On July 14, three of the nation’s largest banks for the second time in 2020 set aside large credit loss reserves for the quarter ending June 30. The size of the reserves is staggering, totaling $26.8 billion in the aggregate. The banks’ provisions are in response to anticipated losses stemming from the prolonged adverse effects of the coronavirus pandemic on the economy.
Banks are concerned about a rising number of COVID-19 cases in the South and West, where states and cities have reopened businesses to the public. The economic impact of a rising number of COVID-19 cases is expected to be increasingly severe as the CARES Act economic aid provisions for small and midsize businesses and the unemployed wind down.
Currently, Congress has yet to enact another round of stimulus, and concerns over the growing national debt and policy disagreements over extended unemployment insurance coverage and aid to cities and states may delay congressional action or reduce the size and limit the economic impact of any stimulus package.
Trillions in Short-Term Aid
Up to now the banking industry has benefited from a combination of massive, largely bipartisan fiscal support from the federal government and extraordinary asset purchases and emergency lending by the Federal Reserve to provide additional liquidity to banks, interbank lending, mutual funds, corporate debt markets and small to midsize businesses. To date, trillions of dollars have been appropriated by Congress to combat the COVID-19 pandemic and its economic impact.
From a policy perspective, this is in sharp contrast to the 2008 Emergency Economic Stabilization Act’s Troubled Asset Relief Program, which appropriated approximately $700 billion in fiscal support to the banking industry. TARP proved to be highly controversial during and long after the global financial crisis of 2008.
In response to the COVID-19 pandemic and its economic impact, the Fed expanded its bond buying program and quickly relaunched several emergency liquidity programs created during the global financial crisis. It also created new programs such as the Paycheck Protection Program Liquidity Facility and the Main Street Lending Program facilities with a financial backstop from the Secretary of the Treasury using funds appropriated under the CARES Act.
The PPPLF extends credit to eligible financial institutions that originated loans under the Paycheck Protection Program. Despite some criticism over PPP loans made to certain classes of borrowers, the PPP been very popular and has had a positive impact on maintaining employment levels. Its economic impact, however, will lessen as its loan forgiveness funds are fully dispersed.
The MSLP facilities target small to midsize businesses that have 15,000 or fewer employees or 2019 revenues of $5 billion or less. These businesses constitute a key sector of the economy and a major source of employment. To date, the MSLP has not generated a lot of activity or interest. Lenders may be cautious about taking on additional credit risk due to the weak economy and borrowers may find the MSLP facilities’ term sheets to be unattractive.
Forbearance Can’t Last
These efforts, along with the Dodd Frank Act’s regulatory reforms mandating comprehensive stress testing, higher and better-quality capital and liquidity and enhanced prudential standards, clearly enabled the banking industry to withstand the initial shock of the COVID-19 pandemic-related shutdowns.
The policy approach has been to stabilize key industries and markets, and to mitigate damage to the consumer credit and housing sectors affected by historically high unemployment levels. The strategy is predicated upon a relatively swift return to near normal economic activity. Pre-COVID-19 pandemic, economic activity likely will not return until a vaccine and an effective COVID-19 treatment regime are developed and widely available. Despite promising vaccine research and treatment protocols, it is still unclear if a comprehensive public health response will be in place in the near term.
The challenge for policymakers, regulators and bankers is as follows: How do you prevent a prolonged pandemic-induced downturn from becoming a widespread banking crisis?
Recent regulatory forbearance efforts on capital ratio levels and buffers, on-site examinations, CECL implementation and loan modifications are justifiable as short-term measures. Unfortunately, history has repeatedly shown that forbearance is not a long-term solution. The savings and loan crisis and Europe’s halting response to the global financial crisis underscore that prompt recognition of losses and maintaining strong capital levels are essential to having a banking system that is capable of lending through an economic downturn.
Weak banks conserve capital and are incapable of making the loans businesses need to restart the economy. Capital is always available until you need it.
Banks would do well to use this interval to fully assess the risk levels in their asset classes, modify loans where appropriate and project their future capital needs and plan accordingly.
Thomas J. Curry is a partner in Nutter’s corporate and transactions department. Daniel W. Hartman is an associate in Nutter’s litigation department. Kate Henry and Blake C. Tyler are associates in Nutter’s corporate and transactions department. Curry is former U.S. comptroller of the currency and all are members of the firm’s banking and financial services group.