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The BAN Report: PPP Update / Housing Market Headwinds & Tailwinds / CRE Value Disconnect / Market Cool to Banks-9/24/20

PPP Update

Please forgive me! The biggest news on PPP has been the total lack of progress on processing PPP forgiveness applications. According to the American Banker, the SBA has not signed off any loan forgiveness.

The $1.6 billion-asset NexTier Bank in Kittanning, Pa., submitted the first of 95 applications on Sept. 15, while the $2.2 billion-asset First Choice Bancorp in Cerritos, Calif., has processed about 200 applications in recent weeks. The $1.4 billion-asset IncredibleBank in Wausau, Wis., has submitted 50 loans since the forgiveness portal opened on Aug. 10.

Each is still waiting for a response from the SBA.

“We have not yet had a single one validated,” said Robert Franko, First Choice’s president and CEO.

“To our knowledge, no one has yet received forgiveness,” Franko added. “There’s no question borrowers are tired of waiting. We have an automated system and everything can be done online.”

The SBA, which is administering the program with the Treasury Department, declined to say how many applications it has received or approved. The agency has 90 days to review files and reach decisions.

A recent GAO report highlighted the problem. Here are the key issues identified in the most recent report related to PPP (courtesy of the Coleman Report).

  • The SBA has begun to develop oversight plans but has not yet finalized or implemented them. Therefore, PPP remains vulnerable to fraud.

  • Although over 56,000 loan forgiveness decisions have been submitted to the SBA, the Agency had still not developed its process for reviewing lenders' forgiveness decisions as of August 14, 2020.

  • The lender's role in loan forgiveness remains unclear.

  • The resource demands and lack of clarity surrounding the application and forgiveness process have led to lender fatigue with the program, which could result in members being less likely to participate in future rounds of PPP.

  • The complexity of the loan forgiveness process creates an undue burden on forgiveness applicants and lenders. The review states a standard forgiveness application can take the borrower between 3-15 hours to complete. At which point, the lender may spend 50-72 hours reviewing complex forgiveness applications.

  • SBA lenders and CPAs are still advising borrowers to wait on submitting their forgiveness applications until SBA releases more guidance.

The GAO has not yet issued additional recommendations in light of these findings. However, its previous recommendations regarding oversight remain unresolved since the SBA has yet to finalize or implement their plans.

Banks are so anxious to move on from PPP, but these delays are not helpful. We strongly encourage the SBA & Treasury to get going on forgiveness, as it is disruptive to borrowers and their lenders. 

Housing Market Headwinds & Tailwinds

The US housing market is facing strong headwinds and tailwinds, making it highly difficult to project where the market is going. On the positive side, existing home sales are showing remarkable strength. In Southern California, home prices are setting new records.

The six-county region's median price reached $600,000 in August, up 12.1% from a year earlier, according to data released Wednesday by DQNews.

That was the largest percentage increase since 2014 and the third consecutive month during which prices set a new all-time high. Sales rose 2.4% from a year earlier.

“We have had houses with 40 to 50 offers,” said Syd Leibovitch, president of Rodeo Realty, which has offices throughout the Los Angeles area. “It’s just bizarre.”


Although the price leaps may seem unlikely amid double-digit unemployment, analysts say the trend reflects the uneven effect of the coronavirus and its economic fallout.

Compared with low-wage workers, people who tend to have the financial ability to buy homes have been far less likely to lose their jobs, and in some ways, their ability to purchase a house has only expanded.

Interest rates have plunged, with the average rate on a 30-year fixed-rate mortgage now below 3%. And many typical entertainment and recreational activities are still closed or operating at reduced capacity, leading some households to save more at the very time they realize they could use much more space.

But, some consumers are struggling to pay their mortgages. The OCC noted a decline this week in 2nd quarter mortgage performance.

The OCC Mortgage Metrics Report, Second Quarter 2020 showed 91.1 percent of mortgages included in the report were current and performing at the end of the quarter, compared to 96.1 percent a year earlier.

The percentage of seriously delinquent mortgages—mortgages that are 60 or more days past due and all mortgages held by bankrupt borrowers whose payments are 30 or more days past due— increased 5.4 percent from the previous quarter and 5.3 percent from a year ago.

According to HUD’s report in July, 17% of FHA loans are either delinquent or in forbearance. Distressed sales will undoubtedly increase when various foreclosure moratoriums end.CoreLogic predicts that distressed sales will cause home price appreciation to slow to nominal levels by next year.

