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The BAN Report 4/29/21

The BAN Report: Re-Opening Update / Big Four Bank Earnings / Housing Shortage / $12.3 Trillion Matters / Worst Boss Ever-4/29/21

Re-Opening Update

While US GDP grew by 6.4% in the first quarter, the full re-opening of the US economy picks up steam. New York City announced a full re-opening by July 1.

New York City is aiming for a full reopening on July 1, Mayor Bill de Blasio said Thursday, suggesting a total removal of COVID-19 restrictions that have been in place for well more than a year by early summer.

“Our plan is to fully reopen New York City on July 1. We are ready for stores to open, for businesses to open, offices, theaters, full strength,” the mayor said on MSNBC.

De Blasio is expected to elaborate further on the plan later in the day. It’s not clear if additional COVID requirements — like proof of vaccinations — would apply to his plan to bring restaurants, gyms, shops, hair salons and arenas back at full capacity.

The mayor has also said indoor masking will remain the norm for some time — a statement he reiterated Thursday as it relates to the full reopening.

“I want people to be smart about, you know, basic – the rules we’ve learned, you know, use the masks indoors when it makes sense, wash your hands, all the basics,” de Blasio said. “But what we can say with assurance now is we’re giving COVID no room to run anymore in New York City. We now have the confidence that we can pull all these pieces together and get life back really in many ways to where it was, where people can enjoy an amazing summer.”

New York State also announced that all indoor and outdoor curfews for bars and restaurants will be lifted by the end of the month. Las Vegas saw its best March since February 2013.

Las Vegas is bouncing back to pre-coronavirus pandemic levels, with new economic reports showing increases in airport passengers and tourism, and a big jump in a key index showing that casinos statewide took in $1 billion in winnings last month for the first time since February 2020.

“I don’t believe anyone imagined this level of gaming win,” Michael Lawton, senior Nevada Gaming Control Board analyst, said of a Tuesday report showing 452 full-scale casinos in the state reported house winnings at the highest total since February 2013.

The cruise lines have gotten approval from the CDC to start sailings by mid-July.

Cruise operators could restart sailings out of the U.S. by mid-July, the Centers for Disease Control and Prevention said, paving the way to resume operations that have been suspended for longer than a year due to the Covid-19 pandemic.

The CDC, in a letter to cruise-industry leaders Wednesday evening, also said cruise ships can proceed to passenger sailings without test cruises if they attest that 98% of crew members and 95% of passengers are fully vaccinated. The move was a result of twice-weekly meetings with cruise representatives over the past month, the agency said.

The CDC also relaxed its rules for fully vaccinated Americans.

The Centers for Disease Control and Prevention took a major step on Tuesday toward coaxing Americans into a post-pandemic world, relaxing the rules on mask wearing outdoors as coronavirus cases recede and people increasingly chafe against restrictions.

The mask guidance is modest and carefully written: Americans who are fully vaccinated against the coronavirus no longer need to wear a mask outdoors while walking, running, hiking or biking alone, or when in small gatherings, including with members of their own households. Masks are still necessary in crowded outdoor venues like sports stadiums, the C.D.C. said.

The CDC ruling opens the door up for outdoor concerts and sporting events this summer. In Massachusetts, for example, new rules announced by the Governor will allow large venues at 100% by August 1, thus allowing the Boston Marathon, full capacity at Fenway, and full crowds at Gillette Stadium. By the second half of this summer, Americans can enjoy a world that looks more like 2019 than 2020.

Big Four Bank Earnings

Banks reported robust earnings this month, buoyed by strong trading and releases of loan loss reserves.

Bank of America

Bank of America beat expectations for the first quarter.

The bank posted a first-quarter profit of $8.1 billion, or 86 cents a share, exceeding the 66 cents a share expected by analysts surveyed by Refinitiv. The company produced $22.9 billion in revenue, edging out the $22.1 billion estimate.

“While low interest rates continued to challenge revenue, credit costs improved and we believe that progress in the health crisis and the economy point to an accelerating recovery,” CEO Brian Moynihan said in the release.

Like other banking rivals, Bank of America saw a large benefit from the improving U.S. economic outlook in recent months: It released $2.7 billion in reserves for loan losses in the quarter. Last year, the firm set aside $11.3 billion for credit losses, when the industry believed that a wave of defaults tied to the coronavirus pandemic was coming.

Instead, government stimulus programs appear to have prevented most of the feared losses, and banks have begun to release more of their reserves this quarter.

Expenses were higher than expected and loan growth was not great, but overall a good quarter.

JP Morgan Chase

JP Morgan Chase had a great quarter, exceeding expectations on earnings even without the $5.2 billion release from loan loss reserves.

The bank posted first-quarter profit of $14.3 billion, or $4.50 a share including a $1.28 per share benefit from the reserve release, higher than the $3.10 per share expected by analysts surveyed by Refinitiv. Excluding the impact of a $550 million charitable contribution, which lowered earnings by 9 cents, the bank earned an adjusted figure of $4.59, exceeding the $3.10 estimate.

Companywide revenue of $33.12 billion exceeded the $30.52 billion estimate, driven by the firm’s trading operations, which produced about $1.8 billion more revenue than expected.

JPMorgan’s release of $5.2 billion in reserves is the biggest sign yet that the U.S. banking industry is now expecting to have fewer loan losses than it did last year, when it set aside tens of billions for defaults anticipated from the coronavirus pandemic. A year ago, the firm had added $6.8 billion to credit reserves.

