July ’20

The BAN Report: Credit Update / Small Business Closures Rise / 30-Year Below 3% / Jamie’s Firing / The $8MM Skilled Nursing Relationship-7/23/20

Credit Update

Many of the largest banks have now reporting earnings, giving us a better sense of credit quality at banks with several themes emerging.    A few takeaways:

Small Business Loan Deferrals Exceed Most Categories

Bank of America provided their deferrals by various categories and small business non-credit card lending stood at 28% of balances, while Small business card stood at 21%.    These substantially exceeded all other categories.    Many of these customers though were doctors, dentists, and vets, who have strongly resumed operations.

Our internal survey shows that 80% of these borrowers as of a few weeks ago were all back to work with steady revenue. In our contacts with the accounts, 90% indicated no elevated level of continued distress and informed us they’ll need not to continue their deferral.

Beginning October 1, SBA 7(a) and 504 borrowers will need to begin making their own loan payments, as the SBA is now making the payments themselves as part of CARES Act relief.    We will have a better sense of the health of the small business portfolios shortly thereafter.

Deferral Requests Declined Substantially in Latter ‘Q2

Chase noted that deferral requests declined 95% (on a 7-day average) from their peak in early June.    This is consistent with what we have heard from other banks.    The vast majority of customers that needed a deferral have now received one, although the question remains which percentage of deferred loans will become future workouts.

Different banks pursued various deferment strategies.    Some banks were pro-active and asked customers if they needed assistance.   Some granted them automatically, but only upon request.   Others were more selective and required documentation before granting a deferment.   So, banks that granted deferrals more liberally will see higher numbers of deferrals, but a lower percentage of deferrals will become problems.   The less lenient banks will see lower deferrals, but a higher percentage of those deferrals will become future workout loans.

Retail Dominates CRE Non-Accruals

Wells Fargo has been the largest CRE originator since 2009, so its CRE book is a good representation of the CRE industry.    As of the end of the Q2, retail (excluding shopping centers) and shopping centers represented a whopping 46% of all loans in non-accrual.    Additionally, 88% of their increase in criticized assets were in hospitality, retail, and office.

Wells also opined on the direction of CRE values (CFO John Shrewsberry)

While housing prices are forecasted to remain relatively stable, commercial real estate prices are forecasted to decline by low to mid-teens with hotel, restaurant and retail sectors expected to decline much further.

Hospitality & Restaurants Showing Stress

At Western Alliance Bancorporation, 83% of their hotel portfolio is in deferral, although they believe that low leverage select service hotels can support amortizing debt at 50-55% occupancy.    As of 12/31/2019 average DSCR stood at 1.8X with an average LTV of 60.7%.

They are pursuing a unique deferral strategy, using a “six plus six” program in which the borrowers give the bank six months of payments up-front, and then get six months of deferrals six months later.    This approach allows the borrower to show “project commitment.”

Restaurants are showing stress with 20-30% in deferral at Synovus, for example.    Cadence Bancorporation provided some color on restaurant segments, noting that quick service restaurants are “showing resiliency” while full-service restaurants are the “most stressed segment of the portfolio.”

Overall, we are still early in assessing the credit challenges at banks, which have built up reserves, but have not yet seen meaningful increases in troubled loans, which is largely due to the fact that the CARES Act allows banks to modify COVID-impacted loans without TDR status.   During the next quarter or so, we expect substantial migration of loans into workout.    This month, we began to see a fairly dramatic uptick in interest in loan sales as some lenders are choosing to act while market conditions are strong.   We are also getting inquiries from banks that are flush with liquidity and looking to purchase clean loan portfolios.

Small Business Closures Rise

Unfortunately, many small businesses have closed their doors permanently, according to sobering data from Yelp.

Even as total closures fall, permanent closures increase with 72,842 businesses permanently closed, out of the 132,580 total closed businesses, an increase of 15,742 permanent closures since June 15. This also means that the percentage of permanent to temporary business closures is rising, with permanent closures now accounting for 55% of all closed businesses since March 1, an increase of 14% from June when we reported 41% of closures as permanent. Overall, permanent closures have steadily increased since the peak of the pandemic with minor spikes in March, followed by May and June.