 "The CoreLogic Home Price Index registered a 4.3% annual rise in prices through June, which supported an increase in home equity," Frank Nothaft, chief economist, said in a press release. "In our latest forecast, national home price growth will slow to 0.6% in July 2021 with prices declining in 11 states. Thus, home equity gains will be negligible next year, with equity loss expected in several markets."

Only 3.2% of homes have negative equity currently. In 2009 at the peak of the housing crisis, this figure peaked at 26%. So, one should expect less borrowers walking away from their homes or strategically defaulting. Moreover, the US has been under-building homes for some time, so supply should remain manageable. Time will tell if home prices continue to increase due to limited supply, low rates, and a suburban boom, or the stress in existing mortgage portfolios creates negative disruptions.

CRE Value Disconnect

Price discovery on commercial real estate is difficult right now. While there is a consensus that prices have dropped for many assets,  buyers and sellers still seem far apart and there are few sellers that have been forced to act yet.

“The disconnect right now is that values have fallen much faster than pricing, but we’re not observing it yet because there has been a huge falloff in transaction volume,” says Anthony M. Graziano, MAI, CRE, chief executive officer at Integra Realty Resources (IRR).

Graziano estimates that office values have declined between 5 percent and 20 percent, hotels between 30 percent and 35 percent and retail between 25 percent and 40 percent. Those properties that are seeing the bigger discounts are due to some type of systemic vacancy problem or shutdown, or a capital infusion will be required after purchase to stabilize the asset.

Some investors are looking to the public markets for clues on how pricing has shifted. The Green Street Commercial Property Price Index shows that the all-property index is 10 percent below pre-COVID-19 levels with pricing that varies widely across property sectors. Those sectors that have seen the biggest declines in property values year-over-year through August include malls, down 28 percent, lodging, down 25 percent, strip retail, down 14 percent, and student housing, down 11 percent. The only two property sectors that continue to show price appreciation are manufactured housing, up 10 percent, and industrial up 7 percent.

A fundamental problem in most CRE sectors is projected both current and future rent collection. A story last month in the NY times showed the contrast between multi-family landlords and their tenants.

Almost from the moment the coronavirus upended the economy in March, there has been a persistent fear that the loss of wages and employment, concentrated among lower-income service workers, would lead to widespread evictions. According to one study, as many as 40 million people in 17 million households risk eviction by the end of the year — an astounding figure.

Yet interviews with dozens of landlords across the country returned comments like “no difference,” “pleasantly surprised” and “seems like normal.” That view is reinforced by the corporate earnings reports of housing providers and a weekly survey of big landlords by the National Multifamily Housing Council, which for several months has shown little difference from rent collections a year ago.

On its face, the disconnect between upbeat landlords and anxious tenants seems to expose a glitch in the data or an example of the growing economic dissonance — like the stock market’s rise to new heights despite a 10.2 percent unemployment rate. What it actually shows is that for all of the government’s problems in containing the virus, financial rescue efforts were largely effective in keeping tenants in their homes.

As we’ve stated, no one really knows what’s going to happen when borrowers and tenants need to resume their obligations. But, some are certainly struggling. For example, almost 90% of New York City bar and restaurant owners couldn’t make their rent in August.

Eighty-seven percent of bars, restaurants, nightclubs and event spaces in the five boroughs could not pay their full August rent, according to data from 457 businesses surveyed between Aug. 25 and Sept. 11, in a new study released Monday by the nonprofit NYC Hospitality Alliance.

It’s a 7 percentage-point increase from June and a four-point jump from July, darkening the dire picture for eateries desperately seeking relief following six months of partial — and in some cases total — closure due to COVID-19 shutdowns.

Some 34 percent of this group said they could not pay rent at all last month, and only 12.9 percent were able to meet full payments.

When buyers, sellers, and lenders can’t agree on current NOI or future NOI, it makes deals difficult. Unfortunately, some owners will become forced sellers and then we will get a better picture on values. On that note, Wells Fargo filed a foreclosure action on the Palmer House in Chicago, which has been closed since March.

Wells Fargo Bank said in court papers last month that the hotel’s owner, real-estate investor Thor Equities, was in default on its $333.2 million first mortgage, making the property one of the first major foreclosure actions during the pandemic. The Palmer House was worth $305.5 million shortly before Wells Fargo filed its action, appraisers said.

