This week is the first week banks could potentially take Paycheck Protection Program Forgiveness applications. However, most banks are holding off as we do not have a final application, due out this week. WHEN you release your process merits some analysis, and in this article, we discuss 10 important considerations to decide on as you finalize your process.
When to Start Your Process
True to form, last Friday, President Trump signed into law a Paycheck Protection Program (PPP) change giving us yet a new acronym and the need to scramble to figure out how to amend our respective Forgiveness program to accommodate. The good news is that the new law, the Paycheck Protection Program Flexibility Act (“PPPFA”), addresses many concerns of our small business customers. Since these changes now radically offer both production workflow and profitability, in these changes, we highlight the impact of PPPFA and discuss some ways to optimize the process.
Last Friday’s economic data indicated that U.S. nonfarm payrolls rose by 2.5 million in May, compared with expectations for a decline of 7.5 million. In April, nonfarm payroll fell by 20.7 million in the largest single-month drop in records dating back to 1939. Throughout last week, interest rates rose (the ten-year yield rising by 25bps) and the yield curve steepened relentlessly - spread between five-year notes and 30-year bonds widened on Friday to 120 basis points, a level last seen in December 2016.
The future path of the economy is currently unpredictable. Still, the majority of banks have now eliminated two possible scenarios: 1) Best case scenario – that nothing will change from February 2020; and 2) Worst case scenario – that the pandemic will not end in the foreseeable future and banks should avoid loans and invest in riskless securities.
The impact of coronavirus on community banks will be widespread, and, with some borrowers, the restructuring efforts may take a long time and will sap substantial bank resources. Even as bankers are exerting time and effort to help some borrowers stay in business and continue to service their bank debt, other borrowers are looking for new funding, and existing customers, who are creditworthy, are being solicited by competitors. The question for community bankers is how to retain existing strong customers and appropriate ways to structure new debt given the current challenges.
The Fed did more than cut rates on Sunday; they pumped a massive amount of liquidity in the system, sending a signal to banks to level up. Far behind the health of employees and customers in the COVID-19 pandemic, comes the economic impact. Unlike the recession of 2008, where the economic impact came over many months, this pandemic impacted businesses in weeks providing much less time to prepare and adjust. The result is likely to be bad for the economy and bad for banks. If your bank is treating this as businesses as usual, then you are putting your survival at risk.
There has been substantial research on how prepayment speeds of residential mortgages affect the profitability of individual loans and portfolios. Because of the homogenous nature of residential mortgages, many firms have developed highly predictive models to calculate prepayment speeds based on past behavior, portfolio makeup, and macroeconomic variables. However, very little research is available on prepayment speeds of commercial mortgages – this is understandable because of the uniqueness of each commercial loan. Even sophisticated loan risk-adjusted return on capital (RAROC) models
We have written numerous blogs about why banks should reconsider the risk-for-yield business model when it comes to credit or interest rate risk. The return on equity (ROE) in risk-for-yield businesses is low, and the business outcomes during downturns are adverse. Instead, banks should construct an advisory business where taking risk may be just one element in delivering a customer-centric solution.
In our last blog, we reviewed ZIRP (zero interest rate policy) strategies deployed by various central banks. We discussed how ZIRP strategies had been deemed by many economists to be ineffective over the long-term to stimulate economic growth and stoke inflation. We considered forecasts by economists, the forward interest rate market, and FOMC policy member’s future rate path expectations - all point to a low probability of decreasing interest rates. However, one loud voice has been a champion of lowering rates to zero or even negative – the President of the United States.
We are working with numerous community bankers to develop strategies for instituting floors on commercial loans. The idea of protecting floating or adjustable rate assets is not new to community bankers, but the current interest in this concept is spurred by specific and unusual communications and market developments that are worth analyzing.
