Nothing about this crisis aid is easy for business owners and it sure isn’t free.
Even getting one of those Payroll Protection Program loans from the government can trigger a default on a regular commercial bank loan, as it doesn’t only take missed loan payments to get in trouble with a bank.
That is because banks typically make borrowers agree they won’t take out any more loans — even a lifeline PPP loan that likely won’t need to be paid back.
More than 46,000 Minnesota borrowers received PPP loans in the first batch. Banks have been doing the right thing in these cases, said attorney Michael Rosow of Minneapolis law firm Winthrop & Weinstine. Some even waived that no-new-borrowing provision with a blanket statement rather than sending customers a letter.
This is the kind of thing that falls under the federal bank regulator guidance to “work constructively” with borrowers, as the Federal Deposit Insurance Corp. put it earlier as part of its response to the COVID-19 pandemic.
If ever there was a time for banks to follow that advice, it’s now. Foreclosures, debt restructurings and so on can be messy and destructive to the productive capacity of the economy.
We’re still early in this economic crisis, but banks should err on the side of keeping businesses able to recover and able to pay their workers and suppliers.
“What the regulators are trying to tell us is that if somebody is having problems with payments, I wouldn’t go forward with a collection action when really it’s not their fault” due to social distancing requirements including closures amid a pandemic, said Keith Ahrendt, the chief credit officer of regional banking firm Bremer Financial Corp. “It’s taking all that stuff into consideration. And I would say use common sense.”
Bankers have been busy in April, among other things processing the surge of PPP loans for customers. They’ve also taken quick action on other loans.
Big banks in particular, Rosow said, have made broad deferrals of payments or otherwise eased constraints on borrowers.
“What is very fair to say is that banks of all sizes have been going to extreme lengths to work with their customers,” he said. “One institution in particular has given all of its corporate borrowers 90 days of payment holidays, just across the board.”
There are many ways to help business borrowers besides deferring payments, including rewriting their existing loan agreements.
Business borrowers generally agree to a list of do’s and don’ts, from reporting financial results regularly to limiting how much money the owners can take out as profit distributions.
Borrowers might also need to hit financial performance targets, too, like generating sufficient cash earnings over the previous 12 months or maintaining enough asset value as collateral.
Those things, part of what are called loan covenants, are written into agreements to help the bank manage its risk. But they could be changed at least temporarily to see if this short-term economic crisis does flip to the beginnings of a recovery.
It might seem like generous and flexible bankers are a good thing for an economy at any point of the business cycle, but that’s not always the case. The term “loose banking” never describes a good thing.
Banks also have their own obligations to meet, including to depositors. And it’s generally unhealthy to let loan problems fester. This is sometimes explained with the metaphor of pruning a tree. No pruning, no new growth.
Bankers call managing loans in default “workout.” In workout, bankers hope to at least recover most of the principal and interest if not the full amount while keeping the borrower from tipping over.
If it comes to that, both sides have lost.
Loans often go into workout when the bankers conclude the borrower hasn’t done the right things to fix problems, Bremer’s Ahrendt said, obviously not the case for businesses affected by the stay-at-home order required to slow spread of the coronavirus.
If asset prices are declining and odds favor that trend continuing, though, then any bank might decide to move more aggressively. Bankers also can’t let a borrower keep burning cash with no end in sight.
What’s at stake is that no one wants the banks to contribute to making the economic crisis worse by precipitating a cascade of defaults, foreclosures and subsequent asset sales.
That’s the thing that makes recessions so brutal, how one bad thing leads to another. Households that lose income, like from a job loss, almost always reduce their spending, for example. And that ends up cutting the incomes of other people and then they cut back. And so on.
The same kind of thing can happen in foreclosures and messy restructurings, as workers get idled and more assets end up getting dumped on a market with too few buyers already. That can include residential real estate, since small-business loans might be secured by the owner’s house, according to a small-business lending survey.
One of the lessons of the Great Recession of 2007 to 2009 that sticks with Rosow, who chairs the Winthrop & Weinstine practice for banks and loan-servicing companies on workouts and debt restructurings, came from the niche of new concrete pump trucks used on construction sites.
He recalled an estimate from that era that there might be no demand for new pump trucks for 10 years as construction activity collapsed. Bankers and their customers working through loan problems in that industry, he continued, wanted to keep from flooding the used pump-truck market all at once.
“We saw the downward spiral that happened in the real estate market in 2008, and how that impacted everybody across the spectrum,” he said. “Financial institutions are very aware of that. [They] are working very hard to make sure that even those companies that aren’t going to make it are positioned to transfer those valuable underlying assets that maximizes the value and decreases the damage done to the owners.
“And that positions things to be turned on quickly.”