Banking in the Age of COVID-19

March 20, 2020

The events of the last few weeks have been shocking—both from a societal viewpoint and the impact on individuals, governments, and businesses worldwide. After being a lender through the Texas real estate crash of 1986–1990, the tech bubble bursting and 9/11, and the 2008 financial crisis, I see elements of all of those events unfolding in recent weeks. The breadth, suddenness, and unforeseeability of this crisis is shocking.

After 9/11 we had airlines shut down for 7 to 10 days and sports teams took a few days off out of a sense of respect and patriotism. But the number of businesses impacted by COVID-19 so far, and the length of the potential impact, is startling. Not knowing the duration and the immediate revenue impact is stark—thus the Fed’s reducing interest rates to 0 percent in March—itself a stunning move in what was a healthy economy at near full employment. It tells you what the Fed knew and what we may not be able to see yet.

From a credit perspective, I see a few things that CEOs should consider immediately:

Recast your 2020 and 2021 financial plans, assuming drastically lower revenues immediately. You should have a worst-case plan that is darker than your imagination allows. This should be completed and reviewed with your board this week.

If your liquidity was tight before now, you need to undertake immediate steps to preserve existing liquidity and draw down alternative sources of capital with only secondary regard to the dilutive effects on capital.

Remember that there are two bars to clear with banks—one higher bar to get new credit and a lower bar to keep the credit line you already have. Don’t make it easy on the bank to say no to your use of the credit facility by delaying the use of your revolver until you are in a MAC (material adverse change) position.

If you have ample liquidity, consider drawing down enough available liquidity (lines of credit, open term loans, committed capital from investors) to fund operations on your newly downscaled operating plan for a minimum of 12 to 18 months—or longer if you are not expecting a rapid bounce back in the near term.

Once you have your plan recast and have your arms around the worst-case scenario, visit with your banker and either (a) get covenant waivers/resets done in advance or (b) get a line of credit established with wide operating tolerance to get to the lending window quickly, before the banks start having a huge increase in non-performing assets and immediately narrow the lending window.

In 2008, companies were drawing down on the revolvers and keeping the money in government-backed mutual funds. I do not see the same need to avoid a toxic and undercapitalized banking system as in 2008—however, the pain of these events will affect different banks by varying degrees, so I would encourage all companies to have at least two or three safe banks to park your money in. Now is not the time to deal with a weak or undercapitalized bank—no matter what rate they will pay on a CD or MMA. Monitor your bank’s credit rating and be prepared to switch depository institutions if your bank’s rating weakens significantly.

Keep in mind that money market mutual funds have changed since 2008—they no longer have a constant $1.00 NAV (net asset value) and can fluctuate in value based on the quality of the underlying securities. I would not keep corporate cash needed to fund short-term operations in an account with a variable NAV, such as a general commercial paper money market fund.

Staff reductions may become necessary, but start by devising a plan to reduce hours or offer team members reduced pay. This can help you achieve the dual goals of reducing monthly expense burn while maintaining the loyalty and commitment of your staff.

One of the key items bankers always look at is vendor and supply chain diversification. It seems that every company that makes a product feels forced to offshore manufacturing to China—I get it—but if 100 percent of your product supply is shut down, your COGS won’t matter when your company is gone. You must start working today on a secondary source of manufacturing resources that will withstand similar unforeseen events.
Expect any open contracts, purchase orders, and deals with no earnest money to fall through, especially if your customers are in affected industries.

Prepare for assets to devalue by 25 percent or more immediately (even greater if you are in a business that relies on travel or people gathering). If you are selling something and need the liquidity to keep operating, don’t be proud and assume someone retrading a deal on you can be replaced by another buyer.

In addition to those recommendations, here are a few of my personal observations on the current situation:

Banks are in way better shape than they were in 2008. We will find out in 2021, when 2020 earnings are known. Regulators have been way more diligent in risk assessing banks leading up to this event. It appears that the NYSE stock-price party was not accompanied by a bank lending binge like 2008.

When the Fed cut rates to near zero in 2008, I never had a single commercial borrower show up at my office saying, “Hey, I want to borrow some of that cheap money you have on sale.” Interest rates have almost zero impact on the attractiveness of debt to most businesses. Prime bank loans that were at 4.5 percent going down to 2.5–3.0 percent are not going to change any capital decisions. It really is a sign of how bad things are going to get.

With the rapidly declining stock market (based on the apparently accurate perception that future corporate earnings will be massively impacted), I expect to see secondary assets that are sensitized to the stock market and wealth effect deeply discounted for the next 18 months. If you have ample liquidity and low debt levels, the next several months will present massive bargain opportunities from sellers who have leverage or insufficient cash flows and need to get rate cash and reduce balance sheet debt.

I don’t want to see the government make the same mistake they made with TARP in 2009. It was smart, well designed—and made the government billions of dollars of profit by punishing the banking/insurance industries for their collective sins. But it left too many weak competitors in the market after the crisis ended, with excess capacity and too many dollars to lend and not enough qualified borrowers. These adverse events are nature’s way of making the weaker companies perish and rewarding the stronger ones—and if a few airlines, hotels, restaurants need to consolidate, then we will all be better off in the long run, with better capitalized and better run survivors in these industries.

One final thought: We will get though this. I hope that the combined number of deaths from COVID-19 and normal flu season are less in the United States than in prior years due to our increased diligence. Governments, businesses, and people get smarter every year, and while I think the short-term impact on certain individuals and companies will be materially negative, I think our society and culture will be strengthened by this test of our resolve, our community spirit, and our collective health.

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