Will Fed’s new rate cut disrupt post-coronavirus lending?

New report questions if banks will “fully open up their lending spigots”

Will Fed’s new rate cut disrupt post-coronavirus lending?

Originators are facing a bold and challenging environment as the coronavirus pandemic wreaks havoc with the U.S. and global economies. But what is going to happen after the pandemic has abated. At least one source is worried that today’s new normal will not revert back to the pre-pandemic way of doing business.

Kroll Bond Rating Agency (KBRA) is warning that the Federal Reserve’s Sunday night slashing of the federal funds rate could drastically change the lending landscape and consumer access to credit. According to a report authored by KBRA Senior Director Ethan M. Heisler and Chief Strategist Van Hesser titled “Coronavirus (COVID-19): Fed Does Shock and Awe,” the pre-coronavirus banking industry was “struggling to grow loans in the face of restrictive regulatory guidelines and fierce competition from public and private capital markets and shadow banks. The industry’s loan-to-deposit ratio remained rangebound at historic lows around 70%.”

The new health crisis forced many businesses to “draw down on lending lines to bolster financial flexibility in the face of coronavirus-related uncertainty,” the report continued. While the report praised the strength of the banking system and predicted it “should be part of the solution during the unfolding crisis,” it also warned that nonbank lending sources “may be tested during the current pandemic.”

As for the post-coronavirus era, the report’s authors admitted being “skeptical that banks will fully open up their lending spigots – they are not any more interested in catching a falling knife than an investor.” Furthermore, the report speculates that current Fed actions to soften the blows to the economy from the coronavirus and a new policy that went into effect at the start of the year could also create unexpected challenges to lenders and borrowers. 

“While the Treasury market will be swimming in liquidity thanks to the Fed’s actions on March 12, the knock-on effects of an economic downturn on bank loan portfolios will lead to a rise in credit losses for banks,” the report stated. “In addition, the new accounting rule, Current Expected Credit Loss (CECL), went into effect on January 1, 2020, before the virus was generally known or viewed as a threat. Under the plan that bank regulators adopted last year, banks could phase in the regulatory capital effect of the transition increase in the allowance for credit loss over four years, until January 1, 2023. 

“But, if the economy does dive into recession,” the report continued, “the new CECL reserve may have to be adjusted well above the level set on January 1, when many banks adopted CECL and when the economic future looked so benign. The regulatory option, unfortunately, does not provide for the phase-in of this additional increase. Banks – particularly those that lend to consumers and who warned in the last quarter that the mix of CECL amid a recession could lead to a credit crunch – could pull back from providing liquidity to borrowers in an effort to conserve core capital. We will soon discover just how pro-cyclical CECL will be.”