Short answer:
All else equal, swapping a 6.00 % subordinated note for a 6.875 % note raises Byline Bancorp’s interest‑expense cost. That higher coupon will compress the bank’s Net Interest Margin (NIM) and erode earnings unless the additional cost is offset by higher‑yielding assets, an improved rate environment, or other strategic benefits.
Below is a deeper dive into why the higher coupon matters, the mechanics of the transaction, and the scenarios that could mitigate or exacerbate its impact.
1. What the transaction actually does
| Item | Before the transaction | After the transaction | Net change |
|---|---|---|---|
| Principal outstanding (subordinated notes) | $75 million @ 6.00 % Fixed‑to‑Floating, due 2030 | $75 million @ 6.875 % Fixed‑to‑Floating, due 2035 | +0.875 % coupon on the same $75 mm |
| Maturity | 2030 (5‑year remaining) | 2035 (10‑year remaining) | +5 years of amortization |
| Use of proceeds | N/A (redeeming existing debt) | Net proceeds used to retire the 6 % notes | No new cash infusion, just a refinancing |
Cash‑flow impact:
Annual interest expense on the old notes: $75 mm × 6.00 % ≈ $4.5 mm.
Annual interest expense on the new notes: $75 mm × 6.875 % ≈ $5.156 mm.
Incremental annual expense: ≈ $656,000 (plus any incremental amortization of issuance costs).
Because the transaction is a pure refinance (no net new capital raised), the only immediate financial effect is that Byline will now pay roughly $0.66 million more in interest each year.
2. How interest expense interacts with Net Interest Margin
Net Interest Margin (NIM) is defined as:
[
\text{NIM} = \frac{\text{Interest Income} - \text{Interest Expense}}{\text{Average Earning Assets}}
]
- Interest Income comes from loans, securities, and other interest‑earning assets.
- Interest Expense comes from deposits, borrowings (including subordinated notes), and other funding sources.
When a bank’s interest expense rises while interest income stays flat, the numerator (net interest income) shrinks, pulling NIM downward. Conversely, if interest income rises faster than expense, NIM can improve.
In Byline’s case:
- Expense side: +$656 k/year (≈ 0.875 % on $75 mm).
- Asset side: No new assets are financed by the transaction; the net proceeds are merely used to retire debt.
Therefore, the direct effect is a modest reduction in NIM (the exact percentage depends on the bank’s total earning assets, but with a $75 mm balance sheet and, say, $10 bn of earning assets, the drag would be roughly 0.0065 bps—a tiny but measurable hit).
3. Potential offsets / mitigating factors
While the headline effect is negative, the broader context can soften or even reverse the impact:
| Factor | How it could offset the higher coupon | Likelihood / Comments |
|---|---|---|
| Higher yielding assets | Deploy the $75 mm (or a portion of it) into loans or securities that earn >6.875 % on a risk‑adjusted basis. | The transaction does not generate new cash; only the timing of cash flows changes. Any future loan growth would be independent of this refinance. |
| Floating‑rate component | The notes are “fixed‑to‑floating.” If the reference rate (e.g., LIBOR/SOFR) falls after the fixed period, the effective coupon could dip below 6.875 %. | The fixed period is typically 2–3 years; thereafter the coupon resets. In a declining‑rate environment, the cost could actually become lower than the 6 % notes they replaced. |
| Longer maturity (10 yr vs 5 yr) | Extends the funding horizon, reducing rollover risk and providing stability for asset‑liability matching. This can improve earnings volatility and may support higher‑yielding asset growth. | A longer‑dated liability is valuable for a bank that wants to lock in cheap funding now and fund longer‑term loan pipelines. |
| Regulatory capital treatment | Subordinated notes count as Tier 2 capital; a longer‑dated instrument may improve the bank’s capital ratio and reduce the cost of capital overall. | If capital ratios improve, the bank may be able to pursue marginally riskier (higher‑yield) assets with a lower equity cost, partially offsetting the expense. |
| Interest‑rate environment | If market rates rise, the spread between the bank’s loan rates (which often reset faster) and the note’s floating rate may widen, preserving NIM. | The fixed‑to‑floating nature means the note’s interest cost will rise with rates, but loan rates typically rise faster, protecting the spread. |
| Issuance cost amortization | The transaction incurs underwriting fees that are amortized over the life of the notes, adding a small one‑time drag. | This is a minor, short‑term expense. |
Bottom line on offsets:
Only if Byline can generate additional net interest income that exceeds the extra $656 k of expense (or if the floating‑rate leg eventually falls below the original 6 % cost) will the higher coupon be neutral or beneficial. The news release does not indicate any such asset‑deployment plan; it merely describes a refinancing.
4. Strategic rationale – why a bank would accept a higher coupon
Liquidity & Funding Stability
- A 10‑year subordinated note provides a longer, more stable source of capital than a 5‑year note. This can be crucial when the bank wants to grow longer‑term loan books or meet regulatory liquidity ratios.
Capital Structure Management
- Subordinated debt counts toward Tier 2 capital. Extending the maturity can improve the bank’s capital adequacy ratio and potentially lower its overall cost of capital.
Asset‑Liability Matching
- The bank may have a growing portfolio of longer‑term assets (e.g., commercial real‑estate loans) that require a similarly long funding horizon. Even at a slightly higher cost, aligning maturities reduces interest‑rate mismatch risk.
Market Conditions
- The 6.875 % coupon reflects the current market pricing for a 10‑year subordinated issue. A bank might prefer to lock in a rate now rather than risk having to refinance at an even higher rate later if the yield curve steepens.
These strategic benefits are non‑financial (or at least non‑immediate) but are often deemed worth a modest earnings hit, especially for a well‑capitalized institution.
5. Quantitative illustration (hypothetical)
Assume Byline’s FY‑2025 figures (rounded for illustration):
| Metric | Pre‑refinance | Post‑refinance |
|---|---|---|
| Net interest income (NII) | $350 mm | $349.3 mm (≈$0.66 mm lower) |
| Average earning assets | $15 bn | $15 bn (unchanged) |
| NIM | 2.33 % | 2.33 % – 0.004 bps (practically unchanged but marginally lower) |
| Pre‑tax earnings | $100 mm | $99.3 mm (≈0.7 % earnings erosion) |
| EPS (diluted) | $2.00 | $1.98 |
The numbers show a tiny but measurable erosion of earnings. In practice, the impact could be even smaller if the bank’s earnings are driven heavily by non‑interest income (fees, trading, etc.) or if the floating leg later reduces the effective coupon.
6. Bottom‑line assessment
- Immediate effect: Higher coupon → higher interest expense → modest erosion of NIM and earnings.
- Long‑term view: If the bank successfully leverages the longer‑dated funding to grow higher‑yielding assets, or if the floating component eventually reduces the cost, the erosion could be neutralized or turned positive.
- Strategic trade‑off: The bank is likely prioritizing funding stability, capital ratio improvement, and maturity matching over short‑term NIM optimization.
Conclusion: Based on the information provided, the higher coupon is more likely to erode earnings in the near term, unless Byline Bancorp implements a strategy that generates enough additional net interest income to offset the increased cost. The net interest margin will probably be marginally compressed, but the strategic benefits of longer‑dated subordinated capital may justify the modest earnings hit.