Economic Holding Pattern
When the history books are written, 2020 will not be a year fondly remembered by bankers—or anyone else. Major chunks of the economy ground to a halt in mid-March as pandemic shutdowns hit many businesses. The federal government was quick to step in with help, including the Paycheck Protection Program (PPP), which offered a financial lifeline to many struggling small businesses.
At first, many expected the coronavirus crisis to be a short-term blip on the radar. But by October, the new pandemic economy had been grinding along for seven months.
As the end of 2020 nears, for many lenders the new reality boils down to this: Not everything is terrible.
Bankers found that while some clients were struggling, others were holding steady. The loan demand pipeline has slowed, but not collapsed. For the most part, clients are not seeking additional loan modifications. There’s nothing remarkable about credit line usage; customers don’t seem to be tapping those lines for emergency funds.
From one vantage point, the economy in late summer was essentially in a holding pattern. Bankers and customers alike had looked to Congress and the Trump administration in expectation of more aid programs. But a political compromise was problematic. The U.S. House, led by Democrats, passed a $3 trillion coronavirus relief package in mid-May. However, the Republican-controlled U.S. Senate failed to approve a smaller aid bill in early September.
Bankers have learned this year that government programs are something of a moving target, as rules, regulations and guidelines are continually changed or revised.
“We’re seeing decent loan demand, but the new project demand doesn’t seem to be as robust as maybe it was previously,” says Jon Dolphin, president of Minneapolis-based 21st Century Bank. “There are still business acquisitions, there are still opportunities that we’re looking at there. We’re obviously looking at them a little bit differently just based on all the new restrictions. It’s going to be dependent on what type of business it is as to how you look at that transaction today versus four or five months ago.”
Dolphin says that government programs bought business owners some time and peace of mind.
“I think that with PPP [and] some of the CARES Act additions to the economy, it’s probably put things in a position where people were generally more confident,” Dolphin says. “We’re kind of waiting to see what the next steps are.”
The big unknown is what happens to businesses once the rescue packages are gone. PPP and other resources have arguably boosted the economy artificially and in some cases have obscured the true health of some companies.
“It’s kind of challenging to say what the permanent economy is going to look like at this point. It’s kind of sector-driven,” Dolphin says. “Your hotels, your restaurants, your retail, those types of things, entertainment—obviously those things took some major hits, and anything related to those industries [also] took some major hits during this period of time.”
In such a climate of uncertainty, what’s a banker to do when assessing a potential loan?
“You have to look at every deal a little bit harder. And you have to make sure that each deal that you’re approving has more room for error than it did previously,” Dolphin says. “You might have taken a little more risk in January [or] February of this year than you would have after March 15.”
Covid’s unequal treatment
It also means more careful study of specific industries and trends.
“You try to figure out as best you can what impacts have happened to that industry or to that client during that segment of time. You try to study what happened from January to March and then maybe what happened month by month from March to July or March to August,” Dolphin says. “You try to study some trends and you try to figure out what permanent impacts look like and what the going-forward cash-flow stream might look like.”
St. Louis Park-based Bridgewater Bank focuses on commercial real estate lending, which has been robust in recent years. In August it moved into the Bridgewater Corporate Center, a brand-new 84,000-square-foot office building.
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What are its leaders seeing during the pandemic?
“Our multifamily and industrial clients are doing really well,” says Jerry Baack, Bridgewater’s president, CEO, and chairman. “And you’ve got others that are obviously struggling.”
In times like these, a customer’s relationship and history with a lender is more important than ever.
“Our loan demand is still pretty strong, [though] clearly not as strong like it was in February,” Baack says. “But it’s still really robust. There are a lot of banks that have really tightened on underwriting significantly, and we’ve certainly changed our underwriting. Again, it depends on the person, their experience and our level of experience with them, and a bunch of other factors.”
Nevertheless, business is solid, Baack says.
Higher lending hurdles
“We’ve certainly tightened our lending standards, but we’re getting in front of a lot of deals. There’s still a lot of optimism out there,” Baack says. “We deal with entrepreneurs. I think they just find a way to make money. Our loan demand is strong, our pipeline is still really solid.”
Baack says customers have stopped asking for loan modifications, as they were doing last spring.
“In the beginning of this, everybody right away wanted to modify their loans; they were worried that the sky was going to fall completely,” Baack says. “Thankfully, a lot of people that had those initial modifications are not asking for an additional one.”
