Fed Holds Rates Steady: What Banks' Renewed Lending Appetite Means for Your Cost of Funds

The Federal Reserve held rates steady at 3.5%–3.75% yesterday, signaling the "easy money" window that drove cheaper warehouse lines and competitive refinancing is closed for now.¹ Meanwhile, bank C&I lending is finally showing signs of life—and that's a problem if you're competing for deals in the $500K–$10M range.

• Fed funds rate unchanged at 3.5%–3.75% after three consecutive 25bp cuts in Q4 2025; SOFR sitting at 3.66%²

• Powell's message: Economy "on firm footing," growth outlook improved, policy is "loosely neutral"—translation: no urgency to cut further³

• Split vote: 10-2 decision with Governors Miran and Waller dissenting for another quarter-point cut; both were Trump appointees¹

• Market expectations shifted: Futures pricing just 1-2 cuts through year-end 2026, likely in June and December—down from five cuts projected a year ago⁴

• Bank lending rebound: Smaller banks posted second consecutive quarter of C&I loan growth at 0.6%; regional banks reporting stronger pipelines⁵

• Private credit competition intensifying: Direct lending yields still attractive at 10%+ gross unlevered, but spreads compressed; $1.7 trillion in private credit AUM creating fierce competition⁶

• Middle market default watch: KBRA expects defaults to rise in 2026, with 30% of borrowers with near-term maturities carrying leverage above 10x or negative EBITDA⁷

The immediate implication: Your cost of funds isn't dropping materially until mid-2026 at earliest. Banks are waking up to C&I opportunities, potentially squeezing you on cleaner deals. Time to defend your spread advantage in segments banks won't touch.

_{Sources
1 CNBC | Fed rate decision January 2026: Holds key rate steady
2 YCharts | Secured Overnight Financing Rate January 2026
3 CNBC | Fed meeting recap: Powell says economy on 'firm footing'
4 CNBC | Fed preview January 2026
5 Bank Director | Are Bank Commercial Loans Finally Rebounding?
6 KKR | Private Credit 2025: Navigating Yield, Risk, and Real Value
7 KBRA | Private Credit Q3 2025 Middle Market Borrower Surveillance
8 Morgan Stanley | Private Credit 2026 Outlook
9 Federal Reserve | Senior Loan Officer Opinion Survey January 2025
10 Abrigo | Prepare for stronger C&I lending demand
11 Kansas City Fed | Small Business Lending Survey Q2 2025
12 NerdWallet | Average Business Loan Interest Rates January 2026
13 ABF Journal | The Convergence of ABL and Private Credit
14 Financely Group | Asset-Based Lending in 2025
15 Global Growth Insights | Merchant Cash Advance Market 2024-2032
16 Precedence Research | Factoring Services Market 2025-2034
17 Northleaf Capital | Private Credit Market Update Q3 2025
18 Wellington Management | Private Credit Outlook 2026}

What Alternative Business Lenders Need to Know

How Does This Affect Your Cost of Capital?

The Fed's decision to hold means your warehouse lines, revolver costs, and term debt pricing aren't getting relief anytime soon. With SOFR at 3.66%² and the Fed signaling rates are "loosely neutral,"³ expect your all-in cost of funds to stay elevated through at least Q2 2026.

• MCA operators using bank warehouse lines are looking at SOFR + 250-400 bps, putting all-in rates at 6.15%–7.65% before any leverage

• ABL providers with revolving facilities are seeing SOFR + 175-300 bps on senior secured

• Factoring operations using bank credit lines face similar spreads, with larger players commanding tighter pricing

The practical impact: if you priced deals assuming two or three more cuts in early 2026, your spread assumptions need revisiting. Morgan Stanley's private credit team projects first-lien loan yields will trough around 8.0%–8.5% in 2026—still elevated by historical standards but down from current levels.⁸

Why Should You Care About Banks Re-Entering C&I?

Here's the real story buried in the Beige Book and bank earnings calls: after two years of sitting on the sidelines, regional and community banks are getting aggressive about commercial lending again.

The numbers tell the story. Smaller banks posted their second consecutive quarter of C&I loan growth at 0.6% in Q4 2025—modest, but a meaningful shift from the start-and-stop pattern of prior quarters.⁵ Bank CEOs are reporting stronger pipelines and increased borrower inquiries. Old National Bancorp's client survey showed "an awful lot of optimism" among commercial borrowers.⁵

What changed? Three things:

• First, rate certainty. With the Fed signaling a longer pause, businesses are more comfortable making longer-term borrowing decisions. The uncertainty of 2024-2025 kept many on the sidelines.

• Second, post-election clarity. Whatever your political views, businesses now have visibility into the policy environment. That unlocks capital expenditure decisions that were on hold.

• Third, competitive pressure. Banks watched private credit grow to $1.7 trillion while they sat on deposits earning less than their cost of funds.⁶ That math eventually forces action.