The closures per 1,000 are especially high in the western states with Hawaii, Nevada, and California showing the most stress.    Restaurants and retail represent the categories with the highest temporary and permanent closures.

Several categories are showing sustained increased interest since the pandemic, led by Guns & Ammo, Accountants, Hiking, Bike Rentals, Mortgage Brokers, Outdoor Gear, Nurseries & Gardening, Appliances & Repair, Plumbing, and Sandwiches.   And there is a strong rebound in some areas that saw initial challenges at the start of the pandemic.

As measured by a seasonally adjusted share of its root category, we saw interest in wineries plummet at the beginning of the pandemic, dropping 68% in late March and early April. Since, we have seen interest in wineries rise drastically in June, now only down about 6% relative to the baseline level of interest. Donation centers, ice cream and frozen yogurt, seafood, dermatologists, and surprisingly, blow dry services have all experienced similar trends.

There is also a meaningful uptick in searches for black-owned businesses, led by restaurants and bookstores.    Small business lenders will have a meaningful role to support the small businesses that are doing well during these times, and, undoubtedly, many will emerge to take the places of the firms that close their doors.    Kevin O’Leary of Shark Tank argues that the government should stop aiding businesses and let the market decide.

Central to O’Leary’s argument against aid to businesses is a belief that the American economy will be fundamentally changed as a result of the coronavirus pandemic. At its core, it will be an economy relying much more on online sales and digital transformation, he contended. 

“I’ve got 20% of my portfolio that is really hurting, and I actually don’t want the government to prop up zombie companies anymore. Stop doing that,” O’Leary said. “If a company has to die because the world has changed permanently, let it die and let something else replace it.” 

He raises an interest point as people tend to focus on jobs lost and companies lost without considering the jobs gained and companies formed in the vacuum, noting how the wine industry has transformed itself during the pandemic, as wine have risen but through online sales, as opposed to restaurants and tourism.

30-Year Below 3%

Practically every single credit-worthy homeowner should now at least consider a refinance, as the 30-year fixed rate broke the 3% barrier.

The average rate on a 30-year fixed mortgage fell to 2.98%, mortgage-finance giant Freddie Mac said Thursday, its lowest level in almost 50 years of record keeping. It is the third consecutive week and the seventh time this year that rates on America’s most popular home loan have hit a fresh low.

Below 3% is a “tremendous benchmark,” said Jeff Tucker, an economist at Zillow Group Inc. “It’s also an indication that we remain in a crisis here.”

The average rate on the 30-year mortgage stood at 3.72% at the beginning of the year and 3.81% a year ago, according to Freddie Mac.

The spread between the yield on the 10-year Treasury and rate on the 30-year mortgage has narrowed in recent weeks, largely because lenders had spare capacity to process applications after clearing a backlog of refinancings. Still, the larger-than-usual gap means there is room for rates to fall even farther, Mr. Tucker said.

Jumbo loans have not seen the same improvement.

Interest rates on jumbo home loans, those too large to sell to Freddie Mac or Fannie Mae have fallen to around 3.77% from 3.84% at the beginning of the year. From the middle of 2015 to this March, jumbo rates were consistently lower than or equal to the rates on so-called conforming loans, according to Bankrate.com.

Earlier this year, some lenders placed new restrictions on these larger loans—in most markets, loans of more than $510,400—after the investors who typically buy them soured on loans without government backing.

With the Federal Reserve providing liquidity to the conforming loan market, one should not be surprised.    Moreover, many mortgage lenders have stopped originating jumbo loans or have toughened guidelines.    Wells made a big change this month.

The bank is now requiring new clients to bring at least $1 million in balances if they want to refinance a jumbo mortgage, up from a previous level of $250,000, according to people with knowledge of the policy.

The change came in a July 1 overhaul of lending guidelines that broadly lowered barriers to the product for existing customers, while making it far harder for new ones to qualify, said the people, who declined to be identified speaking about the move.

