Paycheck Protection Program
All lenders, businesses, and their advisers are eagerly waiting for more info on the Paycheck Protection Program, a program that allows eligible businesses to receive 8 weeks of loan forgiveness for payroll and other expenses. The Treasury has stated that people can begin applying as soon as tomorrow, but there are a number of unanswered questions, and potential roadblocks. Chris Hurn, CEO of Fountainhead, was intimately involved in both the drafting of the legislation, as well as some of the rule making and we’ve asked him to give us his thoughts on where the program stands.
What’s the latest on the program and what are the key obstacles?
The latest is everyone is waiting for SBA to issue the final rules and regs, which we’ve been told will be tomorrow. The legislation was vague in some areas and conflicting in others. To some extent, a lot of what we are waiting for will be the verification requirements from the lender and closing requirements. And SBA processing requirements. We know that the maximum loan size is going to be 2.5x payroll, but we have not have been told how you would verify payroll.
In my opinion, they made a huge strategic mistake when they arbitrarily came out on Tuesday lowering the interest rate of 4% as a max to 0.5%. That completely wiped out any potential participation on buying this paper from anybody but the federal government directly. Unless there is a mechanism built at Treasury to buy these loans immediately, this program is dead on arrival. Who would make these loans as presently structured?
There is no collateral, no personal guarantees. ½ percentage rate. The first six months is completely deferred. Most of these loans are going to be forgiven in full between months 4 and 9. Moreover, they’re not underwritten, but processed. Why would a lender want to keep this loan on their balance sheet? The name of the game is for a lender who participates to be able to flush these funds over to Treasury, recycle the capital, and go make more loans to help more business owners. Period. No one that I’m aware of has been working about this last piece – creating a mechanism to recycle the funds immediately. I’ve been pounding the table about it for a week with folks in Washington and beyond. Alternatively, if they would allow us to make loans at the maximum of 4%, and then I think there could have been some non-government participants interested in purchasing these guaranteed loans.
Who is eligible that wouldn’t normally be eligible for an SBA 7(a) loan?
A ton of businesses, like businesses that exceed the net income threshold ($5MM average net income for the preceding two years). Certain non-for-profits are eligible. No gross revenue thresholds to consider. If you’re in certain select industries, you can have multiple locations of up to 500 employees and still be eligible for these loans. The fact that you can have a $10MM loan is double the normal SBA 7(a) loan.
The main restriction is whether you have 500 employees or less. But, for certain select industries like restaurants, restaurant supplies, franchises on the SBA directory, hospitality, and portfolio companies of SBIC firms, you could get multiple $10MM loans if you have multiple locations with less than 500 employees for your payroll at these locations.
Doesn’t that mean we run out of money?
I think there is a very real possibility we will be out of money by the end of May.
Thank you, Chris for your insight! The SBA did provide an application form earlier this week, and many originators, even those who won’t be able to process these loans have been sending out their own application forms.
Jobless Claims Soar
More than 6.6 million people filed new claims for unemployment benefits last week, the Labor Department said Thursday, setting a grim record for the second straight week.
The latest claims brought the two-week total to nearly 10 million.
The speed and scale of the job losses is without precedent. Until last month, the worst week for unemployment filings was 695,000 in 1982.
“What usually takes months or quarters to happen in a recession is happening in a matter of weeks,” said Michelle Meyer, chief U.S. economist for Bank of America Merrill Lynch.
The economic damage from the pandemic was initially concentrated in tourism, hospitality and related industries. But now the pain is spreading much more widely. The Institute for Supply Management said Wednesday that the manufacturing sector, which had recently begun to recover from last year’s trade war, was contracting again. Data from the employment site ZipRecruiter shows a steep drop in job postings even in industries usually insulated from recessions, like education and health care.
Law firms, technology start-ups and other white-collar employers that were initially able to keep workers on payroll and let them work from home are now laying people off as revenue dries up.
The skyrocketing unemployment figures are deeply troubling and worrisome. Already there is chatter on a fourth spending bill to combat this awful situation. We think the Payment Protection Program will help, but does it make sense for companies to pay employees when there is no work for them to do? April is going to be just a terrible month, but perhaps May will bring more hope if it looks like we’ve gotten COVID-19 under control.
Force Majeure
April is predicted to be perhaps the worst month in lending history for borrowers of all kinds to make their monthly payments. Additionally, other monthly obligations like rent, are in jeopardy as well. The extent of the pain will often depend on how well the parties involve cooperate during this difficult time. If a CRE borrower gets loan payment relief from its lender, then she can forbear collecting rents from her tenants, who then have a greater ability to pay their employees.
