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The federal funds rate, set by the Federal Reserve, serves as a benchmark for interest rates across the economy. When the Federal Reserve lowers interest rates, the effects ripple through financial markets, influencing borrowing costs, investment decisions, and economic activity. For commercial lenders, these rate changes present both opportunities and challenges that can significantly alter their operations and profitability. Understanding these dynamics is crucial for lenders to navigate the complexities of a changing rate environment. In this blog, we’ll examine some of the main effects that lower interest rates can have on commercial lenders, as well as how AXIS by AIO Logic can help lenders seamlessly adjust to those changes.

Increased Borrowing Demand

Lower interest rates reduce the cost of borrowing, making loans more attractive to businesses. Companies that might have been hesitant to take on debt at higher rates often seize the opportunity to secure financing for expansion, acquisitions, or working capital needs. This surge in demand can be a boon for commercial lenders, increasing their loan origination volumes and, consequently, their revenue from interest income and fees. Lenders that invest in automation and digital platforms to streamline these processes can better capitalize on the heightened demand while maintaining operational scalability.

As a truly end-to-end solution, AXIS by AIO Logic automates and streamlines processes at every stage of the loan lifecycle, including loan origination. In fact, AXIS’s AI can automate the initial screening and validation of loan applications, reducing the time and effort required for manual processing. AXIS can also expedite the origination process through features such as automated term sheet creation and automation-enabled approval memos. Plus, lenders can always have a real-time view of their deal pipeline, thanks to AXIS’s configurable deal stages and automated deal pipeline tracking.

Pressure on Net Interest Margins

While lower rates stimulate borrowing, they also compress net interest margins (NIM), which measure the difference between the interest income generated from loans and the interest paid on deposits or other funding sources. As rates drop, lenders may struggle to maintain profitability, especially if deposit rates approach zero, leaving little room to offset declines in loan yields. In an effort to mitigate this, commercial lenders often turn to strategies such as expanding into higher-yielding loan segments and managing interest rate risk using derivatives or other hedging instruments.

Often, when lenders are seeking to expand into higher-yielding loan segments, asset-based lending is a popular choice. Due to both the popularity and uniqueness of asset-based lending, we placed a heavy importance on it when building AXIS by AIO Logic. In fact, AXIS includes an entire module dedicated to the ABL segment. AXIS’s AI-powered ABL module is the most advanced ABL platform ever brought to market. Among the many benefits of AXIS’s ABL module is the capability to configure fully automated borrowing bases by loan, eliminating the need for multiple systems and Excel.

Heightened Competition

Lower rates often trigger increased competition among lenders as they vie for market share in an environment of robust borrowing demand. Traditional banks, credit unions, and non-bank lenders may lower their lending standards or offer more attractive terms to secure clients, potentially leading to thinner margins and higher credit risk. To stay competitive, many commercial lenders focus on enhancing their value proposition through improved customer experiences. This can include faster loan approvals, personalized product offerings, and leveraging data analytics to anticipate client needs.

For lenders that are interested in providing customized loan structures, AXIS by AIO Logic provides full functionality to do so. In fact, AXIS provides native handling for every commercial loan structure, including amortizing, revolving, ABL, delayed draw, interest only, factoring, and many more. In terms of interest rate structures, AXIS provides independent functionality for Current and PIK interest, as well as simple and compounding interest. In addition to fixed rates, AXIS allows users to choose variable rate structures. For variable rates, users choose the desired index, index calculation logic, and set the margin to be added to the index rate. Once those parameters are set, the applicable rate calculation is entirely automated.

Changes in Credit Risk Profiles

Although lower interest rates make borrowing more affordable, they can also mask underlying credit risks. Businesses that take on debt at low rates may struggle to service their obligations if rates rise in the future or if economic conditions deteriorate. For commercial lenders, this highlights the importance of robust credit risk assessment and monitoring practices. For example, lenders can use advanced analytics and AI tools to assess creditworthiness more accurately and predict potential defaults.

In order to allow lenders to make informed lending decisions, we built AXIS to include powerful financial spreading and analytics capabilities. AXIS’s AI can analyze a wide range of data points (e.g., financial statements, transaction history, market data) to assess the creditworthiness of borrowers, providing more accurate and dynamic underwriting. As part of this functionality, once financials are spread into AXIS, the platform automatically performs vertical, horizontal, and trend analysis in order to calculate 42 financial ratios and score borrower financial health.

Impact on Asset Quality and Loan Portfolios

A low-interest-rate environment can also lead to changes in the composition and quality of loan portfolios. For instance, some borrowers may use cheaper loans to refinance existing debt, improving their financial stability. Others might over-leverage, increasing their vulnerability to future rate hikes or economic shocks. Lenders must balance the benefits of increased lending activity with the risks of deteriorating asset quality. Regular stress testing, portfolio diversification, and proactive borrower engagement are essential to maintaining a healthy loan portfolio.

Access to real-time and insightful analytics is crucial to assist lenders in maintaining a healthy loan portfolio. In AXIS by AIO Logic, we offer a robust suite of automated portfolio reporting and analytics, including standardized and customizable reporting. As part of those portfolio analytics, AXIS includes automated portfolio concentration testing, through which users can define testing metrics and thresholds. If a threshold is breached or trending towards breach, AXIS will automatically trigger notifications. This powerful functionality allows lenders to take proactive action towards maintaining a healthy loan portfolio.

Conclusion

Lowering federal interest rates creates a dynamic landscape for commercial lenders, marked by increased borrowing demand, compressed margins, and heightened competition. While these changes pose challenges, they also open avenues for growth and innovation. By adopting technology, managing credit risk effectively, and enhancing customer relationships, lenders can navigate the complexities of a low-rate environment and position themselves for long-term success. As interest rate cycles continue to evolve, those who anticipate market shifts and respond proactively will be best equipped to thrive. If your firm is seeking to better position itself for the expected increase in lending demand, please feel free to contact us today to schedule an intro call and learn more about all that AXIS by AIO Logic has to offer!