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Banks Face Short-Term Gain, Long-Term Pain as Commercial Lending Crisis Looms

Last Updated September 23, 2020 2:03 PM
Andrew Packer
Last Updated September 23, 2020 2:03 PM
  • The Paycheck Protection Program gave banks $24 billion in fees.
  • With interest rates back at zero, this one-time gain will be offset by declining interest revenue and compressed margins.
  • Even worse, commercial real estate faces significant challenges as the economy retools.

While earnings season is off to a rough start, banks are likely to have a decent quarter. That’s due to a one-time event, and trouble lurks on the horizon for the banking sector once again.

A Stealth Bailout for the Banks

First, the good news. Bank stocks look to be in decent shape right now and should fare well with earnings this quarter . That’s because several banks have benefitted from the Paycheck Protection Program (PPP).

While they didn’t personally take the funds, banks do receive fees for the (mostly forgivable) loans they made to businesses to keep them afloat. The total amount of PPP loan fees comes to $24 billion . Some banks have pledged to donate the profits from these fees.

PPP loan by type
PPP loans averaged under $150,000 across a variety of businesses, with each loan generating a fee for the issuing bank. | Source: lendio.com 

The average PPP loan was less than $150,000, meaning a large number of fees were made from banks large and small.

For smaller banks, the fees from this program are as good a lifeline as the PPP loans themselves. In a way, the banks have stealthily gotten a bailout before they’ve had to deal with any devastating issues.

That’s good, as the Federal Reserve’s decision to cut short-term interest rates back to zero means there’s trouble ahead for the banks.

Commercial Real Estate a Ticking Time Bomb

With interest rates near zero, bank profit margins will likely fall.

That’s because banks tend to make money on the “spread” between borrowing money from depositors and lending long. Right now, depositors are making next to nothing in interest. That makes other assets like bonds and stocks look more attractive right now  (which may explain the surge in retail trading).

Lower profit margins are just the tip of the iceberg, however. Between the PPP and the CARES Act to expand unemployment benefits, fiscal stimulus will fall off a steep cliff at the end of July. As that happens, layoffs may start to rise again.

The hardest-hit spots will be in commercial lending this time, not housing. From shopping centers to office spaces, many of these properties are now being underutilized, if used at all. What’s worse, banks themselves, looking to avoid the danger of another housing crisis, invested heavily in the commercial space .

Commercial real estate
Unlike housing, commercial real estate is already down about 10% from its peak and may face a crisis as borrowers default. | Source: Green Street Advisors 

Although the commercial space has half the total debt as the housing market, the investment concentration by banks in recent years is a medium-term danger likely to get worse before it gets better.

Housing, having lower debt ratios than during the last recession, has risen this year, against an 11% decline in commercial properties so far .

So two cheers to the banks when they report earnings in the coming weeks. It may be their last hurrah for some time.

Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com and should not be considered investment or trading advice from CCN.com.