“Overall, this was a great quarter for JPMorgan,” said Octavio Marenzi, CEO of consultancy Opimas. “It is now increasingly clear that the bank over-reserved, and that money is now flowing back into its earnings, concealing some of the weakness in consumer banking.”

Wells Fargo

Wells Fargo also had a strong quarter, beating estimates on earnings and revenue.

Wells Fargo results were helped by a net benefit of $1.05 billion from reserve releases. Banks bulked up their credit loss reserves last year as the pandemic pulled the U.S. economy into a sharp recession, but the financial firms have started to release those reserves as the recovery takes shape.

“Our results for the quarter, which included a $1.6 billion pre-tax reduction in the allowance for credit losses, reflected an improving U.S. economy, continued focus on our strategic priorities, and ongoing support for our customers and our communities,” CEO Charlie Scharf said in the earnings release. “Charge-offs are at historic lows and we are making changes to improve our operations and efficiency, but low interest rates and tepid loan demand continued to be a headwind for us in the quarter.”

The bank expects to see its commercial and middle market loan portfolio to grow later in the year as the economic recovery gains steam, chief financial officer Michael Santomassimo said on the earnings call.

“The demand across most commercial client segments has been pretty weak, and it seems to have stabilized over the last couple of months … we do really expect to see that commercial banking demand start to pick up as the economy picks up,” Santomassimo said.

Commercial loan pipelines take time, so it will be another quarter before any uptick in commercial lending is seen by banks.

Citigroup

Citigroup completed the strong quarters for the major banks, beating on both earnings and revenue.

Citigroup on Thursday posted results that beat analysts’ estimates for first-quarter profit with strong investment banking revenue and a bigger-than-expected release of loan-loss reserves.

The firm also said it was shuttering retail banking operations in 13 countries across Asia and parts of Europe to focus more on wealth management outside the U.S., one of the first big strategic moves made by CEO Jane Fraser, who took over in February.

The bank reported profit of $7.94 billion, or $3.62 a share, exceeding the $2.60 estimate of analysts surveyed by Refinitiv. Revenue of $19.3 billion topped the $18.8 billion estimate.

Citigroup said it had released $3.9 billion in loan-loss reserves in the quarter, which resulted in a $2.06 billion gain after $1.75 billion in credit losses in the period. Analysts had expected a $393.4 million provision in the quarter.

The bank posted record revenue from investment banking and equities trading, similar to rival banks that have reported earlier.

The retrenching of retail banks outside of the US is a big move for Citi, which always strived to be the most international of the large banks.    Shrinking bank branches is not limited to the United States.

Overall, the banks reported strong earnings this quarter, although a good portion of the beats was due to reserve releases. The test for banks will be to show meaningful loan growth this year, which will be especially challenging for banks that were most active in PPP as the run-off in PPP will be a tough headwind.

Housing Shortage

Housing prices are surging due primarily to a shortage of housing, thus giving millennials their second housing crisis in twelve years.

A recent bank note from Jefferies said the US was short 2.5 million homes, while Freddie Mac put that estimate higher at a shortage of 3.8 million. There are 40% fewer homes on the market than last year, a Black Knight report found. 

It’s bad news for many aspiring homebuyers — but especially for millennials. It’s just the latest chapter in a long line of bad economic luck.

Daryl Fairweather, the chief economist at Redfin, told Insider it was unfortunate the generation that suffered from the last housing crisis — entering the job force in the middle of a recession — was now facing a different kind of housing crisis.

“Now that they have economically recovered and are looking to buy a home for the first time, we’re faced with this housing shortage,” she said. “They’re already boxed out of the housing market.”

The shortage is a result of several things: contractors underbuilding over the past dozen years, a lumber shortage, and the pandemic. It comes at a time when millennials have reached the peak age for first-time homeownership, according to CoreLogic, and led the housing recovery. But such increased millennial demand has exacerbated the shrinking housing inventory.

“We’ve been underbuilding for years,” Gay Cororaton, the director of housing and commercial research for the National Association of Realtors (NAR), told Insider. She said the US had been about 6.5 million homes short since 2000 and was facing a two-month supply of homes that should look more like a six-month supply.

There have been 20 times fewer homes built in the past decade than in any decade as far back as the 1960s, according to Fairweather. She added that was not enough homes for millennials, who are the biggest generation, to buy.

Another unmentioned cause is the moratoriums on foreclosures and evictions, which are effectively removing distressed inventory from the market. Fundamentally though, the roots of this problem go back to the Great Recession, as we essentially shifted from over-subsidizing home ownership to over-subsidizing rental buildings. Several years ago, I proposed a hypothetical project to a Houston bank.   Two, identical high-rise buildings adjacent to each other in downtown Houston. One was a high-end apartment building. The other was a condo building. The CCO said “we don’t do condos.” I responded, “You proved my point!”

$12.3 Trillion Matters

$12.3 trillion has effectively put the credit default cycle on hold for now.

First, cheap borrowing costs help companies stay alive longer and more easily. That’s a big part of the reason Fitch Ratings just dropped its expected U.S. junk-bond default rate for 2021 to 2%, the lowest since 2017, and doesn’t see it rising much more from that in 2022. About $90 billion of distressed debt was trading as of April 16, down from almost $1 trillion in March 2020, according to data compiled by Bloomberg.