According to Bankrate, originations are down more than 90% from a year ago.   For those looking for jumbos today, they recommended Wells Fargo, Truist, Flagstar, and PNC Bank.

Jamie’s Firing

In a recent podcast, Jamie Dimon described how he recovered from being famously fired by Sandy Weill at Citigroup, in which he took about two years to find his next opportunity.

“When I was fired from Citi … I was totally surprised,” Dimon said on the podcast. But “I shouldn’t have been. There were a lot of tell-tale signs, but I missed them at the time.”

Dimon, who “went from working 80 hours a week to zero,” used the down time to figure out what kind of leader he wanted to be in his next role. He read biographies of national leaders and took up boxing to relieve stress.

“People say you have a shelf life,” Dimon told Council on Foreign Relations chairman David Rubenstein at a conference in 2019, so he “took any incoming call.”

“Any job’s a job. I was getting a bit restless. I couldn’t fill up my day,” he said.

Dimon interviewed for various positions at companies like Home Depot and Amazon. Amazon in particular “appealed to me a little bit to move — remember [the movie] ‘Sleepless in Seattle’ had come out a couple years earlier. [I would] get a houseboat and never put a suit on again,” he told Rubenstein. 

Though Dimon thought at the time that Bezos “had a real opportunity to build something,” it was just “a bridge too far for my family, me. I’d spent my whole life in financial services. And so I decided I should probably find something in financial services.”

In 2000, Dimon became CEO of Chicago-based Bank One and was excited to be part of the bank’s growth. That year, Bank One reported a loss of $511 million, according to The Harvard Business Review. With Dimon as CEO, just three years later, Bank One reported a record profit of $3.5 billion.

In 2004, JPMorgan Chase bought Bank One, and in 2005, Dimon was named CEO of JPMorgan Chase.

In a time of high unemployment and economic unrest, his story provides some inspiration on how an industry leader bounced back from a professional setback.   We encourage you to listen to this fascinating podcast.

The $8MM Skilled Nursing Relationship

Clark Street Capital’s Bank Asset Network (“BAN”) proudly presents: “The $8MM Skilled Nursing Relationship“. This exclusively offered portfolio is offered for sale by one institution (“Seller”). Highlights Include:

Files are scanned and available in a secure deal room and organized by credit, collateral, legal, and correspondence with Asset Summary Reports, financial statements, and collateral information. Based on the information presented, a buyer should be able to complete the vast majority of their due diligence remotely.

Event Date
Sale Annoucement Thursday, July 23, 2020
Due Dilligence Materials Available Online Monday, July 27, 2020
Indicative Bid Date Thursday, August 20, 2020
Closing Date Thursday, September 10, 2020

Please click here for more information on the portfolio. You will be able to execute the confidentiality agreement electronically.

The BAN Report: PPP Update / CFPB’s Wings Clipped / Goldman Disrupts Corporate Banking / ABS on Trial-7/9/20

PPP Update

This week, the SBA provided detailed loan-level data regarding all PPP loans over $150K. Business names, loan range data, addresses, NAICS codes, zip codes, business type, demographic data, non-profit information, name of lender, and jobs supported are included.   Naturally, this release attracted attention as to who received these funds, especially the billionaires, country clubs, and private jet companies who received funding under the program.

Soho House, the exclusive membership club controlled by billionaire Ron Burkle, received loans totaling $9 million to $23 million by applying for seven loans through its New York, Miami Beach, Chicago and West Hollywood locations. Last month, Soho House raised $100 million from private investors, including Burkle, that gave the company a valuation of $2 billion — equal to its pre-pandemic valuation.  All together, more than 400 country clubs and golf resorts received PPP funding.

The most famous billionaire to receive PPP funds is Kanye West. West’s Yeezy fashion brand received $2 million to $5 million. West has said his brand is worth $3 billion and recently announced a collaboration with Gap that could be worth $100 million or more depending on the company’s performance.

