Why Favor Higher Quality as Credit Squeeze Tightens

The collapse of Silicon Valley Bank and Signature Bank heightens the Federal Reserve's policy dilemma over fighting inflation while maintaining financial stability. We analyze what the crisis means for the banking system and the economy.

  • The Federal Reserve's quarterly Senior Loan Officer Opinion Survey (SLOOS) shows credit conditions have continued to tighten and are much tighter than a year ago.
  • Cracks in the foundation of small and medium-sized business finances have already begun to appear likely due to credit tightening.
  • Companies with lower credit quality, particularly ones that finance themselves predominantly with loans, may continue to see a sharp rise in interest expense, and historical patterns suggest high-yield credit spreads are likely to widen.

We have been longtime fans of the value of the data in the Fed's SLOOS. While it only comes out quarterly, and with a non-trivial lag, it has exhibited solid forward-looking information about credit growth. Also, the data has a long history that is not subject to revisions. The release has historically flown under the radar and tends to not get much attention from the press. However, it is fair to say the May 8 release of the April survey data was the most anticipated publication in the survey's long history.

Lending standards keep tightening

The headline is that while credit conditions continue to show tightness, the deterioration from the prior quarter was less than we would have anticipated. The net percentage of bank loan officers saying they were tightening lending standards for consumer and industrials loans in April was 46%, which compares with 45% in January. But that de minimis quarter-over-quarter change belies the fact that just a year ago, banks were actually easing lending standards.