Second, government officials have flooded the global economy with cash at an unprecedented pace. Monetary and fiscal stimulus for just the U.S. could have amounted to $12.3 trillion from February 2020 through March 2021, according to Cornerstone Macro Research data posted on the Wall Street Journal’s Daily Shot.

That’s a lot of money, leaving a lot of cash sitting in savings accounts and looking for assets to buy. Perhaps some investors feel it’s better to invest it with a company that actually makes something or provides real services than, say, a cryptocurrency started as a joke. 

The more important question perhaps isn’t whether this is a bubble that will pop soon but rather what are the consequences of this era of free-flowing cash. It prevents the dissolution of businesses that perhaps shouldn’t exist, creating so-called zombie companies. And it leaves corporations leveraged to old economies, paying back debt incurred in a past era when they perhaps would rather invest in new technologies amid a quickly changing world.

This debt buildup makes central bankers’ jobs both more difficult and easier in the years to come. It makes it harder because any withdrawal of stimulus, or raising of rates, would be exponentially more painful given the amount of corporate leverage. But it also makes it less likely that conditions will require Federal Reserve officials to raise rates all that much going forward. More debt will pressure longer-term growth and inflation. It reduces economic dynamism. 

We are essentially skipping the clean-up phase during a down-cycle. A normal recession leads to the liquidation and closure of businesses, thus opening up opportunities for the healthy ones to benefit from their better business models and healthier balance sheets. It also is going to make higher rates even more painful, so we may have just delayed the inevitable in some cases.

Worst Boss Ever

An investigation of producer Scott Rudin by the New York Times showed what a brutal boss he was to his employees. Scott is one of only 16 people who have won an EGOT, which is winning at least one Emmy, Grammy, Oscar, and Tony.

Former employees said he threw things at walls, at windows, at the ground, and, occasionally, toward subordinates.

In 2018 he sent a glass bowl airborne, shattering it against a conference room wall, according to several people who were there; another time he smashed a computer on an employee’s hand, several ex-employees said. A former assistant, Jonathan Bogush, said he saw Mr. Rudin hurl a plateful of chicken salad into another assistant’s face when he worked there in 2003.

Sometimes frightened assistants hid in the kitchen or a closet to escape his wrath.

Some assistants kept spare phones to replace those that got destroyed when thrown by Mr. Rudin. There were also extra laptops — to replace those he broke — and his contact list was backed up to a master computer nicknamed the Dragon.

His behavior prompted outrage after it was described earlier this month in The Hollywood Reporter. It had also been described, to less effect, in multiple other accounts over the years.

Mr. Rudin offered both an apology and a bit of pushback to the stories being told about him as a boss. “While I believe some of the stories that have been made public recently are not accurate, I am aware of how inappropriate certain of my behaviors have been and the effects of those behaviors on other people,” he said. “I am not proud of these actions.”

“He’s had a bad temper,” said the billionaire David Geffen, who alongside his fellow mogul Barry Diller has been co-producing Mr. Rudin’s recent Broadway shows, “and he clearly needs to do anger management or something like that.”

Somehow this behavior went on for years, and no other executive, colleague, financier mandated anger-management training? Fortunately, Mr. Rudin is finally getting his long overdue comeuppance.

The BAN Report 3/11/21

The BAN Report: Stimulus Bill Passes / PPP Update / Cash-Out Refinance Boom / $4 Gas This Summer? / RIP GE Capital-3/11/21

Stimulus Bill Passes

President Biden is expected to sign into a law Friday another $1.9 trillion in stimulus. The final package is a boon for American businesses, who will benefit from stimulating the consumer while the economy is re-opening and will not be forced to raise wages.

The legislation, expected to be signed into law by President Biden on Friday, includes $1,400 checks to many Americans and an extension of a $300 weekly unemployment-aid supplement. It doesn’t include a proposed increase in the minimum wage to $15 over four years, meaning retailers, restaurants and others don’t have to worry about higher payrolls for now.

Executives and economists said that unlike the last round of stimulus payments, which came in the midst of lockdowns and heightened economic uncertainty, these checks are more likely to flow into the economy as families face fewer financial constraints, more people are vaccinated and restrictions on travel, dining and other activity are lifted.

The Business Roundtable, which counts the chief executive officers of dozens of the biggest U.S. companies as members, said Wednesday, “While we advocated for a more targeted approach, enactment of this package will help deliver urgent resources to strengthen the public health response and provide assistance for individuals and small businesses hardest hit by the pandemic.”

The U.S. Chamber of Commerce also said it would have preferred a narrower bill. Economic data already points to building strength, the Chamber said in a statement last week, while the current bill “means less money for other priorities, including infrastructure and education.”

The $1.9 trillion package includes $360 billion in aid to state and local governments, $410 billion for $1,400 stimulus checks, $123 billion for COVID-19 (mostly vaccine and testing), $246 billion in expanded unemployment with another $300 / week through September 6, $143 billion in expanded tax credits, $176 billion for education, and $59 billion for small businesses, including $25 billion in grants to restaurants and bars that lost revenue during the pandemic. 

The $25 billion Restaurant Revitalization Fund, administered by the SBA, will be of high interest by banks and lenders. A presentation from the National Restaurant Association had some great details. 