Private jet companies, which have rebounded quickly and received hundreds of millions of dollars under the aviation program of the CARES Act, also got millions in PPP funds. Clay Lacy Aviation, which received $27 million in CARES Act funding and prides itself on its celebrity and VIP client base, also received $5 million to $10 million in PPP funds.

While this may be fascinating as practically every single local business publication did a story on who received the funds in their market, not one member of Congress voted against the CARES Act.   Any business concern with less than 500 employees was eligible, which meant some billionaires and public companies got funds.

Since they did not provide exact loan amounts, we took the mid-point of the ranges and did some analysis.  The data presented represents almost 75% of all the PPP dollars.  In total, 4,318 lenders participated in the program at the reportable amounts (greater than $150K).    Of the 20 largest US Banks, all participated except for The Bank of New York Mellon, Charles Schwab Bank, Goldman Sachs Bank, and Morgan Stanley Bank. The top ten loan categories were as follows:

NAICS Code Category Estimated Loan Amount
722511 Full-Service Restaurants 15,530,675,000
621111 Offices of Physicians (except Mental Health Specialists) 13,412,750,000
441110 New Car Dealers 11,845,950,000
541110 Offices of Lawyers 9,062,925,000
238220 Plumbing, Heating, and Air-Conditioning Contractors 8,365,500,000
236220 Commercial and Institutional Building Construction 7,772,425,000
722513 Limited-Service Restaurants 7,590,500,000
238210 Electrical Contractors and Other Wiring Installation Contractors 7,394,350,000
541330 Engineering Services 6,928,625,000
611110 Elementary and Secondary Schools 6,146,750,000

The program was scheduled to end on June 30, but Congress and the White House agreed on an extension last week, extending the program until August 8.   We can assure you that few lenders asked for this extension!

A head of special assets at a west-coast bank noted that many of these PPP loans may create an event of default. Many commercial borrowers, often frustrated with their primary institution in obtaining a PPP loan, got loans from different banks, creating multiple covenant violations, including obtaining credit elsewhere without the lender’s consent or setting up unauthorized checking accounts.    Some borrowers with competent counsel or accountants did this beforehand. With this new database, it will now be easy to see who broke the rules. Banks are already checking to see who got PPP loans elsewhere.

To access the entire database, click here.

CFPB’s Wings Clipped

Late last month, the Consumer Financial Protection Bureau lost an important Supreme Court decision that undermined the ability of the CFPB to act independent of the Administration.

The U.S. Supreme Court ruled Monday that the president can fire at will the head of the Consumer Financial Protection Bureau but left intact the rest of the statute that created the agency. Congress created the independent agency in 2010 to protect consumers from abuses in the banking and financial services industry that led to the 2008 financial meltdown.

Writing for the majority, Chief Justice John Roberts said the “the CFPB’s leadership by a single individual removable only for inefficiency, neglect, or malfeasance violates the separation of powers.”

But the court did not go as far as the challengers had wanted, limiting the decision to the single-director structure of the CFPB. Roberts wrote: “The CFPB Director’s removal protection is severable from the other statutory provisions bearing on the CFPB’s authority. The agency may therefore continue to operate, but its Director, in light of our decision, must be removable by the President at will.”

While many were happy with this decision, it also means that a President Biden could appoint a new CFPB head that reverses some of the Trump Administration changes. One of those changes came this week when the CFPB reversed a prior rule that required Payday lenders to underwrite Payday loans by the “ability to repay” requirement.

The initial rule, released shortly before President Trump appointed new leadership at the CFPB, effectively banned lenders from issuing a short-term loan that could not be paid off in full by a borrower within two weeks.

The measure required payday lenders to determine whether the customer had the “ability to repay” the loan with an underwriting process similar to what banks use to determine whether a customer can afford a mortgage or other longer-term loan.

The CFPB has now issued a new version of the regulation that scraps those underwriting requirements, in line with a proposal released in February 2019. The new regulation leaves in place the original regulation’s restrictions on how frequently a payday lender can attempt to withdraw funds from a customer’s bank account.