Most property owners and lenders at first hoped that damage from the pandemic would be limited to an interruption of a property’s cash flow, without hurting long-term values. Creditors granted landlords forbearance or restructured loans, hoping they would be able to stay alive until business returned.

Now, some see the foreclosure action against Palmer House as a sign that lenders might be getting tougher, more willing to start the process of seizing control of hotels after defaults.

The Palmer House, which has been closed since March, also shows how rapidly hotel values have deteriorated during Covid-19. Appraisers said the property was valued at $560 million as recently as 2018, plummeting 45% since then.

While there is certainly stress in the commercial real estate market, there is plenty of capital and debt that is on the sidelines, but they are waiting for the defaults to stress values before acting.This is precisely why we have urged banks to move sooner rather than later.   We are encouraged recently by the strong demand for distressed loans portfolio and expect product to increase significantly, especially as banks lose their CARES Act TDR-relief at year-end.

Market Cool to Banks

While the stock market is essentially flat for the year, bank stocks have not received the same love from the market despite some strong performance amongst banks, particularly those with strong trading, capital markets, and mortgage origination platforms.

The KBW Nasdaq Bank Index is down 38% this year, while the S&P 500 is up slightly. If that gap were to persist, it would be the banks’ worst full-year underperformance in at least 84 years, according to Barclays analyst Jason Goldberg.

Investors have good reason to be concerned. The coronavirus recession has taken a toll on banks’ bread-and-butter lending businesses. Near-zero interest rates and the tens of billions of dollars they have set aside to cover bad loans have cut into profits, outweighing the trading gains.

Banks in the S&P 500 are still expected to post a median 38% decline in third-quarter earnings per share, worse than the broader index, according to FactSet estimates. Financial companies focused more directly on capital markets are pegged for a smaller, 11% decline.

Still, after the Barclays conference last week, Mr. Goldberg suggested the selloff is overdone and lifted his earnings estimates for most of the banks. “We heard more good than bad,” he wrote in a research note.

Investment banking is another bright spot. Banks have done brisk business helping companies raise cash to ride out the downturn, earning fees advising clients on stock and bond sales and, later, trading those securities.

The banks in the KBW bank Index are trading at 77% of book value, on average. Investors are discounted banks because they are concerned about their asset quality and record-low net interest margins. The environment is challenging for banks, but those who out-perform in mortgage origination, trading, and capital markets will perform the best.


The BAN Report: Back to School / Eviction Update / House Questions PPP Oversight / Child Care Costs Surge / LIBOR Transition-9/3/20

Back to School

Schools and colleges are loading up on pandemic-related items, including keyboard covers, webcams, and plexiglass.

Schools and colleges are purchasing these and other protective products in great quantities as they try to prevent the spread of the coronavirus and calm concerns of teachers, students and parents.

The average U.S. school district will spend nearly $400,000 on products related to the pandemic response, according to an estimate from the Association of School Business Officials International. The Cares Act included $30.8 billion in emergency funding for schools and colleges.

Increased demand from the tens of thousands of U.S. schools and colleges is providing a boost to manufacturers whose sales to other sectors hit particularly hard by the coronavirus, such as the restaurant, travel and entertainment industries, have fallen. Some manufacturers, particularly those that don’t normally count schools among their customers, are straining to meet so much new demand.

The University of Illinois at Urbana-Champaign has been the leader in widescale testing on campus, administering its own two-weekly saliva test.

Here’s how the UIUC system is set up. Each person who comes to campus gets an initial test, then must get tested twice a week. A negative test result within the past four days is linked to your ID via a university-developed tracking app, and without that green light you won’t be admitted to university buildings.

A key component of UIUC protocol is its saliva-based test, which was developed in-house and is similar to one developed at Yale. As researchers at Yale outlined, nasal swab tests have several disadvantages, notably that the swabs can be in short supply, testing requires health care workers to use lots of PPE, and there are also shortages of the special chemicals needed for processing. Those factors make testing expensive and mean tests can take days to process: “Meanwhile, if patients don’t quarantine while awaiting test results that turn out to be positive, infection can continue to spread,” the Yale authors wrote.

In contrast, the UIUC website says that typical saliva test results are available within five hours. A map of on-campus testing centers shows 17 locations, something of a miracle to any city- or suburb-dweller who has had to travel miles—or even to another state—to find an available COVID test.

Even with these protocols, Illinois has seen a recent spike in cases due to campus parties and they are now enforcing stricter protocols.   But, to their credit, they are offering an in-person experience. Many students are questioning why their tuition has remained the same while the product offering has been downgraded to online-only.

