Surprises in the Lender's Stocking

Opening a Christmas gift is risky.  You don’t know if this is something that you really want or if it is something that will be sent to the goodwill box within a week.  We have all experienced this.  It may be an ugly sweater, a necktie that is not meant to ever be in public, or some item there is no way that you will ever use.  It is the same as finding a big lump of coal in your stocking from Santa.

This time of year, we tend to look back at the past and look forward to the future.  When one considers the challenges and possibilities for the new year, it is like receiving presents that you have no idea if they will be absolutely fantastic, or if they turn into the lump of coal.  Here are a few of the mystery presents that lenders find under their tree this year.

I will start with the economy.  We are already nearing record time for an economic expansion.  There continues to be good economic news—strong employment, expanding companies, inflation that is reasonable.  Yet, we just don’t know when the party will end or what will make it end.  Will it slowly fade, or will some violent change cause the growth to come to a screeching halt?  Then what impact will it have on your borrowers?  What sectors of the economy are already showing stress?  We are already seeing quite a bit of stress in agriculture.

Could a debt crisis that is triggered from emerging markets or a financial crisis from uncontrollable deficit government spending, bring the economy to its knees?  If there is a debt crisis, will it reduce the supply of possible funding for new projects?

Interest rates are another mystery.  It is expected we will see another Fed increase this month, but after that, what will be the attitude of the Fed?  Will the yield curve invert?  This is a sign that a recession is coming and would be a large lump of coal in the stocking!  Our recent recessions have been rather severe in nature. 

Will commercial real estate (CRE) lending slow down?  Starting on December 15, 2019 the new Current Expected Credit Loss (CECL) model for allocating loan losses, goes into effect for institutions that file with the Securities and Exchange Commission.  By the end of 2021, all lending institutions will be using this.  This will replace the current Financial Accounting Standards 5 and 114 for allocating credit losses and now require lenders to estimate a loss over the entire life of the loan.  It is expected this will require additional capital reserves due to the increased credit loss estimates.  Will this slow down CRE lending?

Another possible slow down for CRE is the new lease accounting standards for public companies that will begin at the end of this year.  What impact will lease accounting have on long term lease structures that are key to the current triple-net (NNN) lease market?  What happens with permanent debt investors that rely on matching longer-term liabilities to assets with long duration cash-flowing assets?  Will companies that engage in long term sale-leaseback CRE, now relay on holding those assets, thus effectively shrinking the supply of good NNN deals for CRE investors?

This change is a material occurrence.  Moody’s estimates this new Financial Accounting Standards Board lease accounting change may add as much as $1 trillion in liabilities to corporate balance sheets.  This becomes even more complicated with the right-of-use asset calculations that can mitigate this additional liability.  In these figures, the asset value is not determined on the market value, but on the use.  This could result in a decline in assets and correspondingly the company’s net worth.  This possible disruption in longer-term leases could leave the NNN lease market exposed and would be a present no lender wants to see.

Another possible lump of coal is with employment.  This fall, we have more posted jobs than folks who are on unemployment.  As I write, the unemployment rate is at 3.7% and real wage growth is increasing by 3.1% annually.  Employment growth is averaging 170,000 jobs a month.  Many highly skilled jobs are also going unfilled.  Will companies be able to find the labor they need in a tight job market?

A final mystery present that I will mention, but definitely not the last, is the future of regulations.  2019 will mark a time when we have a House leadership that has been historically for increased government oversight, contrasted with a Senate and President who have sought to cut regulations.  The other players are the actual folks who implement the regulations themselves.  Will there be a continued move to unshackle the economy or will this change to a focus for more oversight? 

Each of these mysteries will be wonderful opportunities for some and could be devastating to others.  Our goal for the new year is to be highly aware of what could lie in each stocking and present; then be adaptive quickly to the changes.