On COVID-19
The world economy is in the midst of a severe recession, as huge segments of the global economy are shutdown. According to Bank of America today, US GDP will collapse in the second quarter, falling by 12%, which represents the biggest quarterly decline since World War II. The US unemployment rate will double, especially in hard-hit industries like aviation, hospitality, restaurants, and the cruise industry.
We must admit that we were a tad slow to realize the severity of the virus, believing that many were overreacting and succumbing to a collective panic. Time will tell if we overreacted or underreacted, but the impact on the economy cannot be overstated.
The good news is we have the benefit of learning from the experiences of China. Essentially, China began a lockdown in late January. This week, China announced that there were no new cases originating from mainland China and the virus is essentially in retreat. So, roughly 60 days from lockdown to seeing the light at the end of the tunnel. Of course, China has some advantages in its political system as democracy is not the best form of government in a public health crisis.
If the US is on a similar trajectory, we will begin to reach our peak around mid-May or so. Dr. Anthony Fauci of the NIAID said 45 days was reasonable for the US earlier this week. We concur. Moreover, we think there will be some pressure in April for Americans to get out of their homes and restart their lives. If the testing fiasco is solved by then, perhaps some things can begin to return to normal. For example, restaurants could serve at half prior capacities. Nevertheless, we will be in a full-blown crisis well into May and no one should do anything that contradicts the recommendations of the public health authorities.
While it is difficult to completely avoid this crisis, there are going to continue to be differences between highly impacted areas and others. California, New York, Washington, and Florida appear to be different than other areas. It’s unclear if say Chicago becomes like New York. Some areas may not see much impact at all. But this crisis will only get worse for the next 45 days or so and expect continued spikes in cases.
Clark Street Capital is open for business and we are still going to the office but taking significant precautions. We have canceled all trips for the next 6 weeks. We had a series of closing dinners scheduled for next week, but all were canceled. One was in a small town in Wisconsin, but Wisconsin closed all bars and restaurants this week. We look forward to hitting the road when things began to calm down. Fortunately, we’ve are completing perhaps our most successful quarter in our history.
This represents a massive experiment in working from home. We will learn a lot about how workers function working remotely. Anecdotally, many are telling me they are highly productive. Others are likely to be too distracted by living in a crowded house. On a lighter note, a common question is whether quarantining will lead to either more divorces or more pregnancies. A friend asked me, and I replied more pregnancies, and he said I was the only one who chose the latter!
The silver lining here is this will be a severe, but short recession. There will be a massive coiled spring ready to be unleashed this summer. Consumers will enjoy 0% interest rates and gas prices close to $1 / gallon. While there will be an increase in bankruptcies, we think the panic predictions are overstated, as lenders will act rationally here, preferring to wait this out before taking drastic actions.
Our advice to you all is to hang tight, hunker down, wash your hands, stay at home, and keep your chin up!
Person on the Street
This week, we have had a number of conversations with market participants about how their institutions are handling the crisis. Here is what a few are saying as we tried to paraphrase their views.
Kentucky Bank President
This week, we closed all our branches to only drive-up locations. Bars and restaurants closed this week. We are worried about our hospitality exposure.
One area of interest is the use of lines of credit. Fortunately, we don’t have many large C&I customers that may draw down their lines of credit, but we are monitoring our HELOC borrowers to see if they are drawing down their credit lines.
Almost everyone is working from home. I’ve enjoyed the productivity of far less interruptions so far.
Bank President w/ Hotel Concentration
We met in DC this week with the Trump Administration to discuss assistance for the hospitality industry. The occupancy rates have plummeted. In larger markets, you are seeing 10-20% occupancy and 30-50% in small towns. Some hotels are contemplating shutting down for the time being.
All new hotel projects are on hold as we see how this plays out.
Distressed Debt Investor
We are anticipating that every restaurant & retailer is going to skip their April lease or loan payments. We are still bidding on new deals, but we are a bit more cautious. Having said that, there has been increased interest from sellers.
Locally, some banks are lowering interest rates to 0% upon request. Our downtown is pretty much shut down.
Other banks are saying they are getting calls left and right from borrowers that can’t meet payroll. One bank advised the borrower to make the payroll, but not the mortgage payment. Workout officers at banks are hard to reach as they are dealing with multiple fire drills.
Chicago Bank CCO
Our management team has always been pretty spread out anyway, so working remotely is not too painful. Our lobbies are closed, and drive-throughs are open. Our traffic is way down as are our phone calls.
We are going through an FDIC exam now, and they are asking 20 banks including us to provide daily updates on what we are seeing in the marketplace. We’ve gotten about a dozen calls from borrowers looking for relief. Hotels are seeing stress as occupancy rates have evaporated almost overnight. Extended stay hospitality is doing a big better, but still bad. Some of our Dunkin Donuts franchises saw dramatic drop-offs of sales over the weekend.
We are waiting on some guidance from the FDIC on TDRs. We would like to move quickly, but we want to see if we will get some relief from classifying minor concession as TDRs.