WSJ Noted spoke to more than two-dozen college students at both public and private universities, as well as about a dozen college officials for this article. These students overwhelmingly say they shouldn’t have to pay full tuition if instruction is online. Many institutions maintain that, regardless of the mode of delivery, the ultimate value lies in the education they provide. And, in terms of fees, colleges also say they are necessary to maintain services that draw students to their institutions in the first place. 

Colleges are in a bind as national enrollment dropped by over 200,000 students last year, largely due to the cost, which has grown much faster than median income. But, paying the same for online classes has touched a nerve for many and there are more than 100 lawsuits seeking refunds.

Eviction Update

As courts have re-opened and state eviction moratoriums end, retail landlords are launching eviction proceedings against their delinquent tenants.

While overall retail rent collections have improved to 77% in July from around 54% in April, some tenants, particularly from the apparel, fitness and theater categories, have continued to struggle with payments, according to data from Datex Property Solutions, a real-estate data firm that tracks rent collection on thousands of properties across the country.

During the coronavirus-shutdown period that started mid-March and extended to as late as August in some cities, tenants have implored their landlords for deferrals and lower rents to stay in business. States also imposed moratoriums on commercial-real-estate evictions, which offered temporary respite until they expire. New York Gov. Andrew Cuomo extended the state’s moratorium until Sept. 20 from a previously extended Aug. 20 deadline.

Landlords said they have modified tens of thousands of leases over the past few months, including deferrals or discounts in exchange for lease extensions or other concessions, such as the removal of clauses that prohibited certain types of tenants in the neighboring space, such as direct competitors or other uses of common-area space. But for some, negotiations reached a stalemate and landlords said they have no choice but to resort to litigation.

In Minneapolis, Eric Ruzicka, a partner at Dorsey & Whitney LLP, said his law firm has commenced around 30 eviction filings for commercial tenants, including restaurants, children’s play zones and bridal shops that were hurt by the drop in tuxedo rentals for proms.

As deferrals from lenders run off, landlords need to collect their rents in order to make their loan payments.   Securitized lenders, in particular, seem to be acting faster to demand loan payments, as they did not receive the same relief from TDR status that the banks received from the CARES Act.   Tenants and landlords not paying their rents and mortgages only work so long as the lenders play along, but that can’t last forever. Apartment evictions are still subject to various state, local and federal moratoriums. This week, the CDC announced a four-month ban on most evictions Tuesday. Here is who is covered:

“Covered person” means any tenant, lessee, or resident of a residential property who provides to their landlord, the owner of the residential property, or other person with a legal right to pursue eviction or a possessory action, a declaration under penalty of perjury indicating that:

1) The individual has used best efforts to obtain all available government assistance for rent or housing;

2) The individual either (i) expects to earn no more than $99,000 in annual income for Calendar Year 2020 (or no more than $198,000 if filing a joint tax return),6 (ii) was not required to report any income in 2019 to the U.S. Internal Revenue Service, or (iii) received an Economic Impact Payment (stimulus check) pursuant to Section 2201 of the CARES Act;

3) the individual is unable to pay the full rent or make a full housing payment due to substantial loss of household income, loss of compensable hours of work or wages, a lay-off, or extraordinary7 out-of-pocket medical expenses;

4) the individual is using best efforts to make timely partial payments that are as close to the full payment as the individual’s circumstances may permit, taking into account other nondiscretionary expenses; and

5) eviction would likely render the individual homeless— or force the individual to move into and live in close quarters in a new congregate or shared living setting— because the individual has no other available housing options.

This is an extraordinary intervention in housing by the CDC that will likely be challenged. Unfortunately, evictions are a necessary tool for landlords to manage their delinquent tenants and continued government intervention may produce negative externalities.

House Questions PPP Oversight

A report from the majority staff of the Select Subcommittee on the Coronavirus Crisis questioned the oversight of the PPP programming, raising a number of issues affected tens of thousands of loans.

  1. Over $1 Billion in Loans Went to Companies That Received Multiple Loans. Staff analysis identified 10,856 loans in which the borrower received multiple PPP loans, for a total of over $1 billion in outstanding loans. Of the 10,856 loans identified, only 65 would be subject to additional scrutiny based on the Administration’s stated plans to audit loans over $2 million. PPP rules prohibit companies from receiving multiple loans.

