CLO performance in 2023, what's next?
The eagerly awaited ECB’s Bank Lending Survey (BLS) for Q1 2023 was released this week. A total of 158 banks responded to the questionnaire, which now includes Croatian banks as a result of their adoption of the euro at the start of the year. Importantly the BLS was carried out between March 22nd and April 6th and therefore includes the reaction of European bank managers to the U.S. regional banking issues, along with the aftermath of Credit Suisse’s demise.
There was a further tightening in financial conditions, as tighter monetary policy works its way into the economy and although the pace of tightening remained rapid, overall the results were consistent with a macro picture of a slowing economy, but with no signs of stress, which is what we believe the ECB would like to see. It is interesting to note that every quarter banks provide answers for by how much they are tightening/loosening standards for the current quarter, but also their projections for the next quarter. Although conditions for Corporates in Q1 2023 tightened slightly more than what banks expected in the last survey, we think the difference is immaterial as it’s still in line with historic averages. This means banks did not tighten financial conditions in Q1 2023 by a lot more than they thought would be the case in Q4 2022. We take this as a sign of strength given that the topic of the quarter was the failure of Credit Suisse, SVB and Signature Bank and bank managers could have been excused for turning the taps off more severely across the board. In addition, when looking at the reasons why banks tightened credit conditions, the most important factor, according to the banks themselves, was an “Increase in risk perceptions”, with “Cost of funds and balance sheets constraints” only playing a minor role.
Demand for credit weakened across the board, chiefly in response to higher interest rates. The pace again was quite steep and it is a very strong signal that financial conditions are indeed tight in the Eurozone, in line with the ECB’s objective. We note that part of the decrease in loan demand was in the ‘Inventories and working capital’ category, which is consistent with the easing of supply chain pressures that we observed in the PMI Manufacturing releases during the quarter.
Finally, there were interesting comments in the “Ad hoc questions” section. Overall, banks reported a deterioration in market access when it comes to issuing debt securities, while Retail funding remained broadly unchanged. The shift from short term deposits into longer term deposits continued, in line with consumers and corporates looking for higher yielding alternatives for their monies. As we commented a few weeks ago, we think this is hardly a sign of people losing confidence in the European banking sector.
In conclusion, banks responses to the BLS in Q1 speak of a slowing economy, where there is less access to credit, but also less demand for credit, mainly as a result of higher interest rates. We believe the ECB will take note that their objectives of cooling the economy and therefore dampening inflationary pressures in the future are being achieved and that this should mean we are closer to the end of the monetary policy tightening cycle. We also got confirmation that there are no signs of systemic banking stress in the Eurozone at this stage, which is consistent with the extraordinarily good earnings that banks have shown in Q1 so far.