PPP Winds Down
Bankers involved in PPP can finally breathe a sigh of relief this week, as the race to process and close PPP loans has ebbed significantly. The good news is there is no longer a concern that the program will run out of money. In fact, the PPP funds allocated may not even be used up.
The good news is that the second round funding is being directed heavier towards the small businesses that were the intended recipients of these loans. The average loan size is significantly lower. In the first round, $31 billion went to loans over $5MM or 9%. Through May 1, the percentage over $5MM dropped to 6%.
Bankers have been working long hours to get these deals done. This publication did get some complaints from bankers when we called out their complaining last week (doesn’t that prove our point?), but there is no question that bankers have showed their devotion to their clients the past few weeks.
It’s 4 a.m. Tuesday, and Charlie O’Brien at Adams Community Bank, Shena Kelly at Coastal Heritage Bank, and Quincy Miller at Eastern Bank, are up trying to get loans approved.
So much for banker’s hours.
These lenders haven’t become night owls by choice. Instead, they have figured out that to outwit the US government’s achingly slow system that provides “emergency” loans to small businesses, they’re better off working in the middle of the night.
Kelly, a commercial portfolio manager at Coastal Heritage in Weymouth, pulled an 18-hour day Monday, but she couldn’t sleep knowing she had 30 more loans to process. Her customers, she said, are like family. After finishing up at midnight, she was back at it a few hours later.
We have only talked to one bank that is not doing these loans. This has been a remarkable effort by lenders, bankers, and SBA officials to roll-out a program in a very short time period. Everyone involved should take a well-needed break!
With thousands of businesses preparing to ask for their eight-week loans to be forgiven, banks and borrowers are just now beginning to realize how complicated the program may turn out to be. Along with lawmakers, they are pushing the Treasury Department, which is overseeing the loan fund, to make forgiveness requirements easier to meet.
The Consumer Bankers Association warned on Wednesday that loan forgiveness is the “next shoe to drop” for the program, and the Independent Community Bankers of America raised alarm that struggling borrowers have been misled.
One of the biggest stumbling blocks is a requirement that businesses allocate 75 percent of the loan money to cover payroll costs, with only 25 percent allowed for rent, utilities and other overhead. That has become more difficult as the economic crisis from the virus drags on and as some businesses face a prolonged period of depressed sales, even once they reopen.
On Tuesday, more than 20 bipartisan senators urged Mr. Mnuchin and Ms. Carranza to change the loan forgiveness criteria to allow small businesses, and particularly restaurants, to use the program, saying just 50 percent of the loan should be devoted to payroll, with the rest paying for other overhead.
Even if the businesses do not get all the forgiveness they are hoping for, the terms are still very advantageous. A 1% interest rate is as good as it ever gets for a commercial loan. Unfortunately, the unemployment benefit is so generous (most people making less than $70K will make as much on unemployment), that many employees would rather be laid off than retained. We believe this is actually a worse problem for the lenders than the borrowers, as the lenders will be stuck with 1% loans for a while. Sure, they can borrow from the Fed at 35 basis points, but that is still not much of a spread. The longer these loans stay outstanding, the less profitable this program is for the banks. Our advice to lenders is don’t screw up the forgiveness aspect. Make sure your borrowers are using these funds to maximize the forgiveness.
SBA Cuts Disaster Loans
The Small Business Administration is applying new restrictions to the Economic Injury Disaster Loan program, putting an emergency source of funding further out of reach for entrepreneurs.
Starting on May 4, the SBA said it would only accept applications from agricultural businesses that were interested in the so-called EIDL.
The disaster loan program was one of several lifelines made available to entrepreneurs amid the coronavirus pandemic. Initially, applicants who were accepted into the program were eligible for up to $2 million in loans at an interest rate of 3.75%, plus a $10,000 advance grant.
As businesses flooded the SBA with applications, the agency curtained the grant amount to only $1,000 per employee, up to $10,000.
Now, the SBA has curtained the program even further by restricting who can apply for a loan, as well as limiting the maximum amount borrowed to $150,000 – down from $2 million – according to The Washington Post.
The SBA has been overwhelmed with demand, and there has been pressure to prioritize agricultural borrowers. Funding appears to be running out as well. The SBA programs work best when they are originated by its lending partners, not by the SBA directly. Congress is likely to address this funding problem in the next stimulus bill.
