Sizing the Impact of Potential Portfolio Loss Due to COVID-19
Bill Bromback – Chief Research Officer
August 18, 2020
Sizing the expected loss due to the impacts of COVID-19 is challenging for 3 reasons:
1. Prior to the crisis, there was an existing pool of borrowers that may have been in distress and missed debt payments or in default. The problems associated with those accounts may have become more aggravated due to the crisis, but have remained in a “pending/hold” state due to the CARES Act.
2. As the coronavirus hit, the magnitude of the potential loss problem multiplied as unemployment skyrocketed across many industries. However, tracking and actively managing potential losses became a challenge due to the relief offered to borrowers via the CARES Act. The different relief options offered via the CARES Act are coming to an end on the following dates:
Jul. 25: Eviction Relief
The CARES Act gave eviction protection to renters who live in federally subsidized or federally backed housing. It also gave relief to those who rent from landlords who have multifamily mortgages in good standing from the Federal Home Loan Mortgage Corp. (Freddie Mac) or the Federal National Mortgage Association (Fannie Mae). The relief applies only to evictions for nonpayment of rent, and rent is still due. All of those provisions end July 25, and after that date, landlords may give delinquent renters a 30-day notice to leave.
Jul. 31: Unemployment benefits
The unemployment rate in June was 11.1 percent, down from a high of 14.7 percent in April, according to the U.S. Bureau of Labor Statistics. The CARES Act provided for an extra $600 a week on top of regular unemployment benefits. (All unemployment benefits are subject to state and federal income tax.) The program ends July 31.
Aug. 8: Paycheck Protection Program (PPP)
The PPP, which extends loans to small businesses affected by COVID-19, will stop taking applications after Aug. 8. The program was set to expire June 30, but Congress passed an extension. The loans will be fully forgiven if the funds are used for payroll costs, interest on mortgages, rent and utilities. Forgiveness will be reduced if full-time head count declines, or if salaries and wages decrease.
Aug. 31: Mortgage forbearance
Those who have mortgages owned by Freddie Mac or Fannie Mae are also eligible for mortgage forbearance, which means that you don’t have to make the payment right now. You still owe the money, either as a lump sum or tacked on to your mortgage. Forbearance isn’t the same as forgiveness.
The U.S. Department of Housing and Urban Development has also imposed a halt to evictions and foreclosures from single-family properties with mortgages insured by the Federal Housing Administration. The moratorium on foreclosures also applies to FHA-insured home-equity conversion mortgages (commonly known as reverse mortgages). Both moratoriums end Aug. 31.
Sep. 30: Student loan payment suspension
The CARES Act allows you to suspend payments to your federal student loans until Sept. 30. It also reduces your interest rate to zero during that time. The law didn’t apply to private student loans. If you’re in default on your federal student loans, your wages, tax refund and Social Security benefits, including disability benefits, can be garnished after Sept. 30.
Dec. 31: 401(k) hardship loans and withdrawals
You can take a penalty-free early distribution from your defined benefit retirement plan, such as a 401(k), until the end of the year. You need to be experiencing coronavirus-related financial hardship, such as a job loss or COVID-19 illness. The waiver applies to withdrawals of up to $100,000 since Jan. 1. Income taxes aren’t waived, but you have three years to pay them, as well as three years to pay the plan back. Also, the limit on loans from retirement accounts has been increased to $100,000, from $50,000, and payments on both new and existing loans can be deferred for a year. The CARES Act also suspended required minimum distributions from defined contribution retirement plans. All of these go away on the last day of the year.
3. Trying to assess how quickly certain geographic markets and industry segments will recover, creating an opportunity to re-ignite economic growth and stimulate job demand/job creation again.
Acknowledging these challenges, here are two approaches to sizing the potential losses:
1. Analyze your current loan portfolio and identify the primary source of income supporting the loan. Next, identify which industry the borrower’s income comes from. There are some industries that have been hard hit by unemployment due to COVID-19 (i.e. hospitality, travel, entertainment, personal services). Attempt to identify industry segments that may recover quickly vs. others that may not. Consider “red flagging” accounts that are associated with distressed industries that won’t recover quickly and then evaluate payment history, FICO score at time of loan and subsequent changes, and changes in disposable income (if possible) for that member. A general loss sizing could be estimated using this approach.
2. Another approach is to analyze how your loan portfolio performed before, during, and 1 and 3 years after the 2008 Recession. What was your delinquency and charge-off experience during those specific points in time? While there are clearly differences between the 2008 Recession and the COVID-19 crisis, the 2008 recession impacts were dramatic:
“The financial crisis and the recession with which it was associated were the worst economic dislocation since the Great Depression. There were large losses in economic output and large declines in employment, household wealth, and other economic indicators.
- Not only did the U.S. economy lose 8.8 million jobs, but half of those losses occurred within the six months that immediately followed the height of the financial crisis in the autumn of 2008.
- In 2009, the year when foreclosures peaked, 2.8 million mortgage loans were in foreclosure, almost four times the number in 2005.
- The cumulative net cost to the U.S. economy has been estimated by the U.S. Government Accountability Office and others to range from more than $10 trillion to $14 trillion in today’s dollars, or up to roughly 80 percent of an entire year’s gross domestic product.
- From 2008 through 2013 almost 500 banks failed, at a cost of approximately $73 billion to the Deposit Insurance Fund (DIF).”
Source: Crisis and Response, An FDIC History, 2008-2013