The U.S. Treasury, the SBA and the Federal Reserve are moving quickly – trying to shore-up our economy.
Nevertheless, private investment will soon be critical to our ability to respond to the “long tail” of COVID-19. HNW individuals, family offices and private investment funds will soon become the investors (lenders and equity holders) of last resort to businesses as we adapt – we each must become a venture capitalist.
The government’s current activities are directed toward restoring the pre-COVID status quo of the capital markets (see the 3/30/2020 Brooking’s Institution – Overview of the Fed’s Financial Market Support Programs). This may temporarily reopen some business doors, but it won’t finance the long-term world we are quickly evolving to – this is not the Great Recession, or even the Great Depression or WWII – it’s very different. To get an early glimpse, I suggest you take a look at this Washington Post Video of Wuhan Daily Life.
You may think that U.S. commercial banks can support our 6,000,000 local businesses – but business lending isn’t what they do anymore without a government guarantee (i.e., the SBA programs). As we began to see last week, even with funds provided by the SBA’s CARES program, they have been resistant to lend to businesses where they don’t already have a pre-existing credit relationship (often offset by a cash collateral account at the bank).
So, the U.S. commercial banking ecosystem isn’t what it used to be. Here’s a snapshot of what’s happened to it over the past 90 years:
- There were over 25,000 commercial banks in the 1930s; there are now well under 4500 – fewer decision-makers in fewer places (often overseas).
- 90 years ago, bank shareholders were typically also the owners of the businesses to whom the bank lent (largely farming). They often joined to form the bank to smooth out the local business communities’ collective cash flow challenges (e.g., crop seasonality).
- 30 years ago, the individual local banker still drove the bank’s internal underwriting decisions. These local bankers had individual underwriting authority up to certain limits which were dependent on their lending (and work-out) experience.
- Now, most banks consolidate underwriting decisions to one location, usually many miles away from the borrower, largely determined by a financial formula.
- Borrowers cannot communicate directly with the underwriters.
- Underwriters themselves are hamstrung by much greater federal and state regulation and oversight.
- Personal Character, one of the traditional “three C’s” of underwriting [along with Capacity (AKA Cashflow) and Capital (AKA Collateral)], is off the table or at least a very distant third place wrt underwriting decisions. Again, today it’s largely formulaic…
- Most of today’s bank portfolios are over-weighted to commercial real estate loans. If small businesses (and larger) don’t pay rents, property owners can’t pay their mortgages and the bank’s own cash flow will suffer – stay tuned for this fall-out.
Some additional take-aways:
- When the SBA’s CARES support runs out, very few banks will lend to smaller businesses;
- There is plenty of capital in the hands of U.S. private investors;
- Individual investors will be able to find returns through private investment that they can’t find speculating in the public stock markets – think “absolute return” and “non-correlated” to equity market volatility.
Carofin’s Knowledge Base can help you to begin thinking about how to participate in an informed and prudent way.