The end of the credit cycle

All good things eventually end unfortunately so when this current credit cycle started it's decent to reality many observers were in denial about what was actually happening. Many of them still are like Paul Krugman, the NY Times economist who still can't see the inflation everyone else is experiencing. Reality has a way of asserting itself however and when it does the denials look pretty absurd. The expert pundits are quite simply clueless and out-of-touch. Meanwhile, small business owners have to figure out how to thrive/survive using information from these sources. Clown show.

I wrote a blog post a while back called "Reversion to the mean" which refers to the tendency of trends to revert to their historic average after they diverge greatly. It's a natural phenomenon that resembles a stretched rubber band which, when stretched to it's limit, will snap back into it's previous state.

We are at the point now where all of the momentum is pushing toward reversion to a much lower level of valuation for just about every asset class you can think of except maybe commodities for which there is still considerable demand.

The most glaring sign that the credit cycle is "long in the tooth" are the rising default numbers:

"The most lagging parts of the credit cycle are delinquencies, charge-off rates and bankruptcies. These peak during or after the recession, but begin rising before it. Delinquencies are slowly rising across loan categories, including credit cards, auto loans and mortgages. Charge-off rates are beginning to climb as well. Wider credit spreads are a leading indicator for the further rise in loan charge-offs banks will soon see."

The cost of capital is a function of risk and the time-value of money. When defaults rise in general credit doesn't stop but it becomes harder to get approvals even when the credit profile is higher. That is because there's more risk perceived by the lender who then requires more security, higher rate, shorter term or all of the above in order to approve capital. There's a tug-of-war going on right now in underwriting offices around the country who have capital piling up that needs to be put to work by lending it out to businesses however they're constrained by the higher approval guidelines due to increased risk.

"Lenders, including Bank of America and JP Morgan, have been increasing loan-loss provisions in preparation for a downturn or a recession. Still, loan-loss provisions for US banks remain more reflective of a zero-interest rate world, and are below where they were in the 1990s, a period with significantly above-zero rates similar to today. Banks are at risk from being under-prepared for a potentially deep recession."

The talking heads on TeeVee are desperate to spin but there's no escaping Mr. reality who once again asserts himself bigly to millions of consumers 24/7.

"Credit has exploded higher since the pandemic. But all good things must come to an end, with credit busts typically following close on the heels of credit booms. Cracks are now emerging in lending markets as the sharpest monetary policy tightening in decades begins to bite."

Capital for small business owners is still available in meaningful amounts and at rates which haven't really changes much in almost 4 years - How many thing can you say THAT about??

Having said that. approvals are harder to come by, some lenders won't even make new offers. That is, the rate is irrelevant if the lenders don't lend. This isn't a glitch and it's not going away. We're at the beginning of the turn in credit cycle so it's good to read up on history in order to prepare for what's coming. OR...You can continue to read my posts! Here's a preview of how things have panned out in the past:

"But after the feast comes the famine. The credit cycle operates in a well-defined sequence: first lending conditions tighten, then demand for loans falls, followed by a fall in loan supply. Loan delinquencies then increase as it is harder to get new credit, followed by a rise in charge-off rates as losses are realized. Finally, bankruptcies and defaults rise as loan losses lead to insolvencies."

My advice to owners is to gain situational awareness, re-evaluate existing sources for basic goods/services and add alternatives when possible and finally, keep your powder dry, there will be unbelievable opportunities coming to a neighborhood near you soon!

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