IEFS Digest — Looking Ahead
4/17/20
Market Update
by Adam Mirsky
Major indexes closed in the green on Thursday, following Trump’s new plan for reopening the US. Yesterday’s gains made up for the losses earlier this week caused by poor housing and unemployment numbers.
While a plan for recovery has been laid-out, the shut-down of non-essential businesses continues to take its toll in the US.
The Federal Reserve Bank of New York reported massive drops in manufacturing this week, with their General Business Conditions Index falling to -78.2, its lowest level since 2001.
Retail sales fell a record 8.7% in March, with factory output down 6.3% (the lowest drop since 1946). While these numbers seem grim, April will likely be worse.
Several banking giants reported earnings this week, publishing significant drops in profit from the changing market landscape. As stated in our previous article, an unstable economy poses an increased risk of defaults on loans. To safeguard against these losses, firms have increased loan-loss reserves by a combined $20 billion in Q1.
Crude oil prices finished yesterday at their lowest levels since 2002. While OPEC reached an output deal last week, thus ending the oil war, the International Energy Agency expects massive declines in demand to continue due to instability in the sector.
The Stimulus Bill: Three Weeks Later
by Nitin Reddy
Winners and Losers of the Stimulus Bill
Three weeks removed from the passage of the CARES Act, the U.S. government’s $2 trillion stimulus bill in response to COVID-19, it is evident who the winners and losers of this massive stimulus are. For an overview of the stimulus bill, take a look at our article from last week.
Winners:
- Large Companies: $425 billion in loans will be administered through a Federal Reserve emergency lending system. The Obama administration created a similar system during the Great Recession in 2009.
- Airline Industry: $25 billion in loans and $25 billion in grants are available exclusively to airlines, aircraft manufacturers, and airports. An in-depth analysis of the benefits provided by the bill can be found on our article from last week.
- Small Businesses: $377 billion in loans and grants are available, with $350 billion coming in the form of support loans through a Paycheck Protection Program, which is discussed in more depth later in this article.
- Citizens/Gig Economy Workers: The bill bolstered unemployment insurance payments, and recipients are eligible to receive those funds for an average of four months. It also extends eligibility to the self-employed and workers in the gig economy such as Uber and Lyft drivers, who are affected enormously by the pandemic.
- Hospitals and Healthcare Facilities: The legislation provides $117 billion for hospitals and veterans’ health care, as well as $16 billion for medical supplies such as PPE (personal protective equipment) and ventilators. It also includes $11 billion for vaccines, therapeutics, diagnostics, and other medical needs. The bill also requires insurers to cover tests for COVID-19.
- Mortgage Borrowers: U.S. regulators have already mandated forbearance to borrowers facing financial hardships due to COVID-19. Additionally, foreclosures and evictions have been suspended through the end of April, and even longer in some cases. For a better understanding of how the COVID-19 crisis has affected the real estate market and rent payments, be sure to read our article from two weeks ago.
- Farmers: The stimulus package includes up to $23.5 billion in aid for farmers. It provides $9.5 billion in emergency funds for agriculture businesses, including livestock producers and growers of specialty crops.
- State & Local Governments: A COVID-19 relief fund with $150 billion was created for states, cities, and other local governments hit hardest by COVID-19. The package includes $400 million in grants for the Election Assistance Commission.
Losers: The Energy Industry
- Oil: Oil executives met with the president on April 3, but the meeting ended without a plan to help the struggling U.S. oil industry. Many of the companies in the oil industry are not likely to be eligible for the large company aid provided by the stimulus bill, as they will have to lay off much of their workforce due to extremely low oil prices. For a more in-depth look at the current state of the oil industry, check out this article.
- Renewable Energy: Before the COVID-19 pandemic, renewable energy stocks rose 140% over the past 3 years (the S&P 500 rose only 40% over the same period). Renewable energy stocks now sit at only 40% above where they were three years ago. This is a result of two factors: lack of funding and reduced demand. While the stimulus bill provides funding to many other industries, such as the airline industry, it does not provide any funding to the renewable energy industry. Demand for renewable energy has decreased, as individuals and businesses have significantly less money due to the pandemic, and are more hesitant to invest in renewable energy sources and technology for themselves or their businesses.
How Large and Small Businesses are Affected by the Stimulus Bill
- Large Businesses: The plan included $500 billion in loans and assistance for larger companies, but the aid comes with strings attached. Companies receiving a government loan are subject to a ban on stock buybacks through the term of the loan plus one additional year. Also, workforce cuts of more than 10 percent are not allowed for businesses that utilize the loan program.They also would have to limit executive bonuses and take steps to protect workers from layoffs.
“We see it as an important win,” said Austen Jensen of the Retail Industry Leaders Association. Jensen said he hopes “necessary” oversight measures won’t delay “getting this capital out into the businesses.”
- Small Businesses: The bill allocated more than $350 billion in aid for small businesses guaranteed by the federal government (mostly loans through the Small Business Administration and banks). It provides eight weeks of cash flow via loans to businesses to cover payroll. The loans will be forgiven provided the businesses meet certain requirements, including limiting reductions in pay and layoffs.
“An instant cash injection is the only way to save small businesses from failing”, according to the Small Business Majority.