21st Century Bank also does some commercial real estate lending, but typically on smaller-scale projects.
“We didn’t do a lot of new apartment, Class A financing ourselves, but I was noting obviously a lot of it occurring around me,” Dolphin says. 21st Century Bank’s headquarters is in downtown Minneapolis, which has been ground zero for development of shiny new apartment towers.
As he watches the skyline today, Dolphin is starting to see some changes.
“There are still some new projects that are breaking ground that maybe were already planned, [but] I’m not
seeing as much happening there,” Dolphin says.
Bankers everywhere are looking to Washington to see if there are additional initiatives offering help to small businesses or important modifications to already-existing programs like PPP.
Bryan Toft, chief sales officer for St. Paul-based Sunrise Banks, is anticipating more federal government changes. “We also are expecting some blanket kind of forgiveness for [PPP loans] $150,000 and under. That’s what we’re hoping for,” he said, emphasizing that it would simplify administration of the program for banks and borrowers. Toft oversees commercial banking and lending.
The process could be streamlined to only require completion of a one-page form. Toft says that 80 percent of the PPP loans that Sunrise handled were under $150,000.
“We have a large SBA presence, and our SBA loan demand continues to be strong,” Toft says. “We probably will see another round of PPP at some point in some form or another.”
Like other bankers, Toft emphasizes that business fortunes amid the pandemic vary by sector.
“Restaurants, hospitality, anything event-related is obviously suffering, and we’re working closely with those businesses with PPP or other various loan and grants programs,” Toft says. “Then we have a middle section that hasn’t been affected much, it’s still doing OK, and there are a few out there doing better than before. The liquor stores come to mind.”
Toft cites business-to-business service companies and commercial real estate as two areas where business remains largely healthy. “Business-to-business seems to be doing OK, at least in our experience,” Toft says. “We haven’t seen much deterioration there. The other one is real estate-related. If you have investment real estate, whether it’s apartments, office, we haven’t seen a lot of issues there at this time. It seems like from what I hear, tenants and landlords are working well together to figure out what’s going on.”
SBA’s major role
Beyond PPP, Toft notes that there’s another key element that has helped businesses during the pandemic.
“The other factor, of course, is the SBA has made the payments for all SBA loans for the last five months,” Toft says. “That’s had a big impact to help these smaller businesses.”
Toft says that Sunrise continues to see demand for new loans.
“There have been some startups, actually. There have been some real estate purchases, some expansions, buying more equipment,” Toft says. “That’s all pretty normal for us.”
So far Sunrise has not seen much merger and acquisition activity. Toft says that PPP and other programs have given business owners a cushion.
“It’s probably still too early to tell,” says Toft of M&A deals. “People have time to figure out what they’re going to do.”
Constant changes to federal programs are business as usual for bankers in the PPP era.
“That is one thing we’ve come to expect,” Toft says. “As we’ve made these decisions, we just kind of [say], ‘Well, this is the best decision we can make based on the information we have.’ ”
Looking to 2021, Toft is optimistic.
“Obviously, we’re going to expect some credit issues and we’re preparing for that, but we have grown this year, and we expect to continue to grow in 2021,” Toft says. “A big part of that strategy is going to be SBA, no question.”
How Are Big Banks Faring?
The fortunes of one of America’s biggest banks, San Francisco-based Wells Fargo & Co., offer some clues to the state of the world in the second quarter. The bank reported a large net loss—$2.4 billion—for the quarter. The company boosted its credit loss reserve by $8.4 billion from the end of the first quarter, bringing the total reserve for bad loans to $20.4 billion.
Per its earnings release, “The increase in the ACL [allowance for credit losses] reflects forecasted credit deterioration due to the Covid-19 pandemic, including a $6.4 billion increase for commercial loans, mainly in the commercial real estate and commercial and industrial portfolios.”
For the second quarter, Wells Fargo’s commercial loans were about the same as the previous year, but were down $54.5 billion, or 9.6 percent, from the first quarter. Wells Fargo said the decline was “predominantly due to a $54.9 billion decline in commercial and industrial loans driven by repayment of revolving lines that were drawn in March at the outset of the Covid-19 pandemic.” —B.G
Burl Gilyard is TCB’s senior writer.