By Charlie Perer, Co-Founder and Head of Originations, SG Credit Partners
In the current market, where sentiment can change on a dime due to everything from supply chain constraints to geopolitical upheaval, it’s essential to expect the unexpected, but that doesn’t mean we can actually see the twists coming.
The 1960s TV series “The Twilight Zone” was both a fantasy and horror show in which characters found themselves dealing with often disturbing or unusual events. This experience was described as entering “the Twilight Zone,” often leading to a surprise ending to each episode.
Every lender knows a proverbial surprise is coming, but the persistent question continues to be when. No better title describes the world we are living in today with both public and private equity in a race to the top and all lenders in a race to the bottom. We are living in a lender’s “Twilight Zone.” Lenders are currently dealing with every risk imaginable and, ironically, unimaginable (i.e., nuclear war), yet the bubble has yet to burst. So, here all of us are at a race to the bottom, while the rest of the market is at a race to the top. The challenge is no lender wants to be the first to stop lending and signal to the market they are calling a top.
Let’s start with the disturbing facts in a lender’s “Twilight Zone,” which are inflation, labor shortages, wage increases, interest rate increases and real margin pressure. Let’s add the unusual factors like the stock market still being around all-time highs, terrifying military conflicts in Eastern Europe, a new Cold War and global ramifications from economic sanctions. Despite all this, liquidity in the market remains strong and competition for debt remains high. This has been partially due to the government supplying liquidity and the corresponding reaction of banks reversing reserves, but it has also been due a “twilight” effect of no one specific issue bursting a bubble. It’s our job as professional stewards of capital to smartly deploy capital and it’s hard to not engage new business when seemingly strong credits are presented. The flipside is that everyone knows that every new and quality credit is one news cycle away from changing, given smart money says we are in overtime in a long-in-the tooth cycle.
Forecasting a bubble or impending a recession has proven to be a literal fool’s errand, so this article is not about timing. Rather, it highlights the current in-between phase where we have to conduct business while knowing there are dark storm clouds on the horizon. Companies, including lenders, can’t afford to not do business. COVID-19 runoff is example No. 1 of how many lenders had massive attrition and corresponding decline in revenue that has yet to recover. This further complicates the “twilight” effect, as many firms find themselves with no real problems but a lack of scale to reach their forecasted plans. The unique thing that makes this cycle different is that people are expecting the expected, but they can’t predict the timing of the predictable. The last two cycles in 2000 and 2008 might have been foreseeable, but they were certainly not predictable. The beauty of the “Twilight Zone” is that we can all expect the unexpected but can’t predict the predicable. The unexpected is here, but we can’t predict what will happen next.
The challenge in this environment is offense rather than defense. How aggressive should any of us be at the top of the market and when is the time to prepare for the inevitable pullback? These are not easy questions to answer, but we should all be thinking about them, as the next cycle is poised to sideline those of us who are not prepared on both offense and defense. In addition, like most cycles, most executive groups are comprised of either constituents who have too much historical experience or those with literally none due to age.
Right now, for lenders, there appears to be no end in sight to the race to bottom. Why should there be when no can point to one specific data point that is going to cause a major market correction? After all, as the “Twilight Zone” explains, “this is the fifth dimension beyond that which is known to man. It is a dimension as vast as space and as timeless as infinity. It is the middle ground between light and shadow, between science and superstition, and it lies between the pit of man’s fears and the summit of his knowledge. This is the dimension of imagination. It is an area which we call the Twilight Zone.”