Bankruptcies Heat Up
Law firms and advisors are beefing up their restructuring and bankruptcy practices due to an uptick of bankruptcy filings. Neiman Marcus filed this morning in Texas. This appears to be somewhat of a pre-packaged bankruptcy, as Neiman appears to have already secured DIP financing.
Neiman Marcus Group Inc. filed for chapter 11 bankruptcy protection on Thursday in Texas, becoming the latest large retailer to seek a court restructuring during the pandemic that has closed much of the U.S. economy. Earlier this week, J.Crew Group Inc. filed for bankruptcy.
“We had a business that was on track prior to Covid-19,” Neiman Marcus Chief Executive Geoffroy van Raemdonck said in an interview. “Everything was going well in our transformation, but we had massive interest payments. Covid threw everything off track. This is an opportunity to reset our financial structure.”
The bankruptcy filing, in the Southern District of Texas, Houston Division, seeks to eliminate $4 billion of roughly $5.1 billion in debt. The creditors will become majority owners of the retailer, which has been controlled by private equity firms. Neiman isn’t planning mass store closings or asset sales as part of the restructuring.
Neiman has secured $675 million debtor-in-possession financing from creditors holding over two-thirds of the company’s debt. The creditors have also committed to $750 million in exit financing that would refinance the DIP and provide additional funding for the business.
We believe its absolutely critical for courts to be open so companies can work out their differences with their lenders in court. Often, the threat of bankruptcy allows firms to work out restructures with their lenders. Hertz temporarily avoided bankruptcy this week by reaching a deal with its lenders.
On May 4, 2020, Hertz Global Holdings, Inc. and The Hertz Corporation (collectively, “Hertz” or the “Company”) entered into forbearances and limited waivers with certain of the Company’s corporate lenders and holders of the Company’s asset-backed vehicle debt. The forbearances and waivers, described below, provide Hertz with additional time through May 22, 2020 to engage in discussions with its key stakeholders with the goal to develop a financing strategy and structure that better reflects the economic impact of the COVID-19 global pandemic and Hertz’ ongoing operating and financing requirements.
As a result of the COVID-19 global pandemic, Hertz and its subsidiaries have experienced a rapid, sudden and dramatic negative impact on their businesses. While Hertz has taken aggressive action to eliminate costs, it faces significant ongoing operating expenses, including monthly payments under its Amended and Restated Master Motor Vehicle Operating Lease and Servicing Agreement (Series 2013-G1) with Hertz Vehicle Financing LLC (the “Operating Lease”), pursuant to which Hertz leases vehicles used in its United States rental car operations. As previously reported, on April 27, 2020, Hertz did not make certain payments in accordance with the Operating Lease. This caused the occurrence of an amortization event on May 1, 2020 under the terms of a series of debt instruments pursuant to which Hertz and its vehicle finance subsidiaries acquire the leased vehicles.
The forbearance agreement is fairly brief and its unlikely that this reprieve will give Hertz enough time to work through its issues. Airports represent two-thirds of Hertz’s revenue, and travel is not expected to rebound for several months. Airport locations are stuck with cars they can’t rent right now and are having trouble finding locations to store the vehicles. We believe Hertz will survive, but a bankruptcy filing appears inevitable.
Meanwhile, the National Review waxed poetic about the beauty of bankruptcy. While we believe bankruptcy serves an important purpose, we generally believe that a primary workout strategy for a lender is to avoid bankruptcy at all costs because it dramatically elevates legal expenses for the parties involved, who could work out their differences elsewhere.
Where Goes Home Prices?
There is an interesting debate as to the direction of housing prices. Some are arguing that the low interest rates and limited supply will keep home prices from falling very much. Zillow is projecting only a 2-3% decline.
Until March, this spring was expected to be the hottest home shopping season in years, with record-low inventory and interest rates, and high buyer demand fueled by ongoing demographic trends, such as an ever-growing share of millennials entering prime first-time homebuyer age.
Those underlying dynamics still exist to fuel the recovery -- already new listings and pending sales have ticked up, as well as increasing adoption of tech tools to enable social distancing -- and others provide resilience against the potential for widespread distressed sales. So the effect on prices will be modest compared to the nearly 25% drop and five-year recovery that defined the housing-led Great Recession.
Today's forecast, based on published and proprietary macroeconomic and housing data, centers around a baseline prediction of a 4.9% decrease in United States GDP in 2020 and a subsequent 5.7% increase in 2021. Under that scenario, which Zillow believes is 70% probable, the market is expected to include:
- A 2-3% drop in prices through the end of 2020, followed by a steady recovery throughout 2021.
