It is useful to note that even where governmental moratoria have relieved tenants of the obligation to pay rent and have halted evictions, these actions have been nothing more than a deferral of lease/rental obligations. When the moratoria are lifted, absent some practical state or federal financial support to renters already way under water, the expectation that these income impaired renters can make up for unpaid rent, even with long installments if the law or the landlord permits, is probably unrealistic. Who would pay for rent “forgiveness” anyway? Taxpayers? Landlords? Lenders? Nobody?
Unfortunately, these economic realities will materially impact the recovery we are all hoping for. The financial impairments have to be absorbed by the system, and there will be a few winners and a lot more losers. For those individual homeowners with mortgages, there has also been state and federal relief against foreclosures… and a little more willingness on the part of lenders to make adjustments as well (see why below). Mostly tolling payments and extending the period of the underlying note. Less pain.
So far, the stock market has been soaring, as those corporations who can, have used the pandemic to pare their workforce, trimming marginal workers and skipping over some collective bargaining agreements. The cost efficiencies, many reflecting a greater reliance on artificial intelligence and related automation, have generated substantial long-term values for the implementing companies. Basically, these companies have no intention of restoring their workforce to pre-COVID levels. Many of those workers will be left stranded.
But corporate America may have its head in the sand over a number of resulting issues. For example, since the US economy is over 70% based at the consumer level, reducing the workforce of necessity impairs the ability of many consumers to resume spending at pre-COVID levels. For large swaths of bricks and mortar retail, their entire business structure has been upended. For those companies, unless they are able to make a smooth transition into online retail, the business horizon is not so rosy.
Some of my clients and friends have asked me why landlords are chomping at the bit to deal with tenants unable to pay rent, while major lenders have been much more accommodating enforcing and collecting mortgage payments. Most of the major lenders are surprisingly flexible, many volunteering to suspend or reduce mortgage interest payments, renegotiate payment terms or to extend the loans for substantially longer periods. Why? Kindness? Keeping up good client relationships? Or something more? And is there a difference between homeowners’ mortgages and commercial equivalents?
When the number of commercial loans, including those to owners of residential rental real estate, become “non-performing,” accounting and tax rules and regulations kick in. When a lot of non-performing loans occur at the same time, there are potential dire consequences. Once a lending institution is forced to write off (full default) or write down (partial default) a bad loan, that “charge” impacts its financial reporting obligations. Federally insured banks are highly regulated and subject to serious stress tests to ascertain viability. Such banks are required to have bad debt reserves, which reflect default expectations in normal economic times. We are not in normal economic times. Unless the bank agrees contractually to the contrary or as permitted under bankruptcy or other laws, the debtor is not relieved of payment obligations on a write down or a write off.
Where a mass of defaults are written down or written off at the same time, the aggregate charge can get quite large, particularly for lenders who specialize in a market sector that is taking a big hit across the board. Each such lender’s balance sheet has to reflect that reduction in value (there are different bad or doubtful debt categories depending on repayment criteria and expectations)… and for public companies where there are a sizeable simultaneous defaults, share prices could get slammed.
“Banks prefer to never have to write off bad debt since their loan portfolios are their primary assets and source of future revenue. However, toxic loans—loans that cannot be collected or are unreasonably difficult to collect—reflect very poorly on a bank's financial statements and can divert resources from more productive activity… Banks use write-offs, which are sometimes called ‘charge-offs,’ to remove loans from their balance sheets and reduce their overall tax liability.” Investopedia.com. And trust me, a big tax deduction is not remotely an offset to a major reduction in the overall value of the lender itself, particularly if it is a public company. Here is where the seeming lender “kindness” kicks in. Additionally, the last thing a home-loan lender wants is vast accumulation of foreclosed homes, where debtors probably borrowed without personal recourse, that they now have to sell. That hurts the balance sheet big time.
Further, banks (and other institutional lenders) cannot keep non-performing loans on their books indefinitely; there are rules that govern how companies must account. “Generally accepted accounting principles (GAAP) refer to a common set of accounting principles, standards, and procedures issued by the Financial Accounting Standards Board (FASB). Public companies.” GAAP accounting is pretty much standard for any large company, public or private.
If lenders renegotiate those loans, extending or reducing payments in a commercially reasonable manner, those revised loans just may no longer be deemed to be in default accordingly. Or the write down is only partial. Since the pandemic hit, major lenders, including banks, have been overwhelmed in renegotiating loans with debtors they believe will, sooner or later, revive after the pandemic subsides. This prevents the underlying loan from becoming a nasty charge against the lender’s balance sheet. It would be different if the federal government required all lenders to take forced write downs/write offs at the same time, leveling the competitive playing field across the entire industry, but that policy is not currently on the table. So, the games must be played.
Where you are beginning to see write downs/write offs occurring more readily is within industries and real estate in business sectors that face prolonged serious financial issues – like hotels and airlines – or where a bankruptcy pretty much requires that write down or write off. For those not keeping their eyes on the minutia in stock valuations, they may have missed the aggregation of flies in the ointment, an economic reality that comes with its own day of reckoning unless federal regulators and policymakers make the necessary adjustments… and not just let the chips fall where they may.
What all of this means for renters is unfortunately simple: those with mortgage obligations have a huge advantage over those who rent their homes. Generally, those who rent tend to have incomes lower than those who own their own homes. Lower incomes, by definition, mean that repaying deferred rent may be an impossible burden on renters. Guess who gets hit the worst? For the nation as a whole, sooner or later, these anomalies will impact how quickly our economy recovers, whether economic polarization continues to widen and whether new political destabilization roils an increasingly frustrated electorate. Good luck with that reality, Mr Biden. Will Congress help or hinder a viable solution.
I’m Peter Dekom, and for those who believe that we are about to experience a rapid ramp up to pre-COVID economic numbers as the vaccine is deployed, they are all in for a rude awakening.
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