When the Paycheck Protection Program was launched on April 3, the first group of lenders to step up and help small business owners access desperately needed capital were credit unions and community banks. Bank of America took action as well, but other major players, like JP Morgan and Citi were slow to get involved, and the Small Business Administration’s PPP portal was plagued with probles that frustrated users at a time when all they wanted was answers. It was the smaller institutions that pulled through.
“Community banks and credit unions were the heroes of the program, stepping up to support businesses in their communities,” says Carl Streck, CEO of MountainSeed Real Estate Advisors.
With significant portions of their earnings and balance sheets taken up by loans on commercial real estate assets whose revenues have been wiped out by COVID-19 – hotels, neighborhood retail centers, restaurants – Streck says these smaller lenders, who account for around 95 percent of the financial institutions in the U.S., are now facing risks to their bottom lines.
As commercial entities struggle to generate income and fail to make their interest payment, their lenders will experience shortfalls of their own.
“When that happens broadly throughout a bank’s balance sheet, the bank has a real struggle,” says Streck. “We’re going to begin seeing large amounts of commercial real estate bank loans in default, in restructuring, in foreclosure because the market fundamentals have changed for the foreseeable future.”
Those defaults haven’t materialized yet, but they could start popping up with alarming frequency this summer. At the beginning of the COVID-19 quagmire, Streck explains, many smaller banks and credit unions gave their commercial clients forbearance periods of 90 days. That means the first wave of non-payments could be on its way as soon as next week.
“I think the banking system is waiting with bated breath for July 1 to roll around to see if borrowers will not have the ability to pay their mortgage payments en masse,” Streck says.
If that happens, he expects re-appraisals will be ordered on the afflicted properties, which could be disastrous for commercial property owners. A property whose value has plummeted could see its LTV explode, say from 70 percent to 120 percent. Owners of these sinking properties will then need to provide significant amounts of additional equity to get the loan back in compliance with its LTV requirements.
“The borrower may or may not have the equity to put into the deal,” Streck says. “There’s going to be a lot of restructuring that goes on in the back half of 2020.”
Credit unions and community banks have been strengthened considerably over the last ten years by the same rules, guidelines and liquidity requirements put in place to protect the industry’s largest players after the Great Recession, so Streck isn’t worried about these smaller institutions following their clients down the road to insolvency. But they will face severe administrative challenges for in the coming months.
The Paycheck Protection Program already meant a lot of heavy lifting for these banks. “Forgiveness,” says Streck, “is going to be extremely difficult.”