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Commercial Loan Automation
Credit - Small Loans
Outlook 2021 - The Second Half
At the end of 2020, lack of clarity surrounded the economic outlook for 2021. Few were confident in what the new year will be line. Following the earnings releases of the first quarter, that uncertainty persists and intensifies. Our economy is invisible. It has been drowned in $13T worth of government support, the likes of which we haven’t seen since WWII. Our banks are asking the same questions they did on 4Q20, such as:
• What should I expect from loan demand?
• Deposit inflows and persistency?
• How do I underwrite in a post-pandemic world?
• How to I plan for the inevitable losses to come? And when will they come?
New questions emerge as well, such as:
• Is inflation a mere spike of here to stay?
• Which industries will recover?
My good friend Robert Albertson freely admits he shares the prevailing uncertainty, but his excellent analysis helps shed some light on key trends that might eventually lead us to greater certainty.
Below are some of the key points of his current thesis, with my comments.
1. Capital expenses and commercial investments are still weak, while consumer spending has recovered, reflecting strong pent-up demand for goods and services that were depressed in the past year plus, especially leisure and hospitality. People want to go outdoors, be at a different place than their usual abode, and take vacation.
2. Consumer spending has leveled off in April 2021. That, coupled with job growth number well below expectations, could imply sluggish recovery and yield anemic loan demand.
3. Loan demand is geography- and industry- specific, but the aggregate picture shows overall weakness. This is not surprising considering the huge amount of liquidity injected into the economy, which now resides in consumers’ and businesses’ bank accounts. The economic uncertainty further exacerbates the loan demand problem, as is Debt Forgiveness.
4. Credit losses have been deferred even further, which brings to question the appropriateness of current reserve levels. Debt Forgiveness and other deferrals (such as rent) are beginning to season, which might bring some clarity to the picture in the next two quarters barring additional government spending. Loss forecasting models haven’t worked since the pandemic started, and likely will not work effectively for the remainder of this year either. In a way, the government privatized losses thus far, and there are no signs of the process abating soon. This implies continued outstanding credit performance across the board in the medium-term.
5. Uncertain psychology. How do you underwrite in the post-pandemic world? Uncertainty implies risk, for which banks should be paid, but a systemwide loan-to-deposit ratio in the 60%s won’t allow banks to raise prices and lose deals. Diversification is a risk reduction tool that is available to us. Avoid sector concentrations as you book new loans, and consider secondary and tertiary risks exposure to key factors such as ESG, dependence on energy, rising employment costs etc.
6. Regulatory uncertainty has not eased, and will continue to cast a pall over the industry until all key positions are filled. In the meantime, there is growing concern among banks about a shift in the regulatory atmosphere.
7. Inflation rearing its head; is it a spike or is it a trend? Many brilliant minds feel strongly and can explain and document diametrically opposing viewpoints. Some feel it is inevitable in light of huge liquidity inflows and government support (the highest levels since WWII), combined with supply constraints and supply chain disruptions causing spikes in the price of prices. Others believe that all is in hand, and the upcoming infrastructure bill will fill in the significant job shortfall COVID brought about.
8. Participation rate (percent of the workforce which is working or actively looking for work) crated again. Full economic recovery depends on workers filling the millions of vacant job positions, particularly in the hospitality and food businesses. Staffing entry-level and unskilled labor jobs is quite challenging these days, including for banks. Turnover is increasing as employees are willing to consider a change, now that the pandemic is ebbing.
9. Recovery is uneven across industry sectors. There are winners and losers, both by sector as well as by geography and other variables (such as cities vs. suburbs and country living). Some business models have deteriorated despite early openings, whereas others flourished. There are extraneous factors that explain that (such as the exodus from cities, millennials buying homes, or the importance of garden centers in the mental health of the population). In addition, the quality and nimbleness of Management made a big difference in the viability of many businesses, even in ailing sectors. Overall the economy that is emerging from the crisis is different from the one we had when it started. The numbers show robust improvement in hospitality and leisure, but not much elsewhere. The numbers show robust improvement in hospitality and leisure, but not much elsewhere. As Jay Powell says: “We are recovering…to a different economy”.
The past year brought us many lessons, including demonstrating our ability to do well in an uncertain environment. The second half of 2021 is unlikely to bring much greater clarity to our environment, assuming continued government support. The only course of action is to accept uncertainty, remain true to your risk appetite statement and leverage your core strengths. Acting quickly, thoughtfully and decisively, like we did in 2020, will be an asset to our management teams as we continue to write the script while we are filming.
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