With the world’s attention, and understandably so, on any and every developing story related to the coronavirus pandemic, I thought I would take a quick look at a few underlying financial metrics that existed within the banking industry at year-end 2019, as compared to those same metrics just before the start of the Great Recession. The U.S. National Bureau of Economic Research (the official arbiter of U.S. recessions) states that the last recession officially began in December 2007 and ended in June 2009, spanning just over eighteen months. Consequently, I looked at relative measures of capital strength as they stood at quarter-end, September 30, 2007 versus those same capital ratios on December 31, 2019.

Instinctively I believed (and hoped) that the industry possessed stronger underpinnings today then just before the country entered the Great Recession, as a combination of regulatory mandates and guidance coupled with the prudence of lessons painfully-learned during the last devastating downturn have effectively yielded a more robust risk management architecture at most banks. The numbers bear this out, while I would also add that a cursory statistical review of the banking sector’s liquidity, reserve levels, existing problem assets, etc. also reflect, on average, a stronger foundation today as banks, and the nation, take on this enormous challenge. Focusing on key tier 1, leverage and risk-based core capital ratios, measurements are typically 15-30% higher for the industry at this time than they were when banks entered the Great Recession:

Last month we had touched on the current volatility existent in the markets (the Dow experienced eight consecutive days of 5% or more moves in the index, and an unprecedented eleven-of-fifteen such daily percentage swings over the last three full weeks of March), and the resultant downdraft in financial equities that has witnessed, on average, carnage of 35-40% for most bank stocks. Over the past five weeks, approximately $15 trillion of global stock market wealth has been eviscerated. And since “duration” of this pandemic continues to be the biggest unknown, it is virtually impossible to definitively assess the depth and breadth of the devastation (emotionally and financially) that will occur in the coming weeks and months. It has clearly become a case of epidemiology versus economics, with still too much uncertainty. Phrases such as “Slow the Spread”, “Flatten the Curve”, “Shelter in Place”, “Self-Quarantine”, and “Stay Safe / Stay Home” are now firmly part of the national lexicon. Fortunately, the banking sector entered this unprecedented challenge with a more solid foundation and a more robust risk management architecture.Timing is both the most critical and the most unknown factor. Consensus expectations already assume a brutal Q2. Goldman Sachs just revised its initial forecast of a 24% decline in GDP for the quarter, to now a 34% drop in Q2, with the expected unemployment rate jumping to 15%. Recessions are typically the result of gradually deteriorating market conditions, not immediate and devastating shocks.  Most market experts are preliminarily projecting unemployment estimates that range between 10% and 20% during 2020. St. Louis Fed president, Jim Bullard, has opined that he expects the unemployment rate to exceed 30% by the second or third quarter, before returning to around 4% by the end of next year. For context, unemployment peaked at 9.9% during the Great Recession, and approximately 24.9% during the Great Depression. Unemployment now stands at 4.4% in March (rising from its most recent 3.5% level), but with last week’s jobless filings, we are effectively already approaching Great Recession levels. As the market tries to assess when it expects both COVID-19 will be contained and when consumer confidence will return, stock prices have been swiftly and indiscriminately battered. Banks have absorbed the brunt of this sell-off, being one of the hardest hit sectors in the market, as they quickly traced toward levels last seen coming out of the Great Recession:

 

This is not a call to “back-up the truck” and load-up on bank stocks. Rather, it is simply a reminder that sometimes the pendulum can swing far (and wildly) before it begins to swing back. Coming out of the Great Recession as stability returned to the markets with the economy back on firmer footing, and banks having weathered a difficult storm during that financial crisis, investors were rewarded for their patience and perseverance as reflected in the chart above. Control that which you can, and remain laser-focused on the fundamentals of your operations. And try to take some solace, for whatever it is worth at the moment, that many economists are anticipating that economic stability and a return to a “new normal” should begin to surface later this year.With bank stocks trading at depressed levels, the market appears to have deeply discounted valuations in anticipation of future credit losses and possible capital needs as the industry moves through the unknown. The nation’s largest banks have suspended stock buybacks (probably a wise move, politically, as the “optics” look terrible for taking capital out of the market when potentially it could be re-directed toward lending support), while they have not followed their European brethren as yet in cutting or eliminating dividends. I believe the current dividend stance speaks to both the relative underlying strength of the U.S. financial sector, while also underscoring what very well could be a meaningful source of cash flow for many folks at this time. With virtually unprecedented economic devastation as a rapidly moving healthcare crisis potentially evolves into a massive economic downturn, the Fed is trying to keep a “liquidity crisis” from becoming a “solvency crisis” that could lead to a “banking crisis”. Consequently, I believe the emphasis has firmly shifted toward long-term strategic considerations as the next few quarters have already been effectively “written-off” by investors.

