Funding Reaches a Tipping Point

Deals are still being funded but rising interest rates have changed nearly everything.

FINALLY, IT HAS HAPPENED. Six years of lush liquidity have given way to a new funding landscape in which the grass is still green, but there’s less of it, and it’s quite a bit more expensive. Experts say there’s still ample capital to satisfy borrower/lessee demand. But fast-rising interest rates are causing funding entities to rush to get deals done, and customers are fretting about paying more to borrow. Keith Moore, Senior Vice President and Group Head-Capital Markets at Wintrust Commercial Finance, explains the phenomenon of shrinking liquidity:

“The Federal Reserve Bank’s moves to increase interest rates over the past year have given traditional bank depositors alternative places to park their money to achieve higher returns with the same amount of liquidity and short-term access,” he says. “This outflow of deposits has reduced the amount of capital banks have to lend. And the fairly steady flow of new lending, while not robust, has pushed average loan-to-deposit ratios to 90% or more. Capital markets are still open and functioning, but there’s increasing selectivity on transactions and more discipline around pricing to achieve internal return target levels.”


Similar to market conditions during the 2008-2009 Great Recession, Moore says that in light of more judicious capital allocation, bank clients tend to get preference on new investment opportunities. “This focus on the best allocation of capital has also led to more scrutiny and perhaps tightening of lending standards with regard to collateral and structures,” he adds.  

At the same time, Greg Stitt, Vice President of Syndications at First American Equipment Finance, an RBC / City National Company, notes that inflation, supply-chain issues and the possibility of recession have kept markets roiled. “What we have now is a rapidly changing environment with less buy-side interest in certain deals, and a more selective approach from funding sources than we’re used to seeing,” he says. “These factors, along with the inverted yield curve, have resulted in varying opinions of how deals should be priced.”

A String of “Wobbles”

Indeed, everything happening in funding seems tied to climbing interest rates. Almost one year has passed since the Fed announced the first of what would become half a dozen hikes in the short-term interest rate in 2022. Bob Blee, Global Capital Markets Leader at Healthcare Financial Services, GE Healthcare, shares his perspective: “The rapid and significant rise in rates made for a very choppy and challenging funding environment in 2022. We began the year with the five-year swap rate at 1.47%, and by late November, it was 4.05%.”

Along with rising swap rates, Blee says credit spreads have widened across all classes, most noticeably in non-investment grade. “Those of us on the capital markets side have had to move quicker to get deals funded and rely on interest-rate locks to protect ourselves as well as our customers,” he says, adding, “Customers are anxious, and everyone has become more conscious of getting deals done.”


Capital markets professionals emphasize that deals are still getting done; they just cost significantly more than they did in 2021 and early 2022. But Nick Colvin, Vice President-Indirect Originations at Fifth Third Bank, National Association, is seeing differences in behavior between larger and smaller lenders. “In general, some of the looming economic uncertainty seems to have caused a bit more pressure on liquidity premiums,” he says. Liquidity premiums are internal buffers lenders add to their pricing to ensure a minimum level of profitability on a transaction. “My sense is that there are a number of smaller institutions that operate as coupon players and are saying as long as they’re getting a 6% rate, that’s acceptable, because it’s above their average portfolio return,” he continues. “Conversely, larger institutions, which closely monitor the daily fluctuations in their cost of funds, are more tightly wound. Larger lenders are more focused on their overall liquidity and the granularity of returns on each individual deal in their portfolio.”

Colvin also sees funding entities using different benchmark interest rates. “For the first time in a long time, a variety of indices are being used to index deals,” he says. “LIBOR swaps, SOFR swaps, Treasuries and benchmarking to Internal Cost of Funds are all somewhat common.” The development has created less consistency in the way institutions price deals to their customers, which can create challenges in the capital markets space. “Depending on what pricing governors your institution is bound by, it has the potential to give a competitive advantage to those lenders able to be more flexible.”

Moore, on the other hand, says the majority of traditional lessors and lenders use average-life swaps as their benchmark for pricing, and their cost of funds is usually a function of that rate plus a liquidity premium allocated by their internal treasury groups. “So as swaps and treasuries have risen, banks’ costs of funding has quickly followed suit,” he concludes.   

Pockets, or the Lack Thereof

On the borrower side, several funding professionals say transactions with higher-than-average risk are seeing the highest price increases. Stitt says proper structuring and pricing are key. “We’re seeing pockets of the market with decreased funding capacity or tightened requirements for certain deals,” he notes. “In general, there’s still a lot of uncertainty out there.”


Moore senses cautious optimism surrounding the oil and gas space. “It’s a bit early, and given the ongoing war in Ukraine and the uncertainty with the current administration’s position on the industry, there could be opportunity here when the outlook becomes a little clearer,” he suggests. 

Others see consistent conditions across markets and geographic areas. “I think what’s happening is universal,” says Colvin. “I haven’t heard of any areas where lending is particularly robust.”

What’s Coming

Because the Fed has said rate hikes will continue in 2023, sources interviewed here expect funding instabilities to continue. But Blee thinks the worst of the choppiness will have passed. “Rates may peak early in the year, and we’ll have to manage with where we are,” he says. “But I don’t think we’ll be dealing with a 200 basis-point rise in swap rates. Everyone doing business on a fixed-rate basis either goes with Treasury or swap rates, and most equipment finance business is fixed-rate.”

Blee thinks tighter underwriting conditions will persist nonetheless. “Shorter terms, more collateral and possibly other requirements will have an overall impact on liquidity for capital markets and for markets in general,” he says. “I don’t think there will be a recession, but growth may be so anemic it will feel like a recession. But if inflation comes under control, we’re all going to feel a little wealthier,” he adds. “We may be making the same wages, but if inflation drops to a more comfortable level, we’ll feel like we’re doing better.”


Colvin thinks the economy is in for a rough ride. “Over the last couple quarters, lenders have already begun seeing the negative impact that rising operating costs are having on businesses in their portfolios,” he says. Rising costs tend to tighten liquidity as lenders brace for still more uncertainty if interest rates keep rising and inflation remains high. “All of a sudden, growth opportunities that were fueled by low interest rates over the last few years become detrimental as operating costs get much more expensive,” Colvin explains. As a result, he expects more businesses will be forced to consider lay-offs and expense reductions, spawning a re-focus on unit economics instead of growth. 

Moore believes the amount of capital will still be sufficient in the coming months. “Banks have yet to see any meaningful decrease in credit quality or increase in problem loans, and so will still be actively looking to grow assets through investments in the equipment finance market,” he says. “I also expect that once the calendar turns and the industry begins a new year, everyone starts back at zero with new budgets to achieve, so demand for equipment loans and leases should firm up as we start the new year.

Stitt feels similarly. “I think there’s still plenty of liquidity out there, just not as ample as six months ago,” he says. And while much will be determined by the Fed’s manipulation of interest rates, “the latest inflation reports are encouraging,” Stitt adds. “And thanks to our sales professionals, who’ve had important conversations with our clients, they understand the situation.”