Note: Don’t worry! You haven’t missed one of our commercial loan pricing market updates. We’ve made a slight change to the title of these posts to clear up a bit of confusion with our readers. The title now reflects the month in which we’re sending you the update—so this is the Commercial Loan Pricing Update: July 2023.
Since the upheaval that struck the banking industry in March 2023, we’ve been combing through the Q2 PrecisionLender commercial loan pricing database, looking for evidence of credit tightening and of pricing risk into deals. Midway through the year—and a quarter after the upheaval—it seems clear that banks are still coming up short when it comes to risk-adjusted pricing.
This update will show the mixed bag of results. Spreads and coupon rates increased, but so did funding and liquidity costs—all of which led to relatively flat NIM, despite the uncertainty in the market.
Deal Volume Still Relatively High
Pricing volume at this point is helpful to provide context for our examination of credit tightening. In June, we continued to see relatively high levels of pricing activity, still above the 12-month average.
Priced Commercial Loan Volume, by Month
(Indexed to July 2022 = 100)
SOFR Spreads Break Out of Previous Range
Bankers have clearly taken steps to improve spreads since March. Since then, spreads to SOFR have increased by 16 bps. Also, the May (2.63%) and June (2.64%) marks are above the narrow 10 bps range (~2.45-2.55) that SOFR spreads had been in since last summer.
Note: Prime spreads also rose in June (to 0.13%), but as we have noted before, they have a different behavior pattern due to the comparative high coupon associated with Prime-based deals.
Weighted Average Spread to SOFR
Coupon Rates Continue to Climb
Across the board, coupons have continued a steady climb in 2023. It is perhaps worth noting, though, that the rate of increase has not accelerated noticeably since March. And as we’ll note below, these increases in coupon rates must also be evaluated against the increases in funding and liquidity costs.
Coupon Rate, by Month
Inversion Softens, At Cost of Longer-Term Rates
Meanwhile, the inverted SOFR and FHLB curves continue to serve as a reminder of the uncertain environment in which bankers are pricing commercial loan deals. We’ve had frequent questions from clients about how to approach this situation and those conversations are continuing into the third quarter.
We did notice some softening of the inversion, when comparing snapshots from the end of June to the end of May, with a positive slope returning to the 1-12 month period for both curves (thanks to an increase in the 12-month rates).
An increase in rates at the 60-month point—where most fixed-rate deals are priced—narrowed the inversion for both curves as well. For SOFR, the drop from 1 month to 60 months on June 30 was -122 basis points, less than the approximate -160 bps drops charted at the end of April and May. For the FHLB curve, the 1-60 month drop on June 30 was -96 bps, compared to -119 bps for both the April and May snapshots.
Note: As we mentioned in last month’s update, the FHLB curve includes liquidity premiums. When those are added into the SOFR curve, the two common funding curves look very similar.
SOFR Swap Curve, Selected Dates
FHLB Composite Curve, Selected Dates
Funding and Liquidity Costs Continue Their Rise
While that uncertainty is one strong argument for pushing up spreads and coupons, rising costs are another. Funding costs have continued to push higher throughout 2023, with SOFR funding costs rising 60 bps since March. Please note Prime-based funding costs (not shown) are virtually equivalent to SOFR-based costs. Similarly, adjustable-rate funding costs are nearly identical to fixed-rate costs.
COF by Month, Rolling Trend
Meanwhile, liquidity premiums are also on the rise—regional banks have increased their premiums by 23 bps since March.
Liquidity Premium Within Overall Cost of Funds
Looking more closely at where the liquidity premium increases are occurring, we noted a rise in liquidity costs in term structures with maturities greater than 12 months.
Implied Liquidity Curve from Pricing Activity
Despite Risk, NIM Remains Stagnant
To recap briefly: spreads and coupons are increasing, but so too are funding and liquidity costs. So despite an economic environment that would seem to call for a more disciplined approach to risk-based pricing, banks have only been able to hold the line on NIM in 2023. We have not yet observed consistent or material changes in pricing activity with respect to credit risk (provision costs, capital loads, loan to value levels/mitigation), ROEs or Target ROEs.
NIM by Month, Rolling Trend