How Seasonality Impacts Bank Loan Pricing

More Competitive Loan Pricing

Research has demonstrated that companies do not sell their products or services evenly throughout the week, month, quarter or year.  Instead, in many industries, success rates and failure rates fluctuate throughout periods.  This stems from a number of reasons.  Sales reps are motivated by quotas which must be achieved at the end of the month, quarter or year.  Furthermore, clients are conditioned to expect a change in behavior from sales reps and come to expect discounting at the end of periods.  We looked at almost a thousand loans to see if commercial loan pricing at community banks is also affected by seasonality.  The answers may surprise many bankers.

Why Sales Fluctuate

The substantial research concludes that sales reps are more motivated to meet quotas with potential buyers near the last few days of the month or quarter.  Research carried out by InsideSales.com looked at 9.8 million transactions over nine quarter-year periods from reps at 151 companies. They found that “artificial haste,” driven by end-of-period pressure, is a major contributor to both higher sales, and also higher percentage of lost sales. In other words, while sales people sell more at period-end, they also have a lower success rate.  Had reps been more patient with the sales process, the prospect would be converted but at a slower pace.

Banking is also a sales driven business and banks typically set production budgets for the calendar year, and many lenders are given individual quotas, or incentive pay, for loan generation.  We looked at almost a thousand loans originated over more than three years by approximately 50 community banks across the country.  We measured the loan yield based on funds transfer pricing (FTP) mechanism.  The pricing was not adjusted to credit quality, loan size, cross-sell opportunities or risk-adjusted-return on capital.  The yield on the loans was compared based on the month of production.

Results

The average loan size in our sample was just over $2mm.  Each loan was a “bankable” credit, and all loans were pass-rated credits.  Almost all loans had DSC ratios above 1.2X, and almost all loans had LTVs below 85% (with a majority below 75%).  The average loan credit spread over FTP (in this case we used LIBOR) was 2.41%.  The highest monthly loan credit spread was 2.47% and occurred in the months of August and September.  By far the lowest spread (2.26%) was in December.  The graph below shows the average monthly spreads for all loans categorized by the month of loan closing.

Loan Credit Spreads

The graph below shows the monthly variance to yearly average.  It shows that the lowest loan credit spreads were booked on loans that closed in December, and the second lowest spreads were booked on loans that closed in November.  The months of January and April were also below average.  While September, August, and July were the highest credit spreads for community banks. 

Loan credit spread monthly change 

The above data does make intuitive sense to us.  The loan closing cycle takes somewhere between four and eight weeks.  So loans booked in December are quoted and underwritten in October or November.  It appears that seasonality driven by year-end budgets is a very powerful force in banking.  Lenders (and bank management), motivated to meet budget numbers, are driving down interest margin in the last three months of the year.  Loans closings in October, November, and December have lower spreads than loans closing throughout the rest of the year.  Some of that NIM compression spills over into January where bankers are closing loans that were quoted in November and December.

Conclusion

Seasonality has a powerful effect on commercial loan margins.  Bankers that understand this phenomenon can take advantage of the market by setting loan production budgets for the period ending in September rather than December.  Banks should de-emphasize loan production in the last three months of the calendar year.  By striving to make year-end budget loan production through September, banks can gain approximately five basis points in margin.  A September-end loan budget allows a bank to compete for loans when the vast majority of the competition is less motivated to discount loan margin and avoid competing for loans when most banks are discounting loan pricing (in October, November, and December).