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Commercial Loan Automation
Credit - Small Loans
A View from Robert Albertson, Managing Director and Head of Financial Strategies, PJC The Economy, Upsides and Downsides (Part II)
Finally, credit is a two-edged sword. As we have discussed previously, loss reserves could prove high as there has been little deterioration in credit metrics to date (below), although there are now clear upticks in residential and commercial portfolios (below). There have been many months for lenders to comb their portfolios for risk and a surprisingly sharp decline in deferrals. But it is very premature to declare victory or begin reducing reserves in our view.
Uppermost in this concern is the massive support to our economy in the form of unemployment benefits and PPP lending to small businesses, along with the extremely accommodative monetary policy. The true level of portfolio risk will not be convincingly clear until this support is removed and at least some victory lap is deserved after vaccination deployment. At the moment this deployment is suffering well known delays. With perhaps unfounded but significant resistance within the population, achieving “herd immunity” at 60-70% may take more time than some consider, leaving the possibility of a third round of infections and economic constraints in the fall of this year. COVID is still very much controlling the economy globally. We are unlikely to see full exposure of credit risk until well after support has been removed, certainly not before the second half of this year. We all expect loan losses but we still cannot adequately quantify their severity.
There are multiple risk verticals to watch. Commercial real estate is undoubtedly the largest and repurposing will eventually take years to complete. Hospitality and travel is undoubtedly the hardest hit from employment data. And while CAREs 2.0 has theoretically delayed CECL and TDR recognition, the political tolerance for these may pressure regulators to tighten their judgment and enforcement.
Consolidation is a brighter light as revenue growth remains in the distance and size continues to matter even more so in our outlook. The handful of larger transactions in 2020 revealed many things, including the possibility of significant upside in a buyer’s stock when creative product combinations occur. There is also the more liberal definition of acceptable geographic expansion that is winning over the time-honored branch overlap model. One thing has not changed-the lack of ready buyers. MOEs and low premium deals should dominate this next wave of consolidation and the average size of transactions could rise as regionals consider steps toward becoming super-regionals.
In general, we believe earnings and balance sheet valuations for equities have already skipped 2021 and rest on 2022 and beyond projections and estimates. We want to note that it is unusual for “new year” outlooks to immediately see through to the following year, this time made necessary by ongoing COVID. It is also possible that managements come to view 2021 as a year of “kitchen sink” spending, primarily in the race for applied technology. Nonetheless, relative valuations for this sector remain historically low and strongly suggest overweighting.
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