The Failure of the Small-Business Loan Program
In a time like this, small businesses are especially vulnerable, as they often have a very small cash buffer. The number of cash buffer days is the number of days a business could pay its outflows if its inflows were to stop. As shown in the graphic, for many small businesses, such as restaurants and retailers, if their business is shut down (as it is now), they can not stay open for very long with out an influx of cash. For that reason, the stimulus bill included over $350 billion in small business loans. However, the small business loan program has 3 big problems:
1. For many banks, the program looks high-risk, low-reward.
The reason Congress decided to route its small-business bailout through private banks was simple: only the country’s vast network of federally insured private banks has the necessary infrastructure to directly pay firms’ wage bills in a timely fashion. To incentivize banks, the federal government initially allowed banks to charge fees of between 1 and 5 percent on the loans they dispense, and collect 0.5% interest, even as the federal government remains on the hook for any loans that fail to pay off.
But this new line of business is risky for banks. The administration is requiring banks to verify borrowers’ eligibility and certify the size of the loan they are eligible for. Verifying this kind of information would, in many cases, take an extensive period of time. However, the White House is imploring banks to get money out the door fast. If banks are too trusting, will they end up being on the hook for the ineligible loan, or otherwise liable for complicity in fraud or money laundering? In the bill, it states that lenders will not be held accountable for performing an insufficiently thorough background check on a borrower that proves to be criminal. However, they aren’t completely exempt from an obligation to verify a borrowing firms’ eligibility. That, combined with the logistical difficulties of implementing the program, led banks to insist that even the federal government’s new 1% interest rate was too low for the government’s proposition to make sense.
2. The bailout fund is too small.
This has been the program’s core flaw since day one. There are 30 million small businesses in the United States, and a quarter of them have already temporarily shut down, while 11% are on the verge of closing for good, according to a newly released Chamber of Commerce survey. Estimates suggest that it would cost upwards of $1 trillion to replace all of their revenue lost in the next three months. The Paycheck Protection Program (PPP) only has a grand total of $349 billion to dispense.
Bank of America was one of the few major lenders to participate in the PPP on opening day. Over the ensuing 72 hours, it received loan applications from 177,000 small businesses, which collectively requested $32.6 billion in financing. If those loans were all approved, a single lender will have wiped out nearly 10 percent of the bailout fund in just three days.
3. The most vulnerable mom-and-pop businesses will likely come away empty-handed.
The program’s first two flaws: banks’ fears of the program’s potential risks and the insufficient amount of money available for lending, combine to produce this third flaw. As previously mentioned, Bank of America is participating in the program, but they’re only lending to small businesses that already have a “business-lending and a business-deposit relationship” with the bank. Some institutions, such as Sunwest Bank, are taking applications from new customers, but they are the exception. Given that the demand for these loans exceeds their supply, there’s little incentive for banks to take a risk on a new client, especially when they could be held accountable for extending credit to a fraudulent borrower.
Most small firms have a preexisting relationship with a lending institution. However, some of the most vulnerable small businesses operate on cash and do not have any such relationships. Additionally, small firms are also unlikely to be as well-prepared and informed about policy changes as larger, more profitable ones.
Impact of COVID-19 on Big Banks
Bank stock losses have outpaced market losses this year: JPMorgan’s shares are down more than 30%, Wells Fargo about 42%, Citigroup 43%, and Bank of America 33%.
Compared to Q1 2019, Morgan Stanley profits are down 30%, Citigroup profits are down 46%, Goldman Sachs are down 46%, Bank of America profits are down 45%, JPMorgan profits are down 70%, and Wells Fargo profits are down 99% (barely profitable).
With millions of Americans out of work and in need of credit, banks are struggling to keep up as profits plummet. Loan activity will be front-and-center for banks in the days to come as consumers begin to default and businesses seek aid through government recovery programs.
The Road to Recovery
by Adam Mirsky
How much longer are we going to have to keep this going?
Just yesterday, President Trump announced a three-phase plan to reopen the U.S. with a target date of May 1st for the earliest regions. The procedure calls for each state to pass a series of requirements before moving on to the next stage.
Phase one addresses the virus’ high-transmission rate. Following 14 consecutive days of decreasing infection rates, hospitals in the region are required to treat all patients without crisis care. States that pass these limitations are able to open gyms, restaurants, and other large venues (these locations must follow social distancing guidelines). In this stage, the government will still advise tele-commuting, limited travel, and gatherings of no more than 10 people.
Phase two requires another 14 days of diminished infection rate with no sign of a rebound. For applicable states, this will entail reopening of schools, non-essential travel, and administration of elective surgeries.
The final phase will, in theory, return life in the US back to “normal.” After 42 consecutive days of decreasing infection rates, states can resume public gatherings and “unrestricted staffing of work sites.” Even in this final stage, the federal government still advises the practice of physical distancing for all individuals when practical.
If getting all this done by May 1st sounds too good to be true, that’s because it likely is.
Few, if any, states are currently on track to meet this target, with coalitions in the Northeast, Midwest, and Pacific forming to coordinate regional re-openings.
Yesterday, New York Governor Cuomo explained that the state will extend the shut-down of non-essential businesses until at least May 15th; other states within the East coast coalition are expected to follow suit.
As COVID-19 infections begin to slow across the US, only one thing about a return to status-quo seems certain: it’ll be slow.
Tidbits
by Adam Mirsky
- 2 million people globally have contracted COVID-19, with the disease now being documented in 185 countries. The U.S. is the current hotspot of the disease, with over 600,000 cases and 24,000 deaths.
- The Paycheck Protection Program has already reached its massive budget of $349 billion. Congress is currently debating adding an additional $250 billion to the program; Democrats want more allocated for medical services whereas Republicans want a stricter focus on small businesses.
- China’s Q1 GDP dropped 6.8%, marking its first recorded quarterly loss in GDP. As consumer spending and urban unemployment continues to struggle in the US, China acts as a grave reminder for what’s likely to come.
