2025 State of Commercial Banking Preview
In this episode of The Purposeful Banker, Jim Young and Anna-Fay Lohn, Q2 senior strategic business advisor and co-author of the 2025 State of Commercial Banking report, preview some of the takeaways in this year's report, which is based primarily on the proprietary pricing data in Q2 PrecisionLender.
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[Webinar] 2025 State of Commercial Banking
Transcript
Jim Young
Hi, and welcome to The Purposeful Banker, the leading commercial banking podcast brought to you by Q2, where we discuss the big topics on the minds of today's best bankers. I'm your host, Jim Young. Welcome to the show.
Today I welcome in Anna-Fay Lohn, senior strategic business advisor and one of our resident experts on applying the proprietary data from the Q2 PrecisionLender database to identify market trends. Welcome to the show, Anna-Fay.
Anna-Fay Lohn
Thanks so much, Jim. I’ve got to say it's great to see you and join you on the podcast, and this is kind of our first collaboration of 2025, and I'm eager to dive in and begin our year.
Jim Young
Yeah, this will be interesting. We'll do a little bit of behind the scenes on … some of you may be familiar with the market updates that Anna-Fay writes, and she and I work on those. And they involve a lot of long conversations, much of which is me saying, “Can you explain that to me again, Anna-Fay?” And then Anna-Fay patiently explaining, walking me through various commercial banking terms and pricing explanations and that sort of thing.
We will spare you all of that in this one, but I do have some questions to ask you, Anna-Fay, particularly about the State of Commercial Banking presentation that's going to be coming up. And we're excited again to be able to put out that data that really is unique in the market.
And to be honest, we usually have Gita Thollesson on the podcast to do that sort of preview, but we're bringing in Anna-Fay for this one. And this is by no means, like, Anna-Fay's first exposure to State of Commercial Banking. Some of you are familiar with last year, and just over the years, Anna-Fay, you've really played a critical role in reviewing and analyzing the PrecisionLender data that goes into that report, a lot of which is from our monthly commercial market updates. So first, before we dive into things, can you give our listeners a little bit of background about what you were doing in banking before coming to Q2 and your role within the PrecisionLender group?
Anna-Fay Lohn
You bet. So I'll start with my banking background, which was entirely spent in the CFO organization. And there's lots of roles in that group including funds transfer pricing, profitability, investments, treasury, and asset liability management. And collectively, that basket of work could be described as trying to make sense of bank performance. And often this is through the development of what we call management reporting information, which, think what we put in the market update, and KPIs, key performance indicators, think of the measures we talk about in the market update, as well.
So with respect to PrecisionLender, I use all that banking experience in my role on the Advisory team. And all of us on the Advisory team are, in fact, ex-bankers, recovering bankers, and our job is to support clients with best practices and practical solutions to their pricing and portfolio activities.
So one of my specialties has to do with data assembly transformation and usability. And this is where the intersection of my banking background and the market update. I had developed a few performance dashboards based on pricing activity, using that proprietary data. And at the outset of the pandemic in March of 2020, we saw remarkable shifts in that activity and felt that this information could be helpful to our clients. And that said, you and I joined forces as Anna-Fay, the reporter, Jim, the editor, and our first market blog went out in March of 2020.
Jim Young
I feel like also that was a little bit of a Dallas Wells sort of thing, too, in the sense that it if was …
Anna-Fay Lohn
A three-part process. I showed it to him and he said, a half an hour later you called me. So here we go.
Jim Young
And it was a little bit of that whole crisis opportunity thing. Because I think what spurred it was, and this is one of those things where, in retrospect, you look back and you say, well, that honestly we were like, why weren't we doing this earlier? But the impetus I think was, as everyone listening to this knows, in March 2020 bankers and everyone was asking what's going on, what's happening out there? And I think Dallas sort of said, hey, we've got kind of an opportunity here. Let's share what we are seeing. We've got this database, why don't we share this? And we did, and the first one had just unbelievable response and it was sort like, oh, I think we're onto something here. People care about this.