As such, the FDIC encourages financial institutions to work with all borrowers, especially borrowers from industry sectors particularly vulnerable to the volatility in the current economic environment, such as, but not limited to, airlines; energy companies; travel, tourism, and shipping industries; and small businesses and independent contractors that are reliant on affected industries. In addition, the FDIC encourages financial institutions to actively work with small businesses that have less financial flexibility to weather the near-term operational challenges, such as retail, restaurants, and local entertainment businesses, as well as hourly workers and independent contractors.
Bank Investment Banker
The CEOs that I’m speaking to for the past week or so have been very focused internally. They are looking after the welfare of their employees and dealing with closing or suspending service at branches.
These sorts of crisis have a tendency to pick winners and losers and make sure that we are ready for some good ideas for the winners on the other side of it.
Bank M&A is “dead as a doornail.” Stuff that is in the works, we are focusing on making sure it closes. Focusing on pitching in 60-90 days.
Overall, some good feedback from market participants.
Lenders Respond to Distressed Consumers
Lenders have yet to report a spike in missed payments, but the impact could be considerable. If borrowers start defaulting, they could lose homes and cars. In the longer term, those delinquencies could get factored into their credit reports, hurting their ability to borrow for many years.
Some lenders already have announced programs meant to help. Citigroup, for example, is increasing spending limits for certain cardholders on a case-by-case basis, including those with rising out-of-pocket medical expenses. JPMorgan Chase is delaying due dates for some borrowers on cards, auto loans and mortgages. Goldman Sachs Group Inc. is allowing borrowers who have personal loans from its consumer bank, Marcus, to sign up to delay their payments for a month.
Lenders and credit-reporting firms are still reviewing what they might do for consumers. Some think relief should be offered to all borrowers, or all who ask for it. Another option, requiring people to prove they were directly affected by the coronavirus, could be impractical given the virus’s far-reaching economic effects. That also would become logistically harder if companies have to move customer-service representatives from call centers to work from home.
Lawmakers and others have asked the main U.S. credit-reporting firms, Equifax Inc., Experian PLC and TransUnion what they can do to limit the damage to consumers’ credit standing if they miss loan payments. Representatives from the White House National Economic Council have been in touch with credit-reporting firms, according to people familiar with the matter.
HUD, Fannie, and Freddie this week announced that they are suspending foreclosures for 60 days. Lenders are deciding now whether they wait for the phone to ring or take pre-emptive steps.
Boeing on the Brink
On Tuesday evening, the company said it was in favor of an enormous government support package for airplane manufacturers like itself.
“Boeing supports a minimum of $60 billion in access to public and private liquidity, including loan guarantees, for the aerospace manufacturing industry,” Boeing said in a statement. “This will be one of the most important ways for airlines, airports, suppliers and manufacturers to bridge to recovery.”
Boeing was already coming off the worst year in its history because of the grounding of its 737 Max plane after two crashes left 346 people dead. Now the coronavirus is posing daunting new challenges. Airlines, faced with a precipitous drop in travelers, will not be ordering new planes for a long time and are refusing to take delivery of the ones they have already bought. Boeing cannot deliver jets to Europe or China. Supply-chain disruptions and social distancing measures may force it to shut down factories.
Boeing executives are trying to determine what to do if shelter-in-place orders, school closings or the virus itself makes it impossible to manufacture planes, said a person briefed on the deliberations, who spoke on the condition of anonymity to discuss internal matters.
In recent days, senior Boeing executives have made it clear to the White House and Congress that if the aerospace giant does not receive government assistance, it could decline rapidly, causing significant damage to the American economy.
Our view is there are multiple considerations when evaluating potential bailouts or relief for impacted industries. First off, is there a public interest in keeping these industries in business? And, does that require government assistance? After all, if the bond holders take control of say an airline and it stays in business under new ownership, doesn’t that preserve moral hazard while keeping the jobs and benefits?
Senator Elizabeth Warren did take a stab at conditions for bailouts. Many of these make logical sense. Here is what she suggested:
- Companies must maintain payrolls and use federal funds to keep people working.
- Businesses must provide $15 an hour minimum wage quickly but no later than a year from the end
- Companies would be permanently banned from engaging in stock buybacks.
- Companies would be barred from paying out dividends or executive bonuses while they receive federal funds and the ban would be in place for three years.
- Businesses would have to provide at least one seat to workers on their board of directors, though it could be more depending on size of the rescue package.
- Collective bargaining agreements must remain in place.
- Corporate boards must get shareholder approval for all political spending.
- CEOs must certify their companies are complying with the rules and face criminal penalties for violating them.
Our view is that Washington should consider all bailout requests with a high degree of skepticism and should favor solutions that are a good deal for the taxpayer, such as TARP. Companies like Southwest Airlines, for example, have been profitable for 46 years in a row, while nearly all their competitors have been in and out of bankruptcy court. Why should their spendthrift competitors be rewarded for share buybacks? Moreover, an analysis by Bloomberg showed that the major airlines used 96% of their spare cash buying back their own shares.
Perhaps, the airlines cannot be trusted to manage their balance sheets, and a bailout should entail setting up an FDIC-like entity funded by the industry so that future crises do not require further government assistance.
Anyway, prepare for Washington to debate bailouts for Boeing, the airline industry, the hospitality and gaming industries, and the cruise industry over the next few weeks.