  2. More Than 600 Loans Totaling Over $96 Million Went to Companies Excluded From Doing Business With the Government.  Staff identified 613 PPP loans, amounting to $96.3 million, provided to borrowers that are ineligible to receive PPP funds because they have been debarred or suspended from doing business with the federal government.

  3. More Than 350 Loans Worth $195 Million Went to Government Contractors With Significant Performance and Integrity Issues. Staff found that SBA approved 353 PPP loans, amounting to approximately $195 million, to government contractors previously flagged by the federal government for performance or integrity issues.

  4. Federal Database Raises Red Flags for $2.98 Billion in Loans to More Than 11,000 PPP Borrowers. Select Subcommittee staff compared the federal government’s System for Award Management (SAM) database against the information companies used to obtain PPP loans to identify red flags, such as mismatched addresses. These flags implicated more than 11,000 borrowers and $2.98 billion in PPP loans.

  5. SBA and Treasury Approved Hundreds of Loan Applications Missing Key Identifying Information About the Borrower. These PPP loan applications were approved despite incomplete or missing identifying information on the loan applications, including missing names and addresses.

One should not be surprised that a small percentage of the PPP loans have serious issues. Many of these issues will be addressed during the forgiveness process, as many of these borrowers will not get forgiveness. Secretary Mnuchin did say earlier this week that all of the loans are subject to an audit.

Child Care Costs Surge

COVID-19 has disrupted the cost structure of child care providers, as their costs have jumped 47%.

The coronavirus pandemic has battered child care providers in the U.S. over the past six months, forcing many to close, at least temporarily, and demanding those open adhere to new, stringent safety guidelines. 

Unsurprisingly, these challenges have had financial consequences. To meet the enhanced health and safety guidelines imposed by local and federal agencies, the costs for licensed child-care centers have increased an average of 47%, according to a new report by the Center for American Progress. Home-based family child care is seeing costs increase an average of 70%. 

The cost increases are driven in large part by the need to source and purchase additional sanitation supplies and personal protective equipment for staff. Social distancing guidelines — typically limiting class sizes to groups of 10 — also remain a stumbling block. These restrictions generally reduce the number of children a provider can enroll and increase staff costs. 

The largest expense for child-care providers is staff, according to Simon Workman, American Progress’ director for early childhood policy and author of Tuesday’s report. Staff compensation typically makes up about 70% of a provider’s business budget, even though the average employee makes just above $12 an hour. 

Rising child care costs make returning to the office more difficult. So far, child-care providers have not raised their tuitions, but the providers can’t bear the burden of higher costs indefinitely.

LIBOR Transition

Will there ever be a cooler index than the “London Inter-Bank Offered Rate?” I remember my old man fondly telling me that the bank likes him so much that they gave him a “LIBOR loan.” Who wants to be a Prime Rate borrower when they can get LIBOR? Unfortunately, we only have 500 days left of LIBOR. Meredith Coffey of the Loan Syndications & Trading Association had some great recommendations on phasing out LIBOR.

New business loans should include hardwired U.S. Dollar Libor fallback language by Sept. 30, 2020. This hardwired language just means that a loan will automatically convert from Libor to SOFR, instead of undergoing a time-consuming amendment process. There are more than 10,000 U.S. dollar syndicated loans outstanding; quickly executing so many amendments to replace Libor when it ends would be challenging—even in a benign market. And there should be no presumption that the market will be benign when Libor ends.

Third-party technology and operations vendors should complete all necessary enhancements to support SOFR by Sept. 30, 2020. Lenders and borrowers must be confident that SOFR can be operationalized by Libor cessation as they begin using hardwired fallbacks. The ARRC Business Loans Working Group has worked for over a year with vendors and lenders to develop conventions and calculations to help update loan systems.

No business loans using U.S. Dollar Libor should be originated after June 30, 2021. This is just six months before the potential end of Libor. At that point, it seems wildly inadvisable to add still more deals to the loan backlog that must convert from Libor.

For business loans specifying that a party will select a replacement rate for U.S. dollar Libor at their discretion, that party should disclose to relevant parties the replacement rate they anticipate selecting at least six months prior to when it would become effective. Granted, that’s a mouthful, but lenders and borrowers will need to prepare to transition their loans and uncertainty around the replacement rate makes a challenging process that much harder.

This is a massive headache for lenders, many of whom have notes written years ago that do not even contemplate the end of LIBOR. And, there is no clear question as to what replaces LIBOR, although SOFR has been endorsed by the Fed.

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