A restaurant may receive a grant equal to the amount of its Pandemic-Related Revenue Loss by subtracting its 2020 gross receipts from its 2019 gross receipts.

Any PPP loans will be deducted from the grants. So, a business that was down 50% in revenue from 2020 ($600K in revenue versus $1.2MM in 2019) would be eligible for $400K in grants, assuming they received $200K in PPP loans.  

With GDP projected at nearly 10% for the first quarter, the risk is we end up with an overheated economy, thus forcing the Fed to put the brakes on the economy later this year.   

“It’s unprecedented,” Oxford Economics chief U.S. economist Gregory Daco said of the fiscal response to the pandemic. He expects the latest legislation to add 3 percentage points to U.S. GDP growth this year, and between 3 million and 3.5 million jobs.

At least in the short-run, the economy looks like its heading into a period of unprecedented growth.  

PPP Update

With the PPP program ending at the end of the month, lenders are having difficulty adapting to the President Biden’s recent overhaul two weeks ago.

President Biden announced an abrupt overhaul two weeks ago to funnel more money to very small companies, some of which qualified for loans as small as $1 under the old guidelines. But the Small Business Administration updated its systems only on Friday, and with just three weeks before the program is set to expire, some lenders say there just isn’t enough time to adapt to the changes.

The result has been gridlock and uncertainty that have left tens of thousands of self-employed people frantic to find lenders willing to issue the more generous loans before the program ends on March 31.

JPMorgan Chase, the program’s largest lender this year in terms of dollars disbursed, doesn’t plan to act on the new loan formula before it stops accepting applications on March 19. Bank of America, the second-biggest lender, opted against updating its loan application and said it would contact self-employed applicants to manually sort out their applications — but stopped accepting new ones on Tuesday.

“We have 30,000 applications in process and want to allow enough time to complete the work and get each client’s application through the S.B.A. process,” said Bill Halldin, a Bank of America spokesman.

The two-week exclusivity period for borrowers with less than 20 employees expired on Tuesday. The new rules make it easier for independent contractors to qualify for larger loans. Even though the SBA did increase the fees to make smaller loans, banks have difficulty originating and processing these smaller loans, especially under a short time window. Banks are pushing to extend the deadline.

Banks and other businesses are pressing the Biden administration and Congress to keep the government’s largest small business aid program running beyond its March 31 expiration date, warning that struggling employers need more time to obtain the economic lifeline.

“They don’t have any answers,” Consumer Bankers Association general counsel David Pommerehn said. “They’re preparing for the worst-case scenario, and that is the program shuts down completely on March 31 at 11:59.”

The uncertainty marks the latest drama around the massive Covid-19 relief program, which has provided nearly 7.6 million loans to employers since its creation in March 2020. The loans are popular because they can be forgiven if employers agree to keep paying employees. But since its inception, PPP has been a roller coaster for borrowers and lenders alike because of ever-changing rules and shifting deadlines.

Even though demand for PPP loans has been more muted, it does seem sensible to allow lenders to finish meeting the demand, especially after some new rules were established just a week ago.  

Cash-Out Refinance Boom

American consumers extracted more home equity via cash-out refinances in 2020 than any year since the financial crisis. 

U.S. homeowners cashed out $152.7 billion in home equity last year, a 42% increase from 2019 and the most since 2007, according to mortgage-finance giant Freddie Mac. It was a blockbuster year for mortgage originations in general as well: Lenders churned out more mortgages than ever in 2020, fueled by about $2.8 trillion in refis, according to mortgage-data firm Black Knight Inc.

Some borrowers viewed cash-out refis as a way to cushion themselves against an uncertain economy last year. Others wanted to build and redecorate, and being stuck at home gave them the time to do the paperwork. Homeowners also had more equity available to tap: Though home prices tend to fall during economic downturns, they jumped during the Covid-19 recession.

“The support coming from home equity is unparalleled in helping smooth out the degradations from Covid,” said Susan Wachter, an economist and professor at the University of Pennsylvania. “For those who are in the position to refinance, it’s a major source of support.”

The median credit score of new refis last year approached 800, near the top of the scoring range, according to the Federal Reserve Bank of New York. That includes refis in which the borrower didn’t take cash out.

Todd Kennedy lowered the mortgage interest rate on his North Texas home by almost a percentage point when he refinanced late last year. Mr. Kennedy, who has a credit score around 780, also cashed out about $30,000 in equity to pay for home improvements including repairs to his home’s foundation and new flooring.

So, how worried should we be about this? We believe this is a modest risk.   For one thing, most of these are cash-out long-term fixed rate loans, which are typically sold to one of the GSEs.    HELOC volume has been modest, as most banks have not regained their appetite for HELOCs since the financial crisis.

As of the most recent Quarterly Banking Profile, total HELOCs on banks’ balance sheets stood at $300 billion. At the end of 2015, HELOC balances stood at $465 billion. At the end of 2018, they stood at $667 billion. So, rather than taking out HELOCs and using the loans when they need them, consumers are getting larger lump-sum payments. Perhaps, banks should be doing more HELOCs, so that consumers would only pay interest when they need the money.  

$4 Gas This Summer?

Oil and gas producers, humbled by 2020 and their lenders, are being cautious in their drilling efforts, which could lead to much higher oil prices later this year.

