The industry is seeing an acute spike in committed commercial facility utilization, representing just one more consequence of the sudden and severe economic shock from COVID-19. Treasury teams must mobilize in the immediate term to understand the potential for stress, with an enhanced focus on customer segmentation and relationships. Longer term, Novantas believes the development of an internal view of liquidity stress from this episode can be a competitive advantage in the new normal ultra-low or negative interest-rate environment.
One of the more immediate effects of the COVID-19 health crisis on the banking industry has been the spike in committed commercial facility utilization as businesses look to shore up cash in a sudden recessionary environment. The magnitude of the spike has been acute: many corporates are drawing 100% of committed balances. This is especially true in hard-hit sectors like retail and lodging.
FED H.8 SHOWS MATERIAL INCREASE
This trend has emerged in industry reporting, which lags the market. For the two weeks ending March 25, the Fed’s H.8 reporting shows the strongest average weekly loan growth number in 20 years — since the week of Sept. 11, 2001. Core commercial loan growth increased $302 billion in two weeks compared with an average increase of $138 billion per year during 2017-2019.
It appears that the lion’s share of this growth is coming from drawdowns on existing facilities rather than new credit origination. Most of the volume is also coming from non-financial corporate draws at large banks. We expect this trend will continue as long as companies need cash to supplement lower inflows and receivables.
Drawdown behavior of this sort has long been understood to be cyclical. In times of economic duress, businesses and households alike will draw on existing lines of credit in larger magnitude. These commitment draws are an explicit focus of regulatory liquidity metrics, namely the liquidity coverage ratio (LCR) which prescribes 30-day cash outflow assumptions for credit and liquidity facilities held by retail, wholesale, and financial institution counterparties. (Regulators have recently relaxed these requirements to encourage the deployment of excess liquidity into the economy.)
Accurate and timely reporting around current exposures is critical. LCR is an important guidepost for liquidity risk management, but banks must avoid considering too short of a scenario time horizon for liquidity stress. Furthermore, one-size-fits-all assumptions, such as the 10% outflow on wholesale non-FI credit facilities, fail to recognize the potential for disparate impacts across customer segments. Instead, surgical modeling is required.
Core C&I Loan Growth Acceleration
Source: Federal Reserve H8 Database (Large Domestically Chartered Commercial Banks, SA (Weekly) & Small Domestically Chartered Commercial Banks, SA (Weekly) )
IMMEDIATE TERM: CRISIS RESPONSE
Bank treasury teams must work in conjunction with analytics teams to generate management reporting on daily utilization trends. That means breaking down the wide variations in customer segments to understand differences across industry, region, size, credit rating and other dimensions. For example, a retailer with a strong online presence will likely have different funding needs in the current crisis than one that derives most of its revenue from physical stores.
Relationship primacy is another critical segment. A primary-relationship status would appear to be a clear advantage over other clients because the businesses that draw down credit lines to fund operations generally place those funds in bank operating accounts — essentially making those drawdowns self-funding.
Despite that self-funding, Novantas expects drawn cash to burn over time as businesses support operations and revenues stay depressed. Furthermore, we expect sophisticated companies to spread drawn cash between primary and secondary banks as they try to put a firewall between cash and potential calls on the loan and to prevent netting.
These developments will create clear winners and losers from a liquidity risk perspective, which will have implications for deposit pricing. Winners may be better-positioned to ease margin pressure by reducing rates on interest bearing deposits compared with losers, who will be more cautious on rate decreases given the potential for outflows.
It appears that the lion’s share of this growth is coming from
drawdowns on existing facilities rather than new credit origination.
STRENGTHENING BALANCE-SHEET MANAGEMENT IN THE NEW NORMAL
As the industry settles into a new normal, treasury departments must ensure that learnings around liquidity risk make their way into liquidity-risk management architecture, especially including liquidity stress testing, as well as balance-sheet management strategy.
We believe the development of a more scientific internal view of stressed liquidity will be critical. This data-science exercise should consider deepening segmentation, understanding of balance liquidity at the customer level (particularly flows between commitment and deposit products), early-warning indicator analysis and scenario design.
An empirically-supported view of liquidity buffer requirements will be critical. Effective balance-sheet management in ultra-low/negative interest-rate environments requires the prudent deployment of excess liquidity into earning assets to offset margin pressure and generate shareholder returns. Furthermore, governments will rely on financial institutions to use liquidity and capital to help drive an economic recovery.