A month after the collapse of Silicon Valley Bank, the US appears to have avoided the worst-case scenario — a rapidly escalating financial crisis — and markets have rebounded.
And yet, just below the surface, signs are mounting that credit is drying up in pockets of the economy at a worrisome rate.
Small businesses say it hasn’t been this difficult to borrow in a decade; the amount of corporate debt trading at distressed levels has surged about 300% over the past year, effectively locking a growing swath of businesses out of financial markets; bond and loan defaults have ticked up; and the Federal Reserve says banks have tightened lending standards. Corporate bankruptcies are on the rise, too, particularly in the construction and retail industries.
Some of this is, of course, by design — the result of Fed Chair Jerome Powell’s rapid shift away from the easy-money policies of the pandemic. And none of the signals is cause for alarm on its own.
But, taken together, they underscore the lingering concern that the Fed may have gone too far, too fast in pushing up interest rates to squelch inflation — and that by unleashing the forces that sunk SVB, policymakers could push banks to dial back lending so sharply the economy dives into a deep recession.
“We were already debating a hard landing before SVB happened,” said Torsten Slok, chief economist at Apollo Global Management. “If credit conditions continue to tighten because banks need time to be in a position where they can give loans and operate, that increases risk of a harder landing —even more so than what we thought before.”
Treasury Secretary Janet Yellen recently said that she hasn’t seen evidence yet that lending is contracting and that the possibility that it will hasn’t significantly altered her economic outlook. That view was supported on April 14, when the Fed said bank lending rose for the first time in three weeks.
But other indicators show less reason for optimism. Take small businesses, which are facing more difficulty raising money since worries about regional banks flared up last month. A net 9% of owners who borrow frequently said in March that financing was harder to get than it was three months earlier, the most since December 2012, according to a survey by the National Federation of Independent Business.
John Toohig, managing director and head of whole loan trading at Raymond James Financial Inc., heard a similar story when he informally surveyed about 200 regional banks. He found that about one-quarter toughened lending standards after the SVB collapse caused a swift pullback from some regional banks.
“Most of our customers are worried about funding and deposit pressure right now,” said Toohig. “They’re worried about liquidity.”
That could put more pressure on businesses already showing mounting signs of distress. Even before last month’s banking crisis, bankruptcies among private companies with at least $10 million in assets had jumped to an average of 7.8 each week by late February, a stark increase from the pandemic peak of 4.5 in June 2020, according to UBS Group AG.
“We’re already seeing substantial failure rates,” said Matthew Mish, head of credit strategy at UBS.
The bank said the bankruptcies have been concentrated heavily in the construction, health-care and retail industries. Among companies that have filed recently is bio365 LLC, an Ithaca, New York-based firm that makes specially engineered soil for crop growers. Hit by rising inflation, it was forced to rely on expensive loans to stay afloat. It filed for bankruptcy this month, citing a “nearly debilitating liquidity crisis.”
Barclays Plc strategist Bradley Rogoff said the rise in such distress among smaller companies is an early warning sign of broader financial pressure. “The weakness we are seeing in smaller issuers is likely a harbinger of more stress to come,” he and his colleagues wrote.
Financial analysts anticipate that more companies will default on debt as lending standards are tightened and the Fed’s rate hikes keep rippling through the economy. The central bank is expected to raise rates again next month before likely taking an extended pause.
The volume of US corporate debt trading at distressed levels — a risk premium of at least 10 percentage points over the benchmark for bonds, or a price of less than 80 cents on the dollar for loans — has surged some 28% since last month’s banking crisis to around $300 billion, according to data compiled by Bloomberg. That figure stood at up from about $74 billion a year ago.
“Yes, there is going to be a credit crunch, not a credit crisis,” Jim Caron, co-chief investment officer at Morgan Stanley Global Balanced Funds, said in an interview on Bloomberg Television. “But that credit crunch is going to take place over a long period of time.”
Companies in the leveraged loan market are particularly vulnerable to credit drying up because of their low ratings and reliance on floating-rate debt. About 25% of the $1.4 trillion market carries a B- credit rating, just on the cusp of the CCC grade that sharply curtails access to Wall Street borrowing, according to data compiled by PitchBook LCD.
Some big banks are bracing for more bad loans, according to earnings reports over the past week. Citigroup Inc. said it more than doubled what it has set aside to cover bad loans to $2 billion, the highest since 2020.
Morgan Stanley’s provisions for credit losses quadrupled to $234 million from a year earlier, primarily related to deterioration in the outlook for the economy and commercial real estate business. That industry, which is heavily tied to regional lenders, has about $1.5 trillion of debt coming due by the end of 2025, Morgan Stanley strategists estimated in a note.
Building owners are being squeezed by higher interest rates and downward pressure on rents because of the shift toward working from home. Paul Marshall, of Marshall Wace, one of the world’s biggest hedge-fund firms, warned investors this month that the dynamic is sowing the seeds of what’s likely to be a “fairly severe credit crunch” that is escalating the risk of a recession.
The concerns about such a crunch may also drive businesses to trim their reliance on credit, regardless of whether banks are willing to lend or not. That would threaten to add another drag on the economy as companies scale back investments.
“We are starting to see our customers be less aggressive in expansion and slow down going forward,” said Tom Terry, chief credit officer at UMB Bank, which is based in Kansas City. “Clearly, we have something ahead of us.”