The oil industry is predictably cyclical: When oil prices climb, producers race to drill — until the world is swimming in petroleum and prices fall. Then, energy companies that overextended themselves tumble into bankruptcy.

That wash-rinse-repeat cycle has played out repeatedly over the last century, three times in the last 14 years alone. But, at least for the moment, oil and gas companies are not following those old stage directions.

An accelerating rollout of vaccines in the United States is expected to turbocharge the American economy this spring and summer, encouraging people to travel, shop and commute. In addition, President Biden’s coronavirus relief package will put more money in the pockets of consumers, especially those who are still out of work.

Even before Congress approved that legislation, oil and gasoline prices were rebounding after last year’s collapse in fuel demand and prices. Gas prices have risen about 35 cents a gallon on average over the last month, according to the AAA motor club, and could reach $4 a gallon in some states by summer. While overall inflation remains subdued, some economists are worried that prices, especially for fuel, could rise faster this year than they have in some time. That would hurt working-class families more because they tend to drive older, less efficient vehicles and spend a higher share of their income on fuel.

In recent weeks oil prices have surged to over $65 a barrel, a level that would have seemed impossible only a year ago, when some traders were forced to pay buyers to take oil off their hands. Oil prices fell by more than $50 a barrel in a single day last April, to less than zero.

That bizarre day seems to have become seared into the memories of oil executives. The industry was forced to idle hundreds of rigs and throttle many wells shut, some for good. Roughly 120,000 American oil and gas workers lost their jobs over the last year or so, and companies are expected to lay off 10,000 workers this year, according to Rystad Energy, a consulting firm.

The events of last April were so extraordinary that it will take a while before oil producers regain their mojo. In the meantime, higher oil prices seem inevitable. 

RIP GE Capital

At its peak GE Capital stood at 637 billion in assets, nearly $100 billion larger than say US Bank today and twice as large as Washington Mutual when it failed in 2008. With its latest deal, in which GE is ultimately divesting out of the aircraft leasing business, GE Capital will no longer be a stand-alone division within GE, as it will only have $21 billion in assets remaining, largely a headache legacy insurance unit with some toxic long-term-care policies.

On Wednesday, GE agreed to combine its jet-leasing unit, GE Capital Aviation Services, with rival AerCap Holdings NV in a deal worth more than $30 billion. It will create a leasing giant with more than 2,000 aircraft at a time when global travel has been hobbled by the Covid-19 pandemic. The Wall Street Journal reported Sunday that the two companies were near a deal.

GE will get about $24 billion in cash and 46% ownership in the new merged company, a stake it valued at about $6 billion. It will transfer about $34 billion in net assets to AerCap along with more than 400 workers. The deal is expected to close in nine to 12 months.

Mr. Culp will use the proceeds from the AerCap deal to pay down debts and fold the rest of GE Capital into the company’s corporate operations. GE will take a $3 billion charge in the first quarter and cease to report GE Capital as a stand-alone business segment. The company maintained its financial forecasts for 2021.

“This really does mark the transformation of GE into a more focused, simpler, stronger company,” Mr. Culp said in an interview. GE will essentially return to being a manufacturer of power turbines, jet engines, wind turbines and hospital equipment.

The jet-leasing Gecas unit was the biggest remaining piece of GE Capital, accounting for more than half of the unit’s $7.25 billion of revenue in 2020. The remainder is a legacy insurance business that has plagued the company and a small equipment-leasing operation that helps finance purchases of GE power turbines and wind turbines.

The dismantling of GE Capital is one of the biggest casualties of the financial crisis. While other non-bank lenders like CIT pivoted successfully to become part of depository institutions, GE Capital was dismantled in parts, often by selling the best assets and keeping the toughest assets, including the long-term care policies, which have already required over $20 billion in additional reserves. No one should read former CEO Jeff Immelt’s book, who at least blamed mostly himself for GE’s demise.   

Another misstep came in 2004, when GE spun off its Genworth insurance business but kept a large batch of money-losing policies, forcing GE in 2018 to take a $6.2 billion charge and set aside $15 billion in reserves.

Immelt said he saw “zero” fraud in the insurance business when he was there. “There’s a difference between being wrong and being wrong on purpose.” He added that GE “spent lots of time to make sure we got things right.”

To put it simply, Jack Welch chose the wrong CEO, hiring someone who didn’t understand GE Capital, which could have been successfully re-positioned and de-risked by the right leader. It’s ironic that Welch chose the tall marketing guy who crushed PowerPoint presentations, instead of the two other grittier candidates. Beware sometimes of the person that looks the part!

The BAN Report 2/11/21

The BAN Report: PPP Update / Loan Growth? / Remote for Much of 2021? / Remote Boomtown / The Peloton Story / The 9MM Brooklyn Multi-Family Relationship-2/11/21

PPP Update

Through Sunday, about $101 billion in PPP loans have been approved for PPP Round 2. The SBA’s presentation had a few noteworthy highlights:

A hurdle so far for lenders has been error codes, which prevent banks from processing PPP loans. These error codes have been the result of efforts to root out some of the fraudulent loans originated last year.

The Small Business Administration has announced a series of steps to address a nagging problem with error codes that Paycheck Protection Program lenders claim are needlessly delaying the approval of thousands of loans.

In perhaps its biggest step to remedy an issue that has dogged the program for weeks, the SBA said on Wednesday that it would permit lenders to certify borrowers whose loans are impacted by validation errors to hasten their receipt of funds.