“At this moment of health and economic crisis, the CFPB has callously embraced an industry that charges up to 400 percent annual interest and makes loans knowing they will put people in a debt trap,” said Lauren Saunders, associate director of the National Consumer Law Center (NCLC).

Defenders of payday lenders say the industry provides crucial temporary financing to Americans who lack a credit card, and are frequently the only lenders in economically depressed or remote areas.

Nevertheless, despite the strong lobbying from the banking industry to end the Agency, the CFPB is not going anywhere.

Goldman Disrupts Corporate Banking

Goldman Sachs has entered the lucrative market of corporate transaction banking via an online banking platform, a market historically dominated by a few large banks.

Goldman Sachs recently launched an online banking service for large businesses that it says is more streamlined than traditional banks’ offerings, with features like virtual accounts, quick account opening and predictive analytics to help customers anticipate future cash flows.

In so doing, Goldman entered a market that a small number of large banks own and will be unwilling to give up. It is competing mainly on what it says is a better customer experience driven by modern technology.

Hari Moorthy, global head of transaction banking at Goldman Sachs, pegs the corporate transaction banking market at $80 billion in annual revenue in the U.S. alone, and somewhere between $150 and $160 billion globally.

In Moorthy’s view, the industry has not evolved since 1980.

“These banks are using massive mainframe systems and lots and lots of people; it’s not atypical for a bank to have between 5,000 and 20,000 people in an organization that manages this, a huge operational staff and a huge technology staff all working on old-school technology,” he said.

Its been fascinating to watch a new player like Goldman look at a lucrative market segment and try to build from scratch an attractive product offering. We suspect though that they will meet strong resistance, as these are some of the largest and most lucrative clients of the nation’s largest banks.

Last month, Goldman announced a partnership with Amazon to offer revolving credit lines under its Marcus brand.

Amazon is introducing a new digital credit line for U.S.-based merchants with partner bank Goldman Sachs, CNBC has learned exclusively.

Small business owners who sell items on the e-commerce giant’s platform will soon be receiving targeted invitations from Goldman’s Marcus brand for credit lines of up to $1 million, according to people with knowledge of the project.

Potential borrowers will see the offer on Seller Central, the online hub for Amazon merchants and can apply in a simple two-step process, said the people, who spoke on condition of anonymity because they were not authorized to discuss the partnership publicly. The credit lines will come with a fixed annual interest rate of 6.99% to 20.99% and can be drawn and repaid, like a regular credit card.

Banks should heed the advice of the late Andy Grove: “Only the Paranoid Survive.”

ABS on Trial

The main event in the Hertz bankruptcy is the battle between the ABS holders and Hertz. Hertz is essentially trying to blow up the entire ABS industry by rejecting some, but not all of its leases.

The cars are housed in an entity linked to Hertz’s asset-backed securities and leased to the rental giant. Normally, when a company with ABS files for bankruptcy, it must choose to confirm or reject the entire master lease tied to the debt. If it keeps the lease, it has to continue making payments on the vehicles as it offloads them piecemeal. If it walks away, all of the collateral is liquidated to pay back bondholders.

Hertz wants a judge to allow it to convert the master lease into 494,000 separate agreements so it can reject the terms on 144,000 vehicles. That would allow Hertz to save roughly $80 million a month while it hangs onto the remainder of the cars as it seeks to emerge from bankruptcy a viable company. If the motion fails, Hertz may press for a reduction in payments to creditors, according to people familiar with the matter.

The standoff raises the stakes in what is already 2020’s largest corporate bankruptcy. Hertz is seeking to avoid liquidation and strengthen its balance sheet via the restructuring, while bondholders with billions of dollars at risk who’d grown confident of their chances of being paid back are now threatened with losses. Moreover, industry insiders worry that if Hertz is successful in court, it would re-define the rules that have long governed the ABS market.

Interestingly, the bondholders are supporting Hertz, as this move would allow the company to essentially right-size its fleet. If a debtor is allowed to effectively “cherry-pick” the leases it wants to reject, then it may make future ABS deals more expensive for the borrower. A decision is expected in the next week.

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