Tom Cruise stars in the 2014 sci-fi thriller, Edge of Tomorrow. To stop an alien invasion, the soldier in the movie gets stuck in a time loop where the same day keeps repeating itself. Over the course of several time loops, Tom Cruise develops into a skilled soldier who, in classic Hollywood style, vanquishes the aliens and enters the future. Transfix this to the lending market and we are at the proverbial edge of tomorrow. Lenders have been in a time loop for several years now awaiting a market correction.

What is the Time Loop

The "lending time loop" has been COVID, which brought PPP (plus all the other government programs) and low rates, which stimulated demand and the stock market. Everyone thought COVID was the edge, only to be delayed by PPP. As a result, inflation is out of control while the new liquidity is being sucked out of the system. Absent another government intervention, we are now on the edge of tomorrow, and while we are not under an alien invasion, we are dealing with a number of unseen events, or at least consumer and economic shifts that we haven’t seen since the 1970s. As we try to look ahead, all we can see is the edge.

The battle against COVID wasn't free, and the price is now due. The Federal Reserve is aggressively raising interest rates and taking steps to shrink its stockpile of $9 trillion of government bonds. On Main Street, the majority of people are returning to work, and most COVID trends—like work from home, Peloton, online shopping, Zoom, and others—are starting to slow down. Today's inventory oversupply is affecting the majority of retailers. FedEx recently issued a notice about declining global demand and prices are up across the board.

Facts About the Edge

The following facts are held to be true: The Federal Reserve has constantly kept its word about raising rates, consumer prices have gone up, home prices have gone down, and demand has now slowed. The list goes on for every consumer consumption and economic trend that is being reversed as a result of the removal of liquidity from the system. Although there are a few exceptions, banks' portfolios are generally balanced across most major industries, so they are now finally starting to prepare for tomorrow. This seems to be supported by a global slowdown in publicly announced deals.

Refinitiv estimates that between July and September 2022, worldwide M&A volume was $642 billion, a 42 percent decrease from the previous quarter and the lowest third-quarter figure in a decade. Since the pandemic ravaged Q2 2020, this suggests the slowest overall quarter. The number of worldwide deals fell to its lowest level since Q1 2015, and U.S. deals decreased by a comparable percentage to $278 billion. This is significant since it shows that the volume declines weren't only caused by declining valuations.

The stock market falls, which put many sellers and buyers on hold, as well as the previously cited concerns like rising rates, inflation, and geopolitical uncertainties, among other things, all had a role in the Q3 deal slowdown. With values down, M&A down, liquidity down, and major economic indicators driving market instability, this is what the edge looks like. There is no assurance that we will see a significant recession, but this raises the question of what may be around the corner.

What About Tomorrow

Tomorrow will see a shift of assets from banks to ABLs and other non-bank lenders, as seen through the lenses of Lionsford and the surrounding ecosystem of commercial lending advisors. For the past few years, many of these businesses have been stuck in a time loop, believing that every quarter would mark the moment when banks would start taking preventative measures or would start anticipating the confluence of economic conditions that currently afflict the majority of borrowers.

The end of Q1 2023 should be quite telling for both the senior management teams at the major banks and the entire non-bank sector intended to partner with them. Commercial bank portfolios, which have been spotless for years, suddenly face significant difficulties. Banks grabbed reserves, used them in reverse, and are now putting them back into use. In order to encourage customers to start looking for non-bank alternatives, commercial banks are now actively monitoring all criticized risk-rated credits and conveying their concerns to the clients.

Ironically, the multi-year time loop has made the non-bank world ready for tomorrow—at least those that maintained strict credit screening standards. In the non-bank sector, COVID aided in hastening scale-up and consolidation. As a result of capital efficiency improvements, BDCs are becoming the main engine behind non-bank asset-based lending and are driving costs down.

The larger companies have been planning for several years for what should be a pivotal event once we go over the edge. Nonetheless, commercial lending is a challenging industry, therefore many lenders have offered credit "concessions" to draw in customers, whether they be bank or non-bank. We'll watch to see if those lenders can pull in the reins in time. Only time will tell if we are now finally at the edge, but the real question is whether your company is ready for the future.