The agency also said it would allow lenders to upload supporting documents for loans hit by the error messages.

Relief can’t come soon enough for many PPP lenders.

Error codes emerged as a leading bone of contention for shortly after lending resumed on Jan. 12. In the weeks immediately following the program’s relaunch, the codes interrupted the processing of as many as 30% of the loans submitted for approval.

Attached is the new SBA procedural notice to address the issues with error codes.

Loan Growth?

2020 was a bad year for loan growth at banks, as loan growth shrank for the first time in a decade and just the second decline in 28 years.

Large U.S. lenders saw their loan books shrink in 2020 for the first time in more than a decade, according to an analysis of Federal Reserve data by Jason Goldberg, a banking analyst at Barclays. The 0.5% drop was just the second decline in 28 years.

Bank of America Corp.’s loans and leases dropped by 5.7%. Citigroup Inc.’s loans dropped by 3.4% and Wells Fargo & Co.’s shrank by 7.8%. Among the biggest four banks, only JPMorgan Chase  & Co. had more loans at the end of the year than the start.

Lenders are flush with cash that they want to put to use, and executives say they are hopeful loan growth will pick up in 2021. Brisk lending typically suggests there is enough momentum in the economy to give companies and consumers the confidence to borrow. But the current weakness suggests questions remain about the vigor of the economic recovery.

For banks, this weighed on profit. Net interest income, the spread between what banks charge borrowers and pay depositors, fell 5% across the industry last year—a consequence of shrinking loan portfolios and near-zero interest rates. It was the biggest drop in more than 80 years of record-keeping, according to research by Mike Mayo, a banking analyst at Wells Fargo.

At the start of last year, it didn’t look like this would happen. When the pandemic first hit, big companies rushed to draw down credit lines from their banks, fearful they wouldn’t be able to raise money from investors in the bond market. The loans on bank balance sheets spiked.

Loan books would have shrunk more if not for government support for small businesses. Banks doled out hundreds of billions of dollars in loans through the Paycheck Protection Program. Those loans have stacked up on bank balance sheets, but are slowly being whittled away as the government forgives them.

For the regional and community banks, a disproportionate of loan growth came from PPP, much of which will have run off by the end of the year as these loans eventually get forgiven. Banks are flush with cash, but how do you prudently underwrite new loans in this environment when so many borrowers had choppy 2020s and would be struggling if it were not for unprecedented government intervention? The bond market seems to be picking up the slack.

The average yield on U.S. junk bonds dropped below 4% for the first time ever as investors seeking a haven from ultra-low interest rates keep piling into an asset class historically known for its high yields.

The measure for the Bloomberg Barclays U.S. Corporate High-Yield index dipped to 3.96% on Monday evening, making it six straight sessions of declines.

Yield-hungry investors have been gobbling up junk bonds as an alternative to the meager income offered in less-risky bond markets. Demand for the debt has outweighed supply by so much that some money managers are even calling companies to press them to borrow instead of waiting for deals to come their way. A majority of new issues, even those rated in the riskiest CCC tier of junk, have been hugely oversubscribed.

Banks are simply acting more prudently than their Wall Street brethren, who seem to be able to issue debt for any company, even those with the worst financial prospects. If AMC can issue debt despite as poor prospects as any public company, anyone can.   Chesapeake Energy, after emerging from bankruptcy recently, issued bonds this week at 5.875% with yields in the mid-4s with over $2 billion in orders before its $1 billion launch Tuesday. Perhaps, banks are better off accepting limited loan growth than chasing loan growth.

Remote for Much of 2021?

The long-delayed return to offices keeps getting pushed further back, and some are now seeing returns in the late summer / early fall.

From Silicon Valley to Tennessee to Pennsylvania, high hopes that a rapid vaccine rollout in early 2021 would send millions of workers back into offices by spring have been scuttled. Many companies are pushing workplace return dates to September—and beyond—or refusing to commit to specific dates, telling employees it will be a wait-and-see remote-work year.

The delays span industries. Qurate Retail Inc., the parent company of brands such as Ballard Designs, QVC and HSN, recently shifted its planned May return to offices in the Philadelphia area, Atlanta and other cities until September at the earliest. TechnologyAdvice, a marketing firm in Nashville, initially told employees to plan on Feb. 1 as their return date. The company then pushed the date back to August. Now, TA has decided it will begin a hybrid in-office schedule in the fall of 2021, letting workers choose whether to work remotely or come in, the company says.

Return-to-office dates have shifted so much in the past year that some companies aren’t sharing them with employees. Shipping giant United Parcel Service Inc., based in Atlanta, and financial-services firm Fidelity Investments Inc., based in Boston, haven’t announced return dates, instead telling workers signing on from home that the companies are monitoring the coronavirus pandemic and will call workers back when it is safe.

Nearly a year of makeshift work at home has weighed on employees, leaders say. While many companies say productivity is up, executives worry that creativity is suffering and say that burnout is on the rise. Even so, bosses struggle to say when things will change.

Current office-occupancy rates are highest in parts of the country where large school districts have reopened, according to data from Kastle Systems, a security firm that monitors access-card swipes in more than 2,500 office buildings, from skyscrapers to suburban office campuses.

