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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!

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