- A rapid 50-60% decline in home sales, bottoming out this spring and recovering at a pace of about 10% each month through 2021.
While many economists expect home sales to tumble this year, many forecasts call for prices to climb slightly or hold flat. Mortgage-finance giant Fannie Mae said in April that it expects the median existing-home price to tick up to $275,000 this year from $272,000 last year. Capital Economics forecasts average home prices this year will fall 3% compared with last year. Zillow said Monday that home prices are likely to drop 2% to 3% from previous levels by the end of the year and recover in 2021.
In a forecast released Tuesday, housing-data provider CoreLogic called for nationwide home prices to rise 0.5% between March 2020 and March 2021. CoreLogic forecast annual price declines in some cities including Houston, Miami and Las Vegas.
These forecasts defy logic, history, and common sense. Home prices can rise during mild recessions, such as the early 2000s, in which the internet bubble burst and consumers put money into their homes, while rates were low. We are not aware of any period in which unemployment hit double digits (expected to be 15-20% tomorrow) in which home prices did not fall. Moreover, lenders have been largely prohibited from exercising their rights to initiate foreclosure, but distressed sales are inevitable.
This is precisely why we have advocated loan sales today, prior to the inevitable decline in asset values. No one is certain how and if collateral values will fall, but there is far more risk on the downside. Banks who sold loans in 2008 did much better than their peers that waited.
Both Buffett and Zell Stay on Sidelines
Warren Buffett and Sam Zell have historically taken advantage of economic downturns to load up on stocks. Warren Buffett exited all of his airline stocks last quarter, and has been a net seller of stocks.
Warren Buffett and Charlie Munger's dearth of stock purchases during the coronavirus sell-off is a red flag for investors, hedge-fund billionaire Leon Cooperman said in an email obtained by Business Insider.
"I'm a watcher of Buffett and Munger for good reason," he said. "Uncharacteristically, Buffett sold airlines into weakness and he doesn't seem to be too active despite his liquidity."
"If the greatest investor in my generation can't figure it out, who am I to be bold?" Cooperman added.
Buffett's Berkshire Hathaway conglomerate made only $1.8 billion in net stock purchases in the first quarter, and reported about $6.1 billion in net stock sales in April as it dumped its stakes in the "big four" airlines.
Munger, Berkshire's vice chairman, struck a cautious tone in a Wall Street Journal interview last month. "We just want to get through the typhoon, and we'd rather come out of it with a whole lot of liquidity."
“Too many people are anticipating a kind of V-like recovery,” Zell said in an interview with Bloomberg Television. “We’re all going to be permanently scarred by having lived through this.”
Just as the depression left behind a generation that couldn’t shake the experience of mass unemployment, hunger and desperation, the burdens this crisis has forced on society may be similarly hard to forget. Zell, 78, said it won’t be easy for people to live as they did before the “extraordinary shock” of the pandemic.
He expects some amount of social distancing and working from home to persist long after the acute phase of the outbreak is over, possibly for years. Retail, hospitality, travel, live entertainment and professional sports are some of the industries he sees continuing to struggle.
“How soon will anybody get on an airplane? How soon will anybody stay in a hotel? How soon will anybody go to a mall?” he asked. “The fact that these places may be open doesn’t necessarily mean that they’ll be doing business.”
For now, the raspy-voiced investor who earned his nickname, the Grave Dancer, buying distressed real estate in the 1970s, is watching from the sidelines. Like Warren Buffett, Zell hasn’t found anything to buy since the onset of the pandemic. Part of the problem is a lack of deals.
“Those sellers that wanted to sell still remember the prices that were available seven or eight weeks ago. The buyers are looking at a very different world and expecting to see significant discounts,” he said. “When you’ve got that big a spread, nothing happens.”
The conservatism of investors like Buffett and Zell is concerning. However, it does reflect the lack of deals. The stock market has rebounded so fast that there are fewer bargains. In residential and commercial real estate, the lenders have not yet put any pressure on borrowers to exit their properties, so deals are likely to come later in the year.
The Next Wave in Special Assets
A global pandemic and the end of a prolonged bull market have pressured banks to provide businesses with the liquidity they need to stay afloat. As distressed acquisitions ramp up, banks are seeking new ways to protect their balance sheets and meet the needs of borrowers at this time of uncertainty. IMN invites you to join us on May 14 for a webcast and interactive Q&A highlighting emerging opportunities in the distressed buying space and their widespread implications for financial institutions and investors.