Right now, that means Texas: In Dallas, Austin and Houston, major school districts have offered in-person learning for many months, and offices are roughly 35% full, according to Kastle. By comparison, in New York City, where schools are open part-time for in-person learning, office occupancy is less than 15%.

While we believe that some employees function well remotely, there are others it is bad for, especially young workers who are missing out in-person training and mentorship and management teams. Management teams usually function better when they see each other on a regular basis. But, visiting a downtown office building right now is like going to the airport, so many would rather work remotely until its both safe and convenient to go to the office.

Remote Boomtown

As working remote continues, many workers are fleeing to smaller cities with cheaper rents and outdoor amenities. Bozeman, Montana is one of them.

For the white-collar worker fleeing a pandemic-ravaged metropolis, Bozeman has a lot to offer. The Montana city of just under 50,000 is an hour’s drive from the award-winning Big Sky ski resort, and local businesses like the Rocking R Bar and Cactus Records radiate small-town charm. The one thing newcomers won’t be able to escape: big-city prices.

The average rent for a 2-bedroom apartment in Bozeman hit $2,050 a month in early February, a 58% surge from a year earlier, according to rental site Zumper. The cost of a home also jumped by almost 50%, fueled in part by an influx of office types who switched to remote work when cities locked down — and ultimately decided to relocate when it became clear they wouldn’t go back any time soon. “People who can afford it are buying housing sight unseen and driving the cost of housing up,” says Amanda Diehl, a Bozeman native who returned in 2018 and now runs Sky Oro, a women-focused coworking space.

For Bozeman residents, however, the frenzy has made their plight more acute. The cost of living is more than 20% higher than the national average, while the median income is  about 20% lower, limiting buying power in a market crowded with flush out-of-towners. More housing is coming: According to the city, a handful of new neighborhoods have recently broken ground and apartments are going up downtown. But locals are still getting squeezed out. 

“We have such low vacancy rates, that if they lose a rental, there’s literally no other place to go,” says Heather Grenier, who runs a local nonprofit focused on housing and poverty called the Human Resources Development Council. The Bozeman boom has fueled an “incredible increase” in the local homeless population, as well as a spate of pop-up RV communities for those who’ve been displaced, according to Grenier. “This work was challenging before, but feels impossible now.”

Of course, this is creating its own set of problems – a lack of affordable housing for one. Other places, like much of West Virginia, see an opportunity to capture from the remote trend.

The pandemic, for all its pain, has hastened a number of trends that could aid West Virginia. It has driven a shift toward telehealth, a vital tool in rural communities. It has pushed more consumers into outdoor recreation, a market West Virginia’s scenic gorges and mountain trails are primed to capture. It has boosted political will in the state to prioritize broadband. And the pandemic has sped up a move toward remote work to parts of the country with a more affordable cost of living.

This last trend, which is tied to the other three, could have broad consequences for how states think about economic development. If more workers can live anywhere, states don’t have to throw tax breaks at companies to attract them. They can try to attract workers directly.

“Making a place a good place to live becomes much more important now,” said Adam Ozimek, the chief economist at the freelance platform Upwork. “That’s also a much healthier type of competition than who’s going to give the Bass Pro outlet the biggest tax cut.”

Many people grow up in rural communities and are forced to leave to find good jobs in larger cities. If the remote work trend becomes a permanent phenomenon, it does open up the appeal of affordable places with good quality of life and abundant outdoor recreation. Due to Senator Manchin’s status as the key swing vote in a 50/50 Senate, states like West Virginia could see huge federal investments in broadband, which allows these communities to compete more effectively for remote workers.

The Peloton Story

Fortune had a great story on Peloton’s rapid ascent, as they interviewed four of their five cofounders. A key takeaway is just how difficult it can be to raise capital for a start-up.

Foley: This is important for the founder story. I had a vision and recruited these guys. Within a couple months, I was no longer involved in creating Peloton as you know it. I thought of something, and these guys took it, ran with it, and built it while I was gone. I was on the road for two or three years with a PowerPoint trying to raise money, very much ineffectively.

Cortese: The noes were all stupid. They would be things like, “Oh, well, this doesn’t fit our portfolio thesis.” Or, “No, we don’t like that you have a hardware component. We only think Facebook-style software is going to work.” It’s like, “Are you guys idiots?” Most of these pieces were things that existed in the world—the bike, video streaming. Our job was to bring them together. It’s not like we were inventing a stationary bike from scratch.

Let’s finish off with a lightning round. When was the moment you realized this thing was actually going to work?

Cortese: 2013, Black Friday. Me, John, and others were standing in the Short Hills mall [in N.J.], which was supposed to be a pop-up store. We had the first six bikes we ever made. The only six bikes we had ever made. We put them in that store just to get it open. We were standing there when, all of a sudden, people started coming in. By the end of the day, I think we sold four to six bikes. We went out and celebrated like it was a million bikes. I remember thinking like, “Holy shit, people get it. We’ve got a business.”

Angela Duckworth wrote a great book called Grit, which I highly recommend, which talks about how grit, not talent, determines who succeeds and fails.    The Peloton founders had grit, and plowed on after several years of rejection and now are growing at an exponential rate since the pandemic.

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CEO Jon Winick in American Banker-4/9/20

What does the $600B middlemarket rescue plan mean for banks?

By Jon Prior, Allissa Kline April 09, 2020, 9:00 p.m. EDT

Bankers spent much of Thursday trying to unravel details of the central bank’s new loan-purchase program aimed at helping middle-market businesses survive the economic shock from the coronavirus pandemic.