And again, in retrospect, it seems Captain Obvious. But yeah, anyways, you can kind of go in a little bit to how those things are built. But I did want to sort of share that background of a little bit of how this came to be and really it was COVID five years ago that sparked it.
Anna-Fay Lohn
That's right. And one of the great things about the PrecisionLender database that we work with for this is it has the data science team behind it. And I'll just give a shout out to them. They enhance and enrich that data set continually. And within PrecisionLender, what is great about it is if you're trying to use data is the fact that you've got an apple to an apple to an apple. And by that I mean we can trust the metrics that we're looking at. We can trust spread index, we can trust fee income, we can trust utilization rates. So that gives us great confidence in being able to produce the market update, and it's a lot of fun to produce, I might add.
Jim Young
I should also say if you, and again, we're going to get, I promise we're going to get into this State of Commercial Banking and that sort of thing, but this is sort, again, sort of the market updates are a lot of what feeds it. So, if you are someone listening to this and going, I'm not familiar with these, or how do I find out more about them? We invite you, you can subscribe to them, shoot us an email to insights@Q2.com and just basically say, “Hey, I'd like to start getting those market updates.” If you are probably, if you're on our email lists already, you'll be getting it. But again, and you can always just respond to the email that you get from me and just say, hey, can you please make sure that I'm subscribed to this? Or if you want to add other people within your bank or credit union to get that, that's the way to go with it, insights@Q2.com.
So, that's a sort of the background, it's Anna-Fay, that's your background. It's the background of the foundation of State of Commercial Banking—pricing section of it is what we're really referring to here. So I'm wondering if you could take us a little bit into the process where you and your team are putting together that State of Commercial Banking report. I mean, there's a ton of data within the Q2 PrecisionLender database. How do you decide where to focus?
Anna-Fay Lohn
Well, you're right. Putting together those State of Commercial Banking reportx is both challenging and exciting. So it's challenging because, to your point, where do we decide to focus? And in our case, happily, our clients help us with this part. In working with them day to day and conference interactions such as CONNECT and BankOnPurpose. We have leadership interactions through the Client Advisory Board. We know because our clients tell us what's on the bankers’ minds and their leadership as well. And so that helps us with the challenging part. And it's exciting, because we gather evidence. We're an evidence-based company, we go back to Carl Ryden as our founder, to frame the state of what's important. And we use public information to get started. And by the way, this is among Gita's many areas of expertise, for high-level descriptions framing up what's happening in very broad fabric of banking through public information.
My role, as you mentioned, is more focused on the proprietary data within the space of PrecisionLender, and that includes pricing activity, certain loan portfolios, metrics, as well as deposit portfolios. And we have the habit, because of the market log of keeping this information up to date, so that we're able to connect those broad public themes with the more specific trends.
For example, in this year's State of Commercial Banking, not to give away too much about what's coming up, but the Fed rate cuts began later in 2024 than was generally expected. That's the broad theme. Pricing managers, bank leadership, and lenders all changed their behavior in anticipation of, and in response to, that timing. And we can see those changes in behavior as they play out day by day, week by week, month by month, through the activity information in PrecisionLender. So one conclusion we drew is, pricing managers had greater confidence in their fixed-rate lending at the end of 2024 than they had in midsummer before the rate cuts happened.
Jim Young
One of the things that's kind interesting with the public stuff, particularly those year-end, sort of Fed surveys, where they say, this is what we think we're going to do going in the year forward, and this is how we sentiments and that sort of thing. It's always interesting to compare what bankers say that they want to do or think they're going to do. And then, when you go into that database and pull the stuff out, we can then say, well, this is actually what they're doing. And sometimes it's exactly on line, and sometimes, well, we'll get to maybe a little bit more of that. You find some interesting curveballs a little bit on it.
Looking back at 2024, I mentioned your involvement in that report to last year's. Some of the key themes then were around liquidity management, impact of Basel III on capital, how higher rates were going to impact commercial lending. Now that we have that hindsight, how close were we to the bullseye of how 2024 actually played out?
