CLO performance in 2023, what's next?
The Senior Loan Officer Opinion Survey (SLOOS) was published by the Fed yesterday. The questionnaire reached 65 domestic bank managers’ inboxes on March 27th, with responses due on April 7th. The report has been eagerly awaited by market participants as it contains information about how the larger banks are responding to the problems at their regional peers, which started with the collapse of Silvergate and SVB some weeks ago, and also brought down Signature Bank, and more recently, resulted in the takeover of First Republic Bank by JPM.
It was expected that the report would signal further tightening of financial conditions, the main question being, by how much? The general reaction, which ties with our assessment, is that while there was evidence of tightening, it could have been worse than what was reported.
Regarding lending to “Large and Middle Market Firms” (those with more than $50 million in annual sales) 42.9% of respondents had “tightened standards somewhat”, while 54% allegedly left standards “basically unchanged”, compared to the previous quarter. Both numbers are not dramatically different from what was reported three months ago. In addition, this is broadly similar to what banks reported when asked about standards for “Small Firms”. With respect to households, standards continue to tighten when obtaining mortgages, although we note that compared to their own histories, there are less banks tightening standards in this segment compared to those in commercial & industrial loans. Consumer loan standards also tightened, as expected.
As has been widely reported, Commercial Real Estate (CRE) is in a more difficult situation than Residential and Corporate lending. In the subcategory “Construction and Land Development Loans” for example, 21.3% of banks reported tightening their standards “considerably”, compared to just 3.2% answering the same when queried about their “Large and Middle Market Firms” segment. While in the two subcategories of “Loans Secured by Nonfarm Non-residential Properties” and “Loans Secured by Multifamily Residential Properties”, the numbers were 15% and 12.9% respectively, all much higher than the tightening reported for commercial lending.
What also caught our attention was the demand for loans, as reported by the banks. Most banks reported weaker demand, to various degrees, across most lending categories. In our opinion, this is in line with what the Fed would like to see and reinforces the view that most market participants have that the Fed is almost done with rate hikes. As opposed to lending standards in certain categories which show a similar number of banks tightening compared to last quarter, demand continues to weaken for most products which is a sign that the usual lags in monetary policy continue to operate.In conclusion, we think the SLOOS shows that lending standards are tightening and demand is weakening. This is consistent with growth continuing to slow, which should in turn help to soften inflation. So far, we remain of the view that recent events are not the start of a banking crisis for the larger banks, and the SLOOS report confirms this. However, this does not mean we think negative headlines are over, sadly. Some smaller banks have seen large deposit outflows, which have been partly replaced with funding at the Fed’s window, at higher rates, which in turn hurts Net Interest Margins and the medium term profitability outlook for these banks. CRE exposure is also likely to give markets further headaches going forward in our view, although we expect markets will start to differentiate between the various segments within CRE, and therefore between banks with different exposures as well.