First off, apologies for not writing for a few weeks. I have had a few “too many irons in the fire” lately, and although still in that situation, I decided to take a break tonight and get a post out. And quite frankly, I am irritated at my government right now.
Our great, all-wonderful Federal Reserve (hint–sarcasm alert!) has decided to flood the corporate debt markets for the first time ever, and quite likely against their Congressional mandate and therefore illegal, to buy corporate debt securities. And this includes some bonds that are in the first tier of “High Yield,” or more commonly called JUNK, to support our large corporations. Yes, these same corporations who have lived off the benefit of too-low interest rates for the past 8-9 years. If you doubt this, look at the amount of refinancing activity since we were hit by the coronavirus, totaling $1.9 trillion. The dollar floodgates have opened up!
But my bone to pick this week is not with the Fed or the large companies, who are just taking advantage of the opportunity given to them. If I were a CFO of one of these companies, you’re darn right I would be issuing some corporate bonds as well. I do know a good deal when I see one!
However, lost in all of this noise is the lack of funding for our country’s small- and medium-sized businesses. Just in the past week, I have read a few articles about how we are leaving the small businesses at the curb as we make sure the large companies have a lifeline of financing to survive these tough times. Even Fed Grand Pubah Powell referred to small businesses as a “jobs machine.” And yes, we had the first round of PPP loans that were “targeted” to small businesses. Yes, those with less than 500 employees. Really, 500? When did that constitute “small” businesses? And there were many stories early on of large companies lining up at the small business trough, where luckily many of them were shamed into returning the funds.
But there were also other problems with these funds. For example, they were only for amounts to cover wages, and converted to a grant (not owed back) if you kept your employees hired during the pandemic. After these details were discovered, many companies who needed the money gave it back. Why? Because first, wages for many small businesses do not even start to cover fixed costs. Costs like rent, some amount of utilities, interest on existing loans, etc. Wages are one cost that is variable, where worst case you can temporarily lay off workers until you can reopen your business. Oh, and many workers that would have been laid off could actually make more money by getting unemployment, which made the whole premise of these PPP loans unnecessary.
Then, the PPP loan fund quickly ran out of funds. So many businesses who could have taken advantage were not quick enough to get in line. Now, I am beginning to read stories about how many of these small businesses are shutting for good. And quite frankly, our government assistance on this has been underwhelming.
I have purposely stayed out of “politics” on my blog, as I see no reason to alienate anyone. However, how is this for a neutral take on our representatives in Washington? I doubt there are any elected officials in Washington who care for our country as much as they care about being elected. I guess I have gotten a lot more cynical as I have gotten older. OK, that is all from me on politics.
So back to my small business rant. So late Tuesday night, as I did some light reading before falling asleep, I read the weekly Thoughts From the Frontline newsletter from John Mauldin (it’s free by the way, and a weekly must-read). And John had written about some alarming discoveries about the availability of financing for these struggling small businesses:
Stiff Drink Time
Whether it’s a bond or a bank loan, recovery potential is part of credit analysis. Defaults usually aren’t a 100% loss. What can we expect to get back if the borrower can’t repay? If you have collateral worth, say, 70% of the loan value, then you are taking less risk as the lender and can loan more freely.
Even better is to have the federal government standing behind a portion of the loan. That’s how Small Business Administration loans work. The SBA typically guarantees 50% to 85% of a loan amount, which lets banks offer more flexible terms than many small business owners could get on their own.
Keep in mind, many small businesses are struggling now but not all. Some have new opportunities in this environment. With capital, they could expand and maybe create jobs for the millions who need them. But they need capital first.
Last week I read and reposted a Twitter thread by someone describing himself as a consultant who helps franchisees get loans, often via SBA guarantees. I asked him to contact me and was able to verify his identity, though I can’t reveal it here. He described a terribly frustrating credit environment in his space. Below is a portion of his thread.
“The banks I work with are SBA, conventional lenders who service smaller loans under 2mm and generally smaller operators of these franchise systems, and then larger banks who provide loans to larger operators from 2-50mm. I’m short–20+ banks across ALL spectrum of SME lending.”
“I fund 400-500mm in loans per year through these banks. In February we were on pace to fund well over 500mm and potentially 700mm–growing exponentially year over year.” STIFF DRINK TIME. “Since April 1st we have funded 5mm total through only 2 banks. Let’s dive in as to why.”
“SBA banks–they have lending limits to 5mm. Congress has authorized them to go to 10mm in the CARES Act but they have ignored it. This will become important later. They currently have guarantees from the govt at 80%–pretty good right? DOESNT MATTER THEY STILL WON’T LEND.”
“In fact, they are pushing the government to guarantee 90% of the loans (and likely on their way to 100%–see my prior posts on the de facto nationalization of the banking system). In short SBA has SHUT OFF BORROWERS waiting for more from Uncle Sam.”
