. You can see that it spikes up and down a little bit, but the first couple of weeks in March there was a spike up above the range it had been in before. Meaningfully above. Sticks out pretty nicely on the chart there.

Again, that's not yield curve related. That's not marginal cost of funds stuff. That is one month LIBOR versus the spread over that. We're comparing there to get a true credit spread. There was some panic premium put in there for a couple weeks. I thought it was interesting that last week that spread came down to 232. Year to date, it's been 233. It seems to have come right back in line. Again, that's one that we'll keep updating week to week but it looks like there was this almost visceral reaction in the marketplace for a couple weeks. And again, it was through big volume. It wasn't like it was just a blip but now we seem to be stabilized back there a little bit.

Lots of interesting things going on in the rate world, but still from a credit perspective, the banks don't seem too spooked yet and things generally seem to be as they were. As we see how long this crisis sticks around and what the follow on effects are in the economy, we'll see if that starts to change.

Jim Young:
All right. Well, that will do it for this week's show. Thanks so much for listening. Again, we ask ... We appreciate you guys listening and tuning in. Ask for patience as we try to give you some information that's a little more current. Like I said, sometimes it's just by the nature of it might be a little outdated. But you're smart listeners and we trust you to know, okay, going to disregard that one because that changed yesterday; that sort of thing. Would also want to note if you're listening and you want us to ... Gosh, you've got a question. I wish these guys would take a look at this particular metric or this particular tactic and what they're seeing. Feel free to email me. It's initial J, Y-O-U-N-G. JYoung@PrecisionLender.com. It will be in the show notes as well and if you get our emails, they're coming from me. You can just respond to me, to one of emails, and say, "Hey, Jim. Was listening to the podcast. Would like to hear you guys talk about X."

Again, Dallas, as you pointed out this is a time when things are changing so fast and really, what we're trying to do is be as helpful as possible to our listeners, our readers, our clients and also, those prospects out there.

All right, and now just for those few friendly reminders you're used to. If you want to listen to more podcasts or check out more of our content, you can visit the resource page at PrecisionLender.com or you can head over to our homepage to learn more about the company behind the content. And if you like what you've been hearing, make sure to subscribe to the feed in iTunes, Google Play or Stitcher. We love to get ratings and feedback on any of those platforms. Until next time, this is Jim Young and Dallas Wells and you've been listening to The Purposeful Banker.


About the Author

Jim Young

Jim Young, Director of Content at PrecisionLender, is an award-winning writer with experience in a range of positions in media and marketing, from reporter to website editor to content marketer. Throughout his career Jim has focused on the story – how to find it, how to understand it, and how best to share it with others. At PrecisionLender, he manages the many ways in which the company shares its philosophy on banking and the power of relationships. Jim graduated Phi Beta Kappa from Duke University and holds a masters degree in journalism from Columbia University.

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