“Generally, a force majeure event is an event that is beyond the affected party’s reasonable control, and could not have been foreseen, or, if the event could have been foreseen, is an event that was unavoidable,” say Alexandro Padrés and Alyssa Cowley, partner and associate, respectively, in the Project Development & Finance practice from Shearman and Sterling in an email.
Specific force majeure events have to be explicitly mentioned in the contract, for the clause to be invoked. That creates a gray area for pandemics, epidemics, and quarantines, which are less commonly included. Some mention them explicitly—like the NBA bargaining agreement—but this is largely new territory. If it’s not in the contract, though, the court may choose to judge the case using local jurisdiction or common law.
Major retail and restaurant chains, including Mattress Firm and Subway, are telling landlords they will withhold or slash rent in the coming months after closing stores to slow the coronavirus, according to people familiar with the situation.
“The court system is just going to get flooded with a million of these disputes between tenants and landlords,” said Vince Tibone, an analyst at Green Street Advisors. “If the government doesn’t step in in any form or fashion, it could get ugly. They need to respond quickly.”
We have heard other large national retailers are invoking force majeure, including Dick’s Sporting Goods, and Urban Outfitters. Most commercial property owners have heard from the vast majority of their tenants, but they need cooperation from their lenders to do such. It’s our view that these issues need to be addressed soon by governments, as protracted litigation when courts are largely closed doesn’t serve as well. Of course, tenants can always get out of leases ultimately through a bankruptcy process.
Fed Eases Capital Standards
The Fed said it would exclude for one-year Treasurys and deposits held at the central bank from banks’ supplementary leverage ratio calculation. The ratio measures capital—funds that banks raise from investors, earn through profits and use to absorb losses—as a percentage of loans and other assets.
Big U.S. banks must maintain capital equal to at least 3% of all of their assets, including loans, investments and real estate. By holding banks to a minimum ratio, regulators effectively restrict them from making too many loans without increasing their capital levels.
The banks are sitting on giant stockpiles of cash, U.S. government debt and other safe assets. By tweaking how the ratio is calculated, the Fed is effectively trying to engineer a swap. Remove Treasurys and central bank deposits from the calculation, the thinking goes, and banks should be able to replace them in the asset pool with loans to consumers and businesses.
The Federal Reserve is doing about everything possible to provide relief from banks, so that they in turn can keep lending to their customers. It is hard to argue differently.
Bank Analysts Assess COVID Risk
“Only when the tide goes out do you discover who's been swimming naked,” said Warren Buffett. Bank analysts are now assessing banks to see who is most vulnerable to the COVID-19 crisis, and focus is high on the regional banks, especially those with exposure to CRE, consumer lending, and energy.
Investors are focused on which firms are exposed to the wrong industries as the coronavirus pandemic roils the economy, and they plan to scour for clues as the lenders report results in coming weeks. Bank stocks have plunged as the duration and severity of the crisis remain uncertain. The KBW Regional Banking Index tumbled 41% during the first three months of the year, the worst quarter in its history of more than two decades.
Much of the differentiation between the regional lenders will come from their individual exposure to the hardest-hit sectors and geographies in what economists predict will be the most severe quarterly contraction on record.
“Spoiler alert: Our question for the first-quarter earnings calls is, ‘What is your exposure to airlines, hotels, tourists and other industries exposed to the coronavirus?’” Mike Mayo, a Wells Fargo & Co. analyst, said in an interview.
The pandemic, coupled with an unrelenting price war between Russia and Saudi Arabia, has dealt a crushing blow to the oil and gas industry. Oil posted its worst quarter on record as a result of that double-whammy, with prices falling below $10 a barrel across major shale regions in Texas and North Dakota. That may prove particularly onerous for lenders with exposure to U.S. exploration and production companies.
The good news is our banking system is extremely well-capitalized. But there will be enormous pressure on these well-capitalized banks to step up and do some things that may be contrary to their short-term interest.
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A subsidiary of Clark Street Capital, CSC Specialty Asset Management is led by James McCartney, who brings decades of management of complex portfolios.
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Before joining Clark Street, Jim served in a variety of senior roles with Urban Partnership Bank in Chicago, a community development financial institution capitalized by a variety of Wall Street an regional institutions to acquire the assets of ShoreBank, subject to an FDIC loss share agreement on a highly distressed and complex $1.4 billion portfolio.
Jon Winick, CEO Clark Street Capital
Jon Winick is the CEO of Clark Street Capital. In 2008, at the height of the financial crisis, Jon saw the opportunity to establish a leading bank advisory and loan sale firm, sensing a void in the marke of firms with real-world banking, loan and real estate experience.