Anna-Fay Lohn
OK, well let's just see about that for a second. So with respect to liquidity, we found that this theme remained front and center in 2024, in terms of deposit volume, mix, and costs. And the mix, this was the surprise, the mix continued to shift toward interest-bearing accounts, which had the effect of keeping overall deposit costs higher than they would've been otherwise. So liquidity costs stayed higher than expected, but liquidity was present. So I would call that sort of half-right, if you will.
The deposit betas, that's that word we use for the change in the rate paid on deposits, materialized much later in the year than anticipated. Again, in fact, we didn't even see any material changes until after the September Fed rate cuts. That's unusual.
And then on the Basel III situation, that capital, that whole conversation seems to have been pushed to the back burner, because the concerns over more regulation have eased somewhat in the past few months. What was the theme of where we would be in December back from a political standpoint changed with the election potentially, and nonetheless, higher regulation seems to have been pushed to the back burner. So we don't hear too much about the capital rules for the Basel.
And then the impact of higher market rates, we have seen that be persistent in our commercial lending results, and it's put pressure on loan net interest margin during the entirety of 2024, so that was true.
Jim Young
All right, looking forward then to 2025 State of Commercial Banking, which you and Gita and Debbie Smart will be presenting. And a reminder there will be a link in the show notes to register to attend the webinar. Highly recommend that you do that. And what's really, again, no spoilers here, but a little bit of a teaser for people. What is the number one takeaway for you from this year's report?
Anna-Fay Lohn
I do have my favorite in this, and it is the very rapid relaxation of the inverted yield curve. Essentially, it's relaxed over a three-month period to move from acutely inverted condition to a positively sloped condition. And this is after two years of inversion, which, by the way, bankers had never seen. I had never seen an inverted curve for that length of time. So this ease has been rapid, and now we start 2025 and it'll have an immediate impact on bank performance. It's going to happen on both sides of the balance sheet. The repricing of existing floating-rate loans downward as a function of the index value, and the degree to which deposit rates paid move lower. And those actions may or may not be in complete balance or may have timing differences, which are going to come through in some of our loan pricing activity. So I am tuned in to what the incremental activity is for our bankers as they put the toe back in the water with a positively sloped yield curve.
Jim Young
Yeah, I mentioned earlier about how we have that sort of comparison between the public data that we see, and then the information that we eventually make public that we're looking at in terms of how bankers are behaving. And this has been one of those things that, we've looked at the yield curve and we've had conversations, and I'll typically ask Anna-Fay during these things like, OK, so how does this sort of square with what we typically see for bankers? And Anna-Fay's answer is usually like, well, we've never seen this before, which has been very interesting over the last couple of years with the degree of the inversion of that curve. It's been unprecedented stuff for an industry, as all you know, very cyclical in a lot of ways. Usually this happens, this is what we'll see, and eventually things move, but this has been uncharted territory.
We did see, you mentioned before Fed rates dropped by a hundred basis points, sort of the August, September fall period. You talked this a little bit. If you can elaborate a little bit more about how those cuts are impacting commercial lending and sort of, that's one of those things you typically see, OK, when basis points are cut, this is what we're going to see. So what have you seen and how has it compared to maybe what you would expect to see?
Anna-Fay Lohn
This is just very exciting. So let's sort of talk about this rate cut. That's pretty surprising, because that's not what happened the last time we had rate cuts. Now that, granted, was in the pandemic, but the point is, folks might move to the sidelines. Oh boy, things are getting better for me, the borrower. Oh boy, things are going to get better for me, the lender, because I can raise my spreads, but that's not what we saw in the fourth quarter of 2024.
In fact, the pricing activity was the highest quarterly volume of the year in spite of the seasonal slowdowns for the holidays. So that was interesting. Bankers also maintain their performance levels to a large degree in the fourth quarter, and they specifically did improve the fixed-rate loan, net interest margin report card, which is widely viewed as the first order key performance indicator for banking. So that was just very exciting, and they didn't skip a beat.
