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How the CARES Act Is Still Kicking the Can

  • covid deferred interest default bankruptcy

Tags Booms and BustsMoney and Banks

08/27/2020

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During Real Vision’s Daily Briefing of August 13, Ed Harrison asked rhetorically, “How is it possible for you to have a bull market, a new leg up in the business cycle when bank stocks, the traditional value cyclical trade are 30% off their highs? That's not a signal of bull, it's a signal of secular stagnation.”

The stagnation is there, just no one can see it. The August 7 Grant’s Interest Rate Observer quotes “a knowledgeable friend” concerning the banks: “Right now, if you look at the underlying data on consumer delinquencies, you don’t see a recession at all.” Grant’s's friend goes on to say that home prices have stayed afloat, credit card bills are being serviced, auto prices are going up, as are consumer savings. “You see nothing that looks like a recession,” the anonymous source said, “but it is coming.”

What has cloaked the recession is government largesse in the form of the added $600 to weekly unemployment claims. While the juice from that lemon ran dry August 1, it will be replaced by a $300 or $400 weekly bump once Treasury secretary Mnuchin gets around to cutting the checks.

Not to be overlooked is that banks, as a part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, are granting debt service deferrals. “And they can keep granting deferrals until the sooner of Dec. 31, 2020 or 60 days after President Trump has declared an end to the Covid-19 national emergency,” Grant’s explains. “The law directs that, come the close of the grace period, such loans be treated as performing.” For those wanting to check my work, see section 4013 of the act.

It’s good to be a banker.

You may be thinking, but surely banks aren’t recognizing deferred (uncollected) interest as income, right? Guess again. Grant’s, in an analysis of Signature Bank, learned that “It’s booking debt-service income but receiving no cash.” It’s possible Signature Bank is being more aggressive than its rivals in accounting for deferred interest. According to Brian Foran of Autonomous Research, “We don’t get a ton of disclosure. So, knowing which banks are more and less aggressive on that accounting is tough.”

Take it from an ex-banker: most are being as aggressive as their accountants will let them.

As of June 30, the average bank had 16 percent of its loan portfolio in deferral, according to Thomas McJoynt-Griffith, an analyst with Keefe, Bruyette & Woods. That’s an increase from 13 percent at the end of Q1. Grant’s breaks down where the deferrals lie: Commercial real estate (20 percent), commercial and industrial (14 percent), mortgages (10 percent), and consumer loans (6 percent).

Despite double-digit unemployment rates, banks are keeping loan loss provisions low, no doubt assuming Uncle Sam will keep everyone’s boat afloat. But, all good things come to an end. Grant’s offers this from Lakshman Achuthan, who believes the unemployment rate will remain elevated for years. “Seen in that light,” says Achuthan, “it’s actually optimistic of the banks to put much of their loan books merely in deferral, instead of writing them off.”

The same goes for commercial loans. Evan Lorenz writes, “The consultancy Aaron Allen & Associates estimates that 231,000 of America’s 660,000 restaurants are likely to close forever this year.”

After seventeen major retailers filed bankruptcy in 2019, the running total for 2020 is twenty-five according to retaildive.com. In better times, lease agreements with the names on this list would be called “credit tenant leases,” the definition of which is “a long term lease agreement made between a property owner and a tenant with extremely good credit, typically a major corporation. Credit tenant leases are the basis for credit tenant lease (CTL) loans, which have some of the lowest default rates in the commercial finance industry.”

Mr. Lorenz, deputy editor at Grant’s, summarizes, “Fiddling with accounting only changes the timing of when banks recognize those losses, not the ultimate economic cost.”

If banks are trading just 30 percent from their highs, that may seem too high given all these dud loans. But, if past is prologue, there will be a buyer for all that dodgy paper. Jerome Powell, stay close.

Author:

Doug French

Douglas French is former president of the Mises Institute, author of Early Speculative Bubbles & Increases in the Money Supply, and author of Walk Away: The Rise and Fall of the Home-Ownership Myth. He received his master's degree in economics from UNLV, studying under both Professor Murray Rothbard and Professor Hans-Hermann Hoppe.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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