As bankers you are all accustomed to compiling reams of data and carefully assessing potential variables in an effort to make educated and informed decisions in running your business.  You diligently apply this discipline to determine the creditworthiness of your clients, while at the same time ensuring that your organizations have the resources and capital structure to support and safely conduct your operations. As is often said, if you can measure it, you can monitor it. Consequently, the early stages of this global pandemic not only feeds into our fears of the unknown, but also builds levels of frustration in many of us because the “information” is currently incomplete and therefore open to broad interpretation. Consequently, central banks around the globe have taken a “we’ll do whatever it takes” stance thus far until more definitive data and resultant clarity begins to present itself.

While the data coming-in continues to build, and will hopefully be voluminous in short order, it still seems a bit too early to tell how this is all going to play out. I would love to see the scale of universal testing ramp-up rapidly, so we can get a better handle on actual infection spread and fatality rates in order to better assess and implement that delicate balancing act between current social restrictions and economic policy. The Fed and the Treasury have taken extraordinary steps in an effort to keep the economy running, while hopefully also blunting the swift and dramatic body-blows to our nation’s small businesses. Keep in mind that small businesses are estimated to employ roughly half of the country’s approximate 155 million workforce. So with more than 95% of the U.S. population currently under some form of stay-at-home restrictions, it is easy to understand the immediate and dire need of our policymakers to inject $2+ trillion of stimulus into the economy. And, again, given both the uncertainty of the duration of this healthcare crisis, and the unknowns as to the near-term and long-term financial impact on our economy, this stimulus package is in all likelihood simply the initial down payment on additional support that may be required.

U.S. GDP is just over $19 trillion. Broad swaths of the national economy have been effectively shuttered to combat the growing enormous human toll of this pandemic. Approximately 6.6 million people nationwide (300,000 here in Michigan) filed for unemployment benefits last week. In previous deep recessions, most notably in 2008 and 1980, initial claims during the worst four weeks of those recessions approximated 2 million filings. This means the shock from COVID-19 has compressed a significant deterioration in the labor market into a much shorter period relative to previous contractions.

Again, for context, job losses measured approximately 9 million over roughly 18 months of the Great Recession. Claims filed over the past two weeks reveal that roughly 10 million workers have already been idled. The simple math implies that “duration” will dictate the size and speed of any additional government programs, but I applaud the efforts that recognize this is devastating and needs our immediate attention to deal with the economic hemorrhaging. And while “speed” can sometimes lead to some chaos and frustration in execution as the details play catch-up (visualize an airplane being built while it is already in flight) — as many of you are currently experiencing in trying to corral the process and parameters of SBA-oriented relief programs for your clients — take comfort in that most everyone is trying to navigate that same path in an effort to expedite the delivery of financial support to their communities.

In addition, take comfort in Fed and legislative responses gleaned from the devastating effects of the recent Great Recession, in recognizing that quick and decisive steps could and should be more impactful. Back then, financial market stress was the cause of the crisis, but support was needed in the financial sector to keep the plumbing intact even though some of the players were deemed to have helped cause the crisis in the first place. Today, support is largely geared toward the broad economy and its “victims” (individuals, small businesses), through no fault of their own that have been battered as they have adhered to government-ordered shutdowns and stay-in-place guidelines. The lack of any real or perceived corporate malfeasance this time around has enabled the Fed and Congress to direct stimulus and relief efforts in a manner that keeps our economic engine intact, albeit largely idled for the time being. During the Great Recession, Congress enacted the Economic Stimulus Act (2008), the Troubled Asset Relief Program (2008), and the American Recovery and Reinvestment Act (2009), which collectively “injected” approximately $1.6 trillion over nearly a two-year period. The CARES Act is designed to provide more than $2 trillion, with a notable emphasis on workers and individuals, over the coming days and weeks.

In much the same way, from a healthcare-oriented perspective we are learning as we go in responding to this pandemic. Ideally this will enable our country to assemble a comprehensive epidemiology-led “playbook” for dealing with a similar (or worse) medical crisis that may arise in the future.

Cryptically, many of the metrics used in the annual Fed-scripted CCAR stress testing exercises, focusing on a “severely adverse” hypothetical economic scenario (bottoming of Treasury yields, oil prices in a tailspin, GDP collapsing, dramatic increase in the Volatility index, significant plunge in the equity markets, etc.) are already playing-out. And with the recent surge in unemployment filings, a massive (and rapid) increase in joblessness appears to be the next domino to fall.

