How Deep is the Ocean?
The crisis in the credit markets is creating some new American superheroes. Fed Chairman Bernanke and Treasury Secretary Geithner are today’s dynamic duo engaged in a titanic struggle with the evil forces of inflation, stagflation, a weak dollar and dysfunctional credit markets. Their mission is to keep the specter of a recession from reappearing again.
Their weapon of choice is a high octane capital swap, low interest generator and paper guarantee machine. The machine produces accelerated capital flows by pumping liquidity into credit channels faster than water surging through the Hoover Dam at the height of a Rocky Mountain snow melt.
Just as the great Colorado River brings life and growth to the parched deserts of the American southwest so to is liquidity the essential condition to sustain the economic viability of a corporate enterprise.
Liquidity concerns grow particularly close to the bone of small businesses. Liquidity is their bread of life and small businesses must master the fine art of liquidity management. Unlike large corporations and governments, the ability of small businesses to print money, tap commercial paper markets, leverage or sell assets or engage in other forms of exotic balance sheet alchemy is limited. So at the end of the day, when the payroll is due, a key supplier is waiting by the receptionist for a check and your best sales person is doing her best to close that huge new deal your anxiety grows a bit as you ponder your cash position and begin to project the next three months.
You call your local banker. You are a long standing and valued customer but “risk aversion” continues to creep into the discussion and they tell you that their funding sources have grown “risk averse” due to losses in the sub-prime mortgage market and finding new funding sources have been difficult. So for now at least the expansion of a credit facility with them is not an option.
You keep getting calls from those merchant finance companies that are offering short term loans but the prospect of paying usurious rates of 18%-30% on future credit card receivables will put a major dent in your profit margins. That makes this credit channel’s cost of operating capital prohibitively expensive.
That’s where risk management comes in. Many small business owners are masters at risk management. They are skilled entrepreneurs that put personal capital at risk. They got major skin into the game and that motivates them to continually evaluate how to protect their assets and maximize returns. Many small business owners are extremely gifted at leveraging assets to address opportunities. Assets such as monetary capital, people, intellectual capital, suppliers, facilities and products are routinely utilized to enhance and extend liquidity. But as credit markets tighten all small businesses need to become more aware of preserving liquidity. This can be accomplished by incorporating a few simple risk management practices.
A good place to start is to make sure your systems and business processes are optimized to support efficiencies. Many of the traditional cash management techniques are well known. Small business accounting software and the availability of internet banking tools are a great help to small businesses. These tools help to extend and manage payment cycles, match assets to liabilities and a good banker will help you develop specific strategies and practices to address these issues and improve your cash position.
Another area to consider is to arbitrage credit providers. Obviously this tactic works great during times of enhanced liquidity but credit channels are still vibrant and the market is crowed with numerous providers and products. Though it is true that as more participants enter markets they tend to become more efficient resulting in small spreads the volatility of the credit markets can work to your advantage. If you can replace a line of merchant finance credit with a bank offered facility you will increase your margins by the spread of the savings.
Sources of capital leakage from the company are a major threat to liquidity. Small business managers must be aware of how to assess this risk factor and how to minimize potential damage it can cause. By “leakage” of enterprise capital we mean to suggest that capital invested by the business did not create an acceptable rate of return. A concerted approach to assessing and managing risk factors preserves liquidity, builds equity and a strong balance sheet.
The principal villains that contribute to capital leakage are poor cash management and inappropriate, non-prioritized or misdirected capital allocation initiatives. These initiatives are acquisitions or projects requiring the investment of time, money, personal energy and corporate resource that do not produce an optimal rate of return.
Small businesses need to incorporate opportunity cost in determining ROI on business initiatives. This is because a small business must limit the number of projects it can engage. It must be certain that current projects will build greater value for the business then the project it declined to pursue. An understanding of value at risk (VaR) is also a useful metric to determine what initiative or project will mitigate the greatest risk and produce the greatest return on capital expenditures.
Risk assessment is a powerful opportunity discovery exercise that requires intentionality and discipline. Many small business owners do these assessments in their head and make decisions based on gut feeling or intuition. An opportunity discovery methodology that walks you through an objective assessment of risk factors is a wonderful complement to the fine tuned business instinct of the small business owner.
Lastly, small businesses need to focus on their most profitable products, best clients and key suppliers within their most promising markets. This may seem obvious but many businesses are reluctant to alter their business models to accommodate this blatant reality. Inertia, culture and ego are the principle culprits and ironically clients, products, suppliers and markets pose some of the greatest risks to small businesses.
It is true that a rising tide lifts all boats. We have just experienced one of the greatest economic expansions in the history of the global economy. It’s been a great run. But the party is over. The era of an unending flow of easy credit and cheap capital is over for now. Until happy days return again we must adapt and protect our solvency through effective liquidity management practices. During times of economic uncertainty and distress it’s a great opportunity to build financial health through effective risk management because when the tide goes out the rudderless businesses captained by poor stewards will crash upon the rocks and get beached on unforeseen shoals or sink into the depths of the unforgiving briny deep.
You Tube Music Video: Billie Holiday, How Deep is the Ocean?
Risk: credit, small business, SME, recession, liquidity
Sum2′s Hamilton Plan Getting Scholarly Attention
The following research paper on The Hamilton Plan was written by Deepak Verma, a business student at Baruch College. To our knowledge it is the first scholarly research that incorporates the Hamilton Plans theme of a focus on SME manufacturing.
