“We can never know about the days to come but we think about them anyway…”
Depending on whether you are a seasoned veteran of the lending markets, or a really seasoned veteran of the lending markets, you will likely remember the song Anticipation for at least one or two reasons:
- It was a famous song written and performed by Carly Simon. According to legend, she wrote the lyrics early in her relationship with Cat Stevens while she waited 45 minutes for him to show up at her apartment.
- It was the background theme to a series of Heinz Tomato Ketchup commercials. The song demonstrated that the superior viscosity of Heinz was absolutely worth the interminable wait of dispensing it from the old glass bottles.
So, what do we think about the days to come? And how could they possibly compare to what we have observed over the past couple of tumultuous years? There is certainly a great deal to anticipate now that we are finally exiting the Covid Era.
How will consumers respond to prolonged inflation? Will it lead to significant reductions in non-essential purchases? Worse, will inflation lead to higher defaults? Will consumers now have to choose between paying their credit cards, auto loans, food, healthcare, or mortgage?
On a related note, assuming the Federal Reserve raises rates and ends Quantitative Easing, how will that ripple through lending markets? Will risk credit find more natural levels without continued intervention? What will the detoxification process be like for an economy addicted to cheap money?
Will it turn out nobody has the intestinal fortitude to be the new Paul Volcker, thus inflation will continue to climb inexorably higher? Could it hit 14.8%?
What about the long-term effects of Covid on office utilization? Polls show significant numbers of workers prefer finding another job to returning to an office full time.
Will “sticks and bricks” retail make a comeback, or are shoppers content to click and ship for all eternity?
There are many other “what ifs” to contemplate, not the least of which is the war in Ukraine.
“I’m no prophet and I don’t know nature’s ways…”
However the above hypotheticals play out, it is hard to imagine that even this current Teflon-coated, record-breaking, unstoppable force of a market can continue to grind ever upward and or rates stay suppressed at “cheap money” levels in perpetuity. Many financial institutions are already required to do forward looking stress testing via DFAST, CCAR and or CECL. Certainly, it would make sense to do some stress testing that goes beyond statutory or audit reporting requirements.
In addition to forecasting out potential expected losses over time, lenders might want to gut check some worst case, point-in-time scenarios focused solely on loan metrics like Loan to Value and Debt Service Coverage, or interest rate/market spread shocks. Better to know what Trouble looks like and have a plan before he comes knocking at your door.
At the conclusion of Anticipation, Carly Simon prophetically muses that perhaps these are the good old days, and she should live in the moment not knowing how the relationship would evolve. Lenders do not have the luxury of basking in the moment. Just as Carly’s relationship with Cat turned sour, so too can the external factors that drive portfolio value and performance.
Please reach out to Will Mercer, directly at email@example.com and share your insights. You can also reach him at 617-531-3429.
Will Mercer, Executive Vice President – Analytics
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