The implication for alternative lenders: expect more competition on cleaner deals—businesses with 3+ years of operating history, positive EBITDA, and straightforward collateral. Banks aren't touching the stuff you specialize in (startups, seasonal businesses, distressed situations), but they're going to compress your margins on the easier credits.

Where Are the Spread Opportunities?

If banks are taking the cleaner deals, where should you focus? The answer lies in segments they structurally can't or won't serve.

• Speed-to-close deals. Banks are taking 45-90 days on C&I underwriting. If a business needs capital in 72 hours to secure inventory, make payroll through a seasonal trough, or capitalize on an acquisition opportunity, they're coming to you. Price accordingly.

• Collateral complexity. Bank underwriters are comfortable with receivables and equipment. They get nervous around inventory with rapid obsolescence, work-in-progress, or intellectual property. ABL providers report advance rates of 80-85% on receivables and 50-65% on inventory¹⁴—but banks are at the lower end of those ranges for anything beyond vanilla collateral.

• Credit profile gaps. The January 2025 SLOOS shows banks tightened standards on C&I loans to small firms and raised premiums on riskier borrowers.⁹ If a business has a tax lien from three years ago, a personal guarantee issue, or irregular financial reporting, banks are passing. That's your market.

• Segment-specific expertise. Transportation factoring can hit 100% advance rates because specialized factors understand the asset. Medical receivables, government contractor financing, and seasonal retail all have dynamics banks won't learn. Depth wins.

What Should You Watch on Credit Quality?

Here's where the data gets uncomfortable. KBRA's Q3 2025 middle market surveillance compendium shows warning signs:⁷

• 30% of borrowers with maturities before year-end 2026 carry leverage above 10x or negative EBITDA

• Default monitor rising: KBRA expects the gap between middle market and broadly syndicated default rates to close in 2026

• 2021 vintage stress: Deals underwritten during the COVID-era euphoria—elevated earnings, cheap rates, aggressive leverage—are showing weaker performance

• PIK loans as warning signal: Payment-in-kind features, which allow borrowers to defer cash interest, correlate with eventual portfolio stress

The Morningstar LSTA US Leveraged Loan Index shows trailing 12-month default rates at 1.5% headline, but 4.3% including distressed liability management exercises.¹⁷ That's a meaningful gap that suggests headline numbers understate actual credit stress.

For alternative lenders, the takeaway: tighten your underwriting on businesses in consumer retail, healthcare roll-ups, and companies with significant 2021-vintage debt. These are the first dominoes if economic conditions soften.

How Should You Price for 2026?

Given everything above, here's a framework for thinking about pricing:

• Your baseline cost of funds isn't dropping until June 2026 at earliest, and even then probably only 25 bps.⁴ Build that into your models.

• Bank competition is real on deals above $1M with clean credit profiles. If you're pricing those at 400 bps over your cost of funds, a bank at 250 bps over their (lower) cost of funds will undercut you. Either add value through speed and flexibility, or cede that market.

• Default expectations should rise. The Kansas City Fed's small business lending survey shows 4% of respondents reporting declining applicant credit quality.¹¹ If your historical loss rate is 3%, budget for 4-5% in 2026.

• Spread compression in private credit means the $10M+ market is intensely competitive. KKR notes that even with spread compression, elevated base rates make 10%+ gross unlevered returns achievable for senior secured risk.⁶ But that's for institutional-quality credits. Below that tier, pricing should reflect actual risk, not competitive pressure.

Current market benchmarks:

• Bank small business loans: 6.3%–11.5% APR¹²

• MCA market size: $19.7B projected for 2025, growing at 21.7% CAGR¹⁵

• Factoring services: $5.1B market in 2025, growing at 10.3% CAGR¹⁶

What's the Competitive Landscape Looking Like?

Private credit has fundamentally reshaped competition. Wellington Management notes that middle market direct lending is now roughly the same size as the combined leveraged loan and high-yield bond markets.¹⁸ That's not niche anymore—that's mainstream.

The practical effects:

• Hybrid structures are growing. ABF Journal reports ABL-private credit hybrid facilities grew 15% annually from 2020-2023. These structures blend asset-based collateral discipline with private credit's flexible scale, enabling advance rates 24% higher than traditional ABL while maintaining risk parameters.¹³

• Banks are partnering, not competing. The smart banks recognize they can't match private credit's flexibility. Instead, they're providing warehouse lines, deposit services, and payment processing while private credit handles the actual lending. That's a sustainable ecosystem.

• Scale matters more. With $1.7 trillion in private credit dry powder, the largest managers can deploy capital quickly and at scale.⁶ If you're originating $50M annually, you're competing against shops with $150 billion in firepower. Find your niche or get squeezed. Cornerstone Advisors estimates the next C&I upcycle could reach $1.7 trillion in new lending volume.¹⁰

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