The Fed has slashed interest rates close to zero and is overseeing a new quantitative easing program, but monetary policy isn’t meant to encourage people to go out and buy items, so the Fed is also tapping its lending power capabilities. The notion of a “snap-back” in the economy depends on the course of the virus itself, which dictates how long the economy will remain in shutdown mode. Over this period, the economy needs to at the very least remain “functioning” and businesses need access to funding to survive the storm and re-open in the future. It appears obvious that no policy or set of policies can work unless the public health issue is resolved first, and in the process help the U.S. economy to avoid an extended downturn. Consumers aren’t unwilling to spend. They are unable to spend.

The duration of social interaction restrictions and mandated closings of “non-essential” businesses, while layering-in how quickly and effectively can the government’s stimulus assistance package get to small businesses while those same business seek to remain operationally intact, will dictate what form an ultimate recovery takes. And while I worry about the debt burden that may be assumed at the national level in the process, I am at the moment falling back on “let’s simply get through” if this really gets dire and then we’ll deal with the aftershocks later.  Time is a major unknown, but clearly if all of this extends for long it could build to different degrees of catastrophic. I continue to take tremendous comfort in the country’s legacy of unleashing the drive and determination to resolve the challenges we have historically confronted. I am confident this time will be no different in achieving a successful resolution, as we ultimately get to the other side of this arduous battle. The hope is that we all get to that other side. Compassion always has to win out, as no one can (or should) put a price on a human life — otherwise our society, and the ethical and moral fabric that holds it together, dissolves. We will get through this together.

Last month I wistfully expressed my hope that all the recently shuttered athletic facilities across the country were not at some point converted into de facto “field hospitals” to deal with a dramatic surge in COVID-19 cases. Unfortunately, that has now started. People are incredibly resilient and will willingly sacrifice if they believe it protects their family and friends. I think just about everyone recognizes the fluidity of the situation, and that no one has all the answers, but that we all share a common need to collectively shoulder this burden. It clearly is surreal, and it’s as if we have all been conscripted into a civilian-populated “Army” for a military exercise for which we have received no formal training, and where we cannot yet confidently confront the “enemy” in a manner that guarantees success.  However, I do take tremendous comfort in the sheer brilliance and ingenuity existent within our medical and scientific communities, which I believe are rapidly moving closer to the day we have a cure and/or effective therapeutic interventions. God bless them, and Godspeed.

 

Amidst the turmoil and uncertainty, management teams should continue to focus their attention on the following:
  • Review contingency plans to address potential capital needs, which can be initially framed via both disciplined stress testing exercises and revisiting the bank’s experiences during the recent Great Recession –
    • Shrink the balance sheet (organic)
    • Adjust dividend and/or stock buyback policies (organic)
    • Subordinated debt / preferred stock / common stock (external)
  • Assess current liquidity levels and prospective needs (stress testing) as customer reactions to the pandemic and economic shutdown may include unexpected line utilization (commercial) and deposit withdrawals (retail) –
    • Cash, securities, borrowing capacity, marketable loans
  • Analyze the bank’s existing or potential credit exposure to sectors of the economy that appear may/will be under extraordinary duress, and routinely revisit and discuss the bank’s underlying assumptions and expectations –
    • Small business, retail services, restaurants, hotels, travel-related, etc.
  • In light of continued market volatility, and ever-shifting moves on the yield curve, be sure to carefully assess the bank’s interest rate risk and potential exposure to multiple possible yield curve slopes in coming quarters –
    • Proactively review ALCO models and key assumptions

As I mentioned last month, on the community banking front be a source of information, communication and comfort. These are the times when community banks will truly differentiate themselves from the industry’s larger brethren. Be there for your customers in these difficult times by putting the resources and creativity of your organizations at the disposal of those now-struggling businesses that you recognize are the lifeblood of your communities.

I know we will get through this, but I also recognize that it is going to take time and may very well get even more challenging before it starts to get better.  That said, there are many people – medical & healthcare professionals, policemen, firemen, EMTs, delivery folks, people still interacting with the public as part of “essential services”, etc.  —  who continue to be at great risk, yet perform with compassion and a selfless energy.  Please, please, be kind to them, and let them know (from a distance) how much they are appreciated and treasured.

In closing, attached please find our monthly summary of Michigan’s financial institutions. And again, this simple but heartfelt counsel: Be careful. Be smart. Stay healthy. Take care of your family, your colleagues, your community. Most important, be sure to take care of yourself.

APRIL 2020 - MICHIGAN BANKING SUMMARY