Will community banks need more help from Washington?
Community banks have already shown their value to the economy in a time of crisis. When the Paycheck Protection Program became law by the CARES Act and was implemented by Treasury and the SBA, smaller banks in Texas and across the country worked long hours to make these loans available to their customers and other small businesses in their markets.
The COVID-19 pandemic has brought most businesses to a standstill and the unemployment numbers, over 20 million jobs lost as of April, reflect it. Employees and their families now have a couple of months of breathing room.
The effect of nonperforming and underperforming loans in community bank portfolios continues to be a concern. Congress recognized this by putting a provision in the CARES Act for accounting flexibility in troubled debt restructurings, a provision that we asked our senators to implement. While advantageous, the provision expires at the end of this year.
Some of the regulators in Washington D.C. understand the need for forbearance during the pandemic. In a conference call with Texas bankers in May, Federal Reserve Gov. Michelle Bowman, herself a former community banker, talked about the exam pause that the Fed was engaged in. She also mentioned that community banks are an essential part of the recovery and that the PPP process has shown that community banks have the unique ability to target funds where they are most needed.
But what if these efforts are not enough? Joblessness will continue to grow beyond the current 14.7% level and could reach over 20%, something the country hasn’t experienced since the Great Depression.
Fed Chairman Jay Powell says we need even more stimulus beyond the $3.3 trillion already allocated and a $1.48 trillion deficit. Thirty states have started to open their businesses, but will there be a serious retrenchment if there is a second spike in Coronavirus cases? What happens if a vaccine is not available for a year or two? What happens to community bank assets in an extended economic downturn?
Texas bankers of a certain age remember the late 1980s and early 1990s. Oil, projected to go to $60 a barrel, fell to single digits and commercial real estate prices fell. Until the failure of Washington Mutual, the biggest failure in FDIC history, was the 1988 collapse of FirstRepublic Bank, an institution that arose from the merger of a bank with a huge energy portfolio with another that had a large real estate portfolio.
More than 500 community banks failed. There were 1,927 bank charters in Texas in 1988. There are just a few over 400 now. We can’t afford to lose large numbers of these banks.
In a worsening economic environment, something may need to be done to preserve the viability of community banks, especially due to a crisis they had nothing to do with. Entire communities and agricultural borrowers depend on them.
In testimony before Congress in April, Jay Powell testified that Congressional action is needed to protect businesses and households from “avoidable insolvency.” Community banks are vital partners in this goal.
Options for federal action to preserve community banks
In 2008, Congress appropriated $700 billion in TARP monies that mostly went to the very largest banks. Some of those banks were responsible for the subprime mortgage crisis. Treasury stated they acted to save the most systemically important institutions.
In one transaction, $20 billion in TARP funds was cycled through AIG and given to Goldman-Sachs because AIG had no reserves to cover the credit default swaps they had sold. A strong argument can be made that community banks are systemically important as well.
While this is the simplest solution, it is also the most politically difficult. Which banks do and do not get federal funds will lead to allegations of favoritism, something that happened in 2008 and 2009. Additionally, many in Congress remember the TARP episode as one of the causes of a backlash and an inspiration for the Tea Party movement.
Four years to work through problem loans.
Community banks will need time to work with their borrowers or time to write off bad loans. A mandated regulatory four-year period without the application of GAAP will allow for this. To be eligible, banks will have to have been adequately capitalized and under no regulatory orders as of the end of 2019.
Loans directly attributable to the pandemic will have to be documented as well as efforts to work with borrowers. GAAP accounting would return in 2025. As far as the size of the banks eligible, a good number might be $10 billion. There are 5,397 banks under $1 billion and an additional 616 between $1 and $10 billion.
The ECORA bill allows banks to make ag loans without taxation on earned interest. Tax relief on PPP fees should be considered. Congress could also allow for tax moratoriums to allow banks to buttress capital.
If things continue to go south, all of these options should be on the table.