As part of its broader effort to step up economic relief, the Federal Reserve pledged to facilitate $600 billion in loans to midsize businesses under the Main Street Lending Program. The move spotlighted a sector of the economy that has gotten less attention than small businesses’ struggles to obtain much-needed aid.

“These midsize businesses are having the same issues that the small businesses are having because of the government-mandated shutdowns,” said John Corbett, CEO of the $17.1 billion-asset CenterState Bank in Winter Haven, Fla. “Their revenues have fallen off a cliff.”

Corbett, who attended a call with other executives hosted by the Federal Reserve Bank of Atlanta while the program was under development, said banks with assets between $10 billion and $250 billion were likely to be the main participants in the Main Street program.

Specifically, the Fed is creating two special purpose vehicles funded by an investment from the Treasury Department under the authority of the Coronavirus Aid, Relief, and Economic Security Act that was enacted in March. Through these facilities, the Fed will guarantee 95% of expanded loans or entirely new loans to midsize businesses; borrowers won’t have to start paying them back for one year.

Existing loans can be increased by up to $150 million in some cases under the Fed’s “Main Street Expanded Loan Facility.” Fresh financing provided under the “Main Street New Loan Facility” will be capped at $25 million. Limits would be adjusted so that no business taking out these loans would exceed a total outstanding debt of four times earnings before interest, tax, depreciation and amortization, according to the Fed’s term sheets.

Businesses that have up to 10,000 employees or as much $2.5 billion in 2019 annual revenues may qualify. The loans carry up to four-year terms .

Fed officials told reporters Thursday they expect demand will come in under what they are offering and that they believe their Main Street lending facilities are appropriately sized.

Corbett at CenterState said banks did not anticipate the kind of “stampede” from middle-market businesses that they have seen from smaller ones partly because some of these bigger businesses want to avoid restrictions on stock dividends, executive compensation or other strings attached by the Fed.

“The real question is, are borrowers going to be willing to have the government involved in those kinds capital allocation and compensation issues?” Corbett said.

Jon Winick, CEO of Clark Street Capital, a bank advisory firm in Chicago that specializes in loan sales, loan due diligence and valuation and specialty asset management, said he has “so many questions” about the program, especially around the idea that the Fed is going to take on credit risk. Fed officials generally avoid that but “now they’re setting up a program with substantial credit risk,” Winick said. “We are not clear yet what the intent is for these loans and their creditworthiness. The term sheet mentions 2019 EBITDA, but is it the intent here to make loans that don’t have current cash flow?”

“If that’s the case, then these are essentially projection loans,” he said.

Several banks contacted for this story either did not respond to requests for comment or said they are still trying to figure out what it all means.

Tom Iadanza, chief banking officer at Valley National Bancorp in Wayne, N.J., said the $37.4 billionasset bank “continues to review all federal and state programs.”

The bank, which has already been involved with the lending program for smaller businesses, will keep its local business leaders and consumers informed of “other federal and state programs and assess [those programs] on their merits” so that businesses of all sizes get the relief they need, Iadanza said in an email.

The American Bankers Association and the New York Bankers Association both said they, too, are trying to get their arms around the Fed’s announcements. Taken together with expanded efforts to boost financing for municipalities, new securities under the Term Asset-Backed Securities Loan Facility and the Small Business Administration’s Paycheck Protection Program, the central bank is providing up to $2.3 trillion in financing. Barclays Capital researchers said in a note Thursday that the Fed has turned its support of the financial markets to “11.”

ABA President and CEO Rob Nichols said in a statement that the Fed’s move Thursday was “unprecedented” and that he had “no doubt” banks would step up to play a critical role in the program for midsize businesses.

Winick said he expects the Fed will have to provide more clarity to banks in coming days.

“The No. 1 question here for bankers is under what circumstances is my participation in jeopardy?” Winick said. “What do I have to do as a lender to make absolutely certain that I don’t have any recourse on the 95% originated and sold?”

The launch of the program for more businesses comes as the prospects of a quick recovery from the shutdown are dimming. Meanwhile, the U.S. has seen 10% of workers lose their jobs in the last three weeks, according to Labor Department data released Thursday.

A survey of corporate treasurers conducted for the week ending April 8 by the Treasury Coalition, an industry group, showed that businesses do not expect to get back to normal financially for another eight months after suggesting the week before they could recover in seven months.

“Still, respondents see a light at the end of the tunnel as central bank efforts are viewed positively and as health issues associated with COVID-19 are expected to begin to improve in the coming months,” said Michele Marvin, Global vice president of GTreasury, a technology company that is involved with the coalition.

There were 427,460 confirmed and presumptive COVID-19 cases in the U.S. as of Thursday and 14,696 deaths linked to the disease, according to the Centers for Disease Control and Prevention. However, there are signs the rate of the virus’ spread is flattening in hard-hit areas like New York.

Joseph Lynyak III, a partner at the law firm Dorsey & Whitney, said in a statement that the Fed has begun to “look down the road” with the announcement of these programs to jump-start these businesses.

“The intention is twofold: First, the facilities will provide necessary liquidity to banks to extend the credit,” Lynyak said. “More importantly, however, the facilities will effectively function as working capital loans for businesses as the nation emerges from the COVID-19 emergency.”

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