“Current excuses ARE PLAYING BOTH SIDES (and this applies to all banking segments). A chain with increased sales since pandemic–no loan. ‘We want to wait to see if sales increases are sustainable.’ Doesn’t matter that sales are up. They may not be ‘sustainable.'”
“On the other side for businesses with sales down–‘well we just aren’t comfortable sales will rebound and we have concerns over COVID.’ So, sales up = no loan. Sales down or flat = no loan. Operator size IRRELEVANT. Are some banks lending? Yes. This is 75-80% of SBA banks.”
“They are also being EXTREMELY selective on industries they will do. If you are in an industry with ‘large public gatherings’ you better pray to Santa Claus for money.”
So, businesses with solid revenue still can’t get capital even when the government will guarantee 80% of the risk. Economic recovery will be very hard if this persists. All those loans not being made represent business activity that won’t happen, buildings not constructed, jobs not created.
It doesn’t mean the situation is hopeless. But it probably means we will be stumbling through this morass even longer.
John Mauldin, Thoughts From the Frontline, August 8, 2020
Update on the Economy
Sorry, enough ranting. It takes a lot to get me riled up, but when I do get riled up, watch out. Let’s hope our elected officials remember the little guys who are the backbone of our economy. Although I fear it will be after the election, if at all, before it happens. I do appreciate John’s optimism, though!
So, how is the economy? I am actually starting to see some encouraging signs, even with the COVID spike in the U.S. right now. Retail sales are showing signs of life, and jobless claims continue to drop. Are we out of the woods? Well, not really. At least not yet.
I continue to read speculation that we may be getting a false sense of security, especially with the government stimulus that continues to flow. The additional $600 in federal unemployment support has, in my opinion, been huge. As I mentioned earlier, many who are laid off have more disposable income than when they were working. Add to that the stimulus checks everyone received, and that has likely kept things better than the underlying reality.
I was talking to my sister earlier, and she recounted a conversation her husband had with a salesman at a car dealership. My brother-in-law was inquiring why there was a very limited selection of cars on the lot, and the salesman said that with the stimulus checks, they couldn’t keep cars on the lot as they were selling so quickly. He then added, “Just wait a couple of months, when we get a lot of repos.” How true!
I believe President Trump made a smart move with the executive order to re-approve the federal unemployment benefit, albeit at $400 instead of $600. Illegal? Probably. To get reelected? Of course. But smart, as he boxed the Democrats in from being able to call him on it, as they would likely suffer politically. Sorry, got into the political ditch again. Oh well.
But that does likely keep the economy limping along at least through the election. And maybe we can continue to build momentum between now and then. However, not all is rosy.
In an article earlier this week, ZeroHedge discussed the “biblical” wave of bankruptcies now arriving, something I have been tracking since early on in this recession.
There was a spike in bankruptcies during the week of June 13-20, in fact the highest weekly filings since May 2009. And most of us can probably remember back to that time. And those are just larger companies with over $50 million in liabilities. As we just covered, many smaller businesses have also closed for good. So we are not out of the woods of this recession yet. And mortgage lenders are also preparing for a significant wave of delinquencies as well. In fact, it is being reported now that getting financing for mortgages, especially the larger jumbo mortgages, is difficult. Banks are uncertain about how much loss exposure they have with existing loans, so they have become very conservative with lending more and potentially adding to their exposure.
U.S. – China Relations
As we move further into this Fourth Turning, we should all keep watch for geopolitical issues that start to escalate. And there is no bigger area of potential conflict than the U.S. and China.
There are three primary kinds of wars. Trade wars, currency wars, and shooting wars. And maybe we can add a fourth, political war. When it comes to the U.S. and China, we have had a trade war brewing for a couple of years now, along with some currency spats. Things are now escalating politically, with the U.S. closing the Chinese consulate in Houston, followed quickly by China closing the U.S. consulate in Chengdu. Add to that the Hong Kong issue, and this is one to watch.
I am not about to get into who is right or wrong on any of these, especially being married to someone who is from China. So I remain diplomatically neutral, if for no other motivation than to have a happy, harmonious home life! But I am concerned with the escalations taking place. This week, we had a cabinet-level U.S. representative visit Taiwan for the first time ever, followed by China war games to the north and south of that island, along with an apparent build-up of military assets across the straits from Taiwan. Then, the U.S. flies a group of stealth bombers to Diego Garcia in Asia, added to the already-present patrols of aircraft carrier battle groups in the area. One wrong move by either side, and we could end up with shots fired.
Let’s hope cooler heads prevail. But this is not the only area where tensions could erupt. Greece and Turkey are close to blows in the Mediterranean as well, as Turkey and Russia square off on opposite sides in Libya. It’s getting hard to keep up with the potential areas for significant conflict. As Neil Howe has said, not all Fourth Turnings end in a shooting war, but many do.
That’s all for me this week. Thanks for letting me rant. And get into politics a bit, although I will endeavor to avoid that minefield in the future. We have enough minefields in the world without me adding to it.
Brent
Seay Economics 