Jim Young
Gotcha. OK, I sort of alluded to a little bit of this before, but I'm kind of wondering, it's been almost five years now that you've been tracking this sort of data that feeds into the market updates that, again, forms a large foundation for the State of Commercial Banking. And I've mentioned some unprecedented things and that sort of nature. Obviously the thing that started this, COVID, is something in effect to market in a way that's unprecedented.
But I'm wondering, when you've looked at the data, has there ever been a moment or two where it's really surprised you where, to be honest, you said, OK, that can't be right, and you were like, I’ve got to go back and make sure I run the numbers. Was there something wrong in what I pulled up or that sort of thing? I'm curious if that's happened, if you've had that sort of moment before.
Anna-Fay Lohn
There's a couple of situations that come to mind. One is the transition from LIBOR to SOFR.
Before the fact, the expectation in the marketplace was that SOFR would not emerge as the darling index of choice that it has become for floating-rate structures. There were several contenders, SOFR, BSBY, AMERICBOR to name a couple. And what we saw was a quick tick in the LIBOR pricing, well in advance of when LIBOR was going to be discontinued, which I believe was in the June of '23.
In addition, we saw, within a few months, the concentration of these competing indices falling away and the complete shift to SOFR as the preferred floating-rate index reference point. The speed of this was further enhanced by the CME SOFR term points. You may know that there's a 1, 3, 6, and 12 points on the CME SOFR, which covers a lot of territory in terms of floating-rate references. Bottom line is, now we see from a volume standpoint, that SOFR actually represents over half the volume in loans priced in PrecisionLender. Without, it's very concentrated. It's a two-horse race, fixed and SOFR, and then prime represents a distant third. So that was very surprising, collectively, to the market.
Then, to answer your question about data, we had an example this year and it was, again, it was a function of this inverted yield curve. You may recall in August of 2024, collectively, fixed-rate coupons moved down 50 basis points all at once on the day right after the employment report from July that was delivered on August 3. So I scratched my head about that and really had to go to the map to uncover the details. Found them to be uniform, and off we went. That, the fixed-rate lending has since recovered that plus more and in spite of those Fed rate cuts. So that was an interesting situation for me.
Jim Young
Yeah, absolutely. All right, final question for you here. I know, and probably not fair considering you're locked in the State of Commercial Banking and the report and presentation, but I want to actually go ahead and say, all right, looking past that, what are some of the things that you'll be watching for in the monthly commercial market updates? Anything you're particularly interested in tracking?
Anna-Fay Lohn
So yeah, I'm going to have my eye on the market expectations for any further Fed actions in 2025. We just had a really good employment report from the December situation and from December job markets, and those expectations for any further Fed action could be strong, weak, don't know. They'll emerge as the year progresses, but now it's different. Now we're in a moderately, positively sloped yield curve for the key points that address commercial loan pricing. I'm going to be dialed into that expectation, and specifically whether or not we see pricing managers and bankers changing their behavior in advance, or more reactionary to that.
Collectively, I'm hopeful that there'll be signs of improved performance. It's been a long couple of years for these guys that haven't been able to break out, add more spread, that sort of a thing. So I'm hopeful that new run rates can show green shoots for improved performance.
Jim Young
Yeah, absolutely. Well then, thank you so much for coming on the show, Anna-Fay.
Anna-Fay Lohn
My pleasure.
Jim Young
Obviously, best of luck in the State of Commercial Banking presentation. For those, again, if you want to register for that, it's January 23 webinar. We will have a link to it in the show notes, and so please make sure to check that out.
That'll do it for this week's episode of The Personal Banker. If you want to catch more episodes, please subscribe to the show wherever you like to listen to podcasts, including Apple Podcasts, Spotify, Stitcher, iHeartRadio. Love to hear what you're thinking in the comments, and you can head over to Q2.com to learn more about the company behind the content. Until next time, for Anna-Fay Lohn, this is Jim Young, and you've been listening to The Purposeful Banker.