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Little Thought, Big Implications?


In our latest piece on credit, focused on banks, we highlighted three likely resultants of the underlying market dynamics that were made evident through the collapse of Silicon Valley Bank (SVB). Those three highlighted things were:

  • Valuation: The premium regional banks have historically garnered will be tested.
  • Funding and Margins: Competition for deposits will increase.
  • Credit Creation: The propensity to lend will decrease.

While we are seeing the validity of all three, today we want to focus on the final point, Credit Creation: The propensity to lend will decrease. Ultimately, we believe this final point is extremely important.

Up until this point the Fed has largely been fighting a lonely battle against inflation. It has raised rates at one of the most aggressive paces on record and started the roll-off of its balance sheet. From 2021, financial conditions have come off the lowest levels in decades to align with 20yr averages more closely. The Fed has largely been responsible for this.


Goldman Sachs US Financial Conditions Index (Last 20yrs)

Chart, line chart Description automatically generatedSource: Bloomberg 5/5/2023


The Fed’s latest Senior Loan Officer Survey was released Monday, May 8th, 2023. It showed tighter credit conditions and weaker loan demand.

The commercial banking system reached peak deposits early 2022. Since, deposits have been exiting the banking system. Deposits are a key funding component of banks and often have very short durations. In the case of a bank, or any company for that matter, when liabilities are shrinking in the form of decreased funding it is natural to focus on the asset side of the balance sheet. To date a lot of focus within the marketplace has homed in on the quality of those assets. This makes a lot of sense to us. This said, through our research we do not see broad-based quality issues with balance sheet assets as was the case back in 2008.



US Commercial Bank Deposits (Last 5yrs)

A picture containing text, line, plot, font Description automatically generatedSource: Bloomberg 5/5/2023


What has gotten less attention is very simply the size of the asset side of the balance sheets and the implications shrinking deposit profiles have for this. This brings us back to the propensity to lend, where loans are bank balance sheet assets. Away from mechanically making sense we are getting confirmation from companies via their outlooks and Fed data (like the earlier referenced senior loan officer survey) that loan growth expectations are coming down.

What does all this mean? Through what is happening on the funding/liability side of bank balance sheets, we see banks implicitly joining the Fed’s fight here. Where that transmission mechanism most likely comes in the form of decreased lending (contraction in credit growth) and therefore additional pressure on financial conditions. We are closely watching all these factors as their impact on both the spread and rates markets could have wide ranging implications.


Goldman Sachs US Financial Conditions Index vs. Bloomberg Baa Spreads (Last 20yrs)

Chart, line chart Description automatically generatedSource: Bloomberg 5/5/2023




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