About this episode
According to the Federal Reserve’s latest Senior Loan Officer Opinion Survey, small businesses may be the most vulnerable to banks tightening their lending standards. ----- Transcript ----- Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the takeaways from the Senior Loan Officer Opinion Survey. It's Wednesday, May 17th at 10 a.m. in New York. We've talked a lot about the effects of the turmoil in the regional banks on credit formation, on this podcast. We thought the ongoing liquidity pressures in the regional banking sector may lead to tighter lending standards, which will eventually translate into lower credit formation. The Senior Loan Officer Opinion Survey, conducted quarterly by the Federal Reserve, provides a window on bank lending practices, including the standards and terms for banks to make loans, as well as the demand for bank loans to businesses and households. The survey results published last week, reflect conditions during the first quarter of 2023 and provide a first glimpse on the effect of the regional banking turmoil on banks outlook for lending over the remainder of 2023. The survey showed that banks expect to tighten standards across all loan categories. Banks cited an expected deterioration in the credit quality of their loan portfolios, customer collateral values, a reduction in risk tolerance, concerns about bank funding costs, banks liquidity position and deposit outflows, as reasons for expecting to tighten lending standards over the rest of 2023. While standards for commercial and industrial, the so-called C&I loans, tightened only marginally, the demand for C&I loans fell to levels not seen since the great financial crisis. Even though lending standards only tightened marginally, the tightening came from some loan officers tightening standards considerably. Further, banks reported changes to their modalities of their lending quite substantially. For example, the spread on loans or their cost of funding broke above the pandemic period and entered levels last seen during the great financial crisis. Loan officers also changed credit lines to small businesses drastically, especially regarding the size and cost. They reduced the maximum size and maturity of credit lines, as well as increased collateral requirements and the cost of credit lines. For small businesses in the U.S., such credit tightening comes at a very difficult time. Small business optimism and the outlook for business conditions already deteriorated significantly over the past year, and small businesses acknowledge that the environment isn't conducive for expansion or CapEx. Why does this matter? As small businesses have continued to lower expectations of sales, there were also moderated plans to raise prices in the near term. We see this dynamic raising the risks of downside surprises to upcoming inflation data. Also worth noting that fewer small businesses describe inflation as their number one concern, in fact, more describe interest rates as the number one concern. One of the special questions in this quarter's survey pertained to commercial real estate, so-called CRE. Banks tightened lending standards across all categories of CRE loans. Action cited included, widening loan spreads, reducing loan to value, raising debt service covers ratios and reducing maximum loan sizes. These survey results are consistent with what we had been predicting. Volatility in the regional banking sector has resulted in lower credit formation, due to both lingering liquidity stress and regulatory changes to come. The former is already playing out and the latter is likely to weigh on economic growth over the long term. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.