You’re Gonna Need A Bigger Boat: Recession Implications of Tightening Bank Credit Standards

Senior Loan Officer Opinion Survey (SLOOS)

New SLOOS data very negative. After the shock of March and April, second quarter earnings season was a welcome respite. Earnings were generally good, balance sheets largely stabilized, margin pressure manageable, and credit only incrementally worse. Yet the good results didn’t entirely dispel concerns about 2H23 and 2024; deposits remain a challenge but, mainly, margin and especially credit issues loom. So we find ourselves at the part of the movie where we know there’s a shark in the water, but don’t know exactly when or with what ferocity it will strike. The new SLOOS results say plainly, “You’re gonna need a bigger boat.”

Perfect record, obvious caveat. Figures 1-5 show the SLOOS boasts a perfect record—tightening of credit standards has only been this broad ahead of (or during) recessions. The tightening is not only broad across banks, but across loan types: C&I, CRE, and consumer. Figures 6-8 show a similarly broad, negative trend in loan demand.

On the other hand, when looking across economic/interest rate/credit cycles, one must bear in mind the small sample size. Inevitably, there will come a cycle when this indicator yields a false positive; for all we know, this could be the one. But on the gripping hand, fading 100% correlations is definitionally a low probability bet.

Figure 1: Net percent of domestic respondents tightening standards on C&I loans to large and medium firms

Source: FactSet

Figure 2: Net percent of domestic respondents tightening standards on C&I loans to small firms

Source: FactSet

Figure 3: Net percent of domestic respondents tightening standards on CRE loans

Source: FactSet

Figure 4: Net percent of domestic respondents tightening standards on construction and development loans

Source: FactSet

Figure 5: Net percent of domestic respondents tightening standards on consumer credit card loans

Source: FactSet

Figure 6: Net percent of domestic respondents reporting stronger demand for C&I loans to large and medium firms

Source: FactSet

Figure 7: Net percent of domestic respondents reporting stronger demand for C&I loans to small firms

Source: FactSet

Figure 8: Net percent of domestic respondents reporting stronger demand for CRE loans

Source: FactSet

Loan officers predict more of the same in 2H23. The survey added a forward-looking question this quarter, asking respondents what they expect to see in credit standards during the second half of 2023. The results were similar to what was reported in the traditional questions; a net 38.7% of respondents expected incremental tightening of credit standards at their bank in 2H23. 

Figure 9: Senior loan officers expect incremental tightening in 2H23 

Source: FactSet

Apple Attracts $100 Million in Deposits – Per Day

Apple Savings’ rapid growth highlights threat from tech (and other brands), but also underscores value of traditional branch banking. Apple rolled out its Savings account on April 17, and on August 2, just 107 days later, announced that deposits had topped $10 billion. Making it even more remarkable is that Apple appears to have held its rate steady at 4.15% despite two Fed Funds hikes totaling 50bps since the April launch. A deposit beta of zero is nice work, if you can get it.

On one hand, the effort underscores the threat to incumbent banks from tech and other non-bank competitors who can reduce banking to merely an app within their consumer ecosystem. On the other hand, 4.15% isn’t a low cost of deposits, and serves to underscore the value of traditional banks franchises, including branch networks. The $415 million in interest on these online deposits, after all, would cover the cost of operating a rather extensive branch network that generates noninterest-bearing deposits.      

Figure 10: Savings account interest rates offered by selected online banks

Source: FactSet, BestCashCow.com

Figure 11: Apple advertising a savings rate of 4.15% as of August 6, 2023

Source: Apple.com

Interest Rates

Favorable rate shifts for the week. While the yield curve remains inverted, the 2-10 spread narrowed 18bps to end the week at -73bps. Fed Funds futures took a dovish turn as well; and currently imply rate cuts at each of the March and May FOMC meetings. On the other hand, Figure 16 illustrates the implied average Fed Funds rate by quarter, and suggests limited easing in 2024, with the Fed Funds rate stabilizing around 4% or slightly below.  

Figure 12: The yield curve remains inverted 

Source: FactSet

Figure 13: The 2-10 spread narrowed by 18bps last week but remains very unfavorable for banks

Source: FactSet

Figure 14: Market expectations for the 1Q24 FOMC meetings continue to grow more hawkish

Source: FactSet

Figure 15: Fed Funds Futures imply the first rate cut has shifted from March to May of 2024

Source: FactSet

Figure 16: Fed Funds futures imply 2024 will provide limited relief on funding costs (and CRE refi challenges)

Source: FactSet

Weekly Federal Reserve Balances

August 2 Federal Reserve balances tick up slightly. Total bank borrowings (BTFP combined with the Discount Window) ticked up 0.2% to $107.6 billion. Money market fund balances rose 53bps to $5.5 trillion, while large US banks saw deposits decline by 42bps (and are down 88bps QTD). Total loans in the banking system rose 10bps (and are now up 21bps QTD).
Figure 17: Federal Reserve balances

Source: FactSet

Figure 18: Bank Term Funding Program usage reached another new peak last week

Source: FactSet

Figure 19: Money Market Fund assets hit a new high last week

Source: FactSet

Figure 20: Overall deposits rose but large banks saw a decline

Source: FactSet

Figure 21: Total loan growth is now positive, quarter-to-date

Source: FactSet