ISSUES MANAGEMENT PROJECT
Prof. Michael Kirk Stauffer
DEEPAK VERMA
The Societal and Governmental Environment of Business
Baruch College, the City University of New York
December 16, 2009
Table of Content
Topic Page No
1. Executive Summary 2
2. The Issue: Shrinking Manufacturing Base 3-4
3. The Origin of the Issue and Solution 4-5
4. Small & Medium Enterprises; Catalyst of Sustainable Growth 6
5. Initiative for Development of SMEs 7-8
6. Future of SME and SMEs in USA 9
7. Appendix : References 10
EXECUTIVE SUMMARY
Living beyond means is not sustainable. One of the primary reasons of prolonged Economic and Credit Crisis in United States is its low manufacturing base and American way of consuming more than what is produced. This research paper will examine issue of shrinking manufacturing base of USA, unfair and unethical business practices adopted by countries such as China to boost export thereby causing trade deficit to USA, reasons for low manufacturing base and role of small and medium enterprise (SME) manufacturers in developing a sustainable manufacturing base of the US economy.
Prior to coming at Baruch College for pursuing MBA in finance and investments, I worked for over 10 years with Small Industries Development Bank of India (SIDBI), an apex financial institution of India engaged in the development and financing of SMEs and micro financial institutions. Having worked with this financial institution, I realized the importance of SMEs in bringing sustainable economic development and employment creation, particularly in a mixed economy like India.
The paper will discuss on public-private initiative in USA for development of SMEs, their efforts and capital investment for empowerment and financing of SMEs. Various initiatives taken by private and public sector will be analyzed. Efforts have been made to forecast future of SMEs vis a vis manufacturing sector, role of community development financial institutions (CDFIs), and flow of commercial bank credit and private equity investment in SMEs in the United States.
THE ISSUE: SHRINKING MANUFACTURING BASE
Why should shrinking manufacturing base be an issue in a market driven service oriented economy like US? Federal Reserve Chairman Ben Bernanke stated on Feb. 28, 2007, “I would say that our economy needs machines and new factories and new buildings and so forth in order for us to have a strong and growing economy.” Strong Manufacturing base is the only solution to rising trade deficit and industrial job loss. Manufacturing promotes innovation which leads to investments in equipment and people, research and development, improved products and processes and increase in productivity and higher standards of living. Increase in manufacturing leads to increase in demand for raw materials and other commercial services.
United States has transitioned from an agricultural economy to Industrial economy to a service economy. Over a period of this transition US has lost its manufacturing base substantially and has been importing goods from around the world which has resulted into huge trade deficit and industrial job losses. IMF has categorized the US current account deficit as unsustainable. Warren Buffet also once commented “The U.S trade deficit is a bigger threat to the domestic economy than either the federal budget deficit or consumer debt and could lead to political turmoil… Right now, the rest of the world owns $3 trillion more of us than we own of them.”
Since the United States joined the WTO, US trade deficit has risen from $150.6 billion in 1994 to $817.3 billion in 2006. US reliance on imports ranges from electronic items to apparels and other consumables. For example, electronic items sold in United States are developed by companies such as Philips, Toshiba, Sony, Hitachi, Samsung and Sharp. We have lost significant market share in Auto Industry also. Toyota has surpassed General Motors to become leading auto manufacturer in terms of global sales. Ironically, items such as clothing and apparel where USA had its dominance are also being imported from foreign countries. Over 90 percent of clothing and shoes sold in the United States are made in foreign countries. US economy has thrived on consumerism which has led to increase in demand for goods over the years but production of domestically manufactured goods has been declining, thereby giving rise to imports from foreign countries and loss of industrial jobs.
Critics of the argument say it is the increase in production efficiencies, resulted from technological innovation and advancement that has resulted in loss of jobs. Additionally, it is the increase in consumption which is the root cause of import deficit rather than shrinking manufacturing base. Undoubtedly long term data indicates an increase in US manufacturing, but the way we are loosing our manufacturing share from last 2 decades and if we continue shrinking, we will soon have no choice but to consume whatever is dumped in our market and will be on the mercy of foreign imported goods. Increase in manufacturing has not kept pace with global growth in manufacturing in USA. Since 2000 global manufacturing growth has been 47%, whereas USA has recorded a growth rate of only 19%.
ORIGIN OF THE ISSUE & SOLUTION
What is causing shrinking manufacturing base in the United States? Is it purely competitive and cheaper products manufactured in Asia and Europe or some other factors are also responsible? Undoubtedly competitive global business environment has severely affected domestic production in the United States, this crisis in large arises due to unfair and unethical business practices adopted by its trading partners mainly China. Some of those practices are significant government subsidies, currency manipulation, large-scale dumping in the U.S. market, and other market-distorting practices. Additionally, unfavorable govt. policies, tax structure, increase in cost involved in healthcare, litigation, and regulation has significantly affected the bottom line. Increase in cost and strict regulation forced manufacturing units to move their facilities to other countries where companies do not face those kinds of impediments. Companies operating in the U.S. started outsourcing low-value tasks like simple assembly or circuit-board stuffing, but lower cost of outsourcing and shrinking margin lured them to continue outsourcing sophisticated engineering and manufacturing capabilities that are crucial for innovation in a wide range of products. As a result, the U.S. has lost or is in the process of losing the knowledge, skilled people, and supplier infrastructure needed to manufacture many of the cutting-edge products it invented.
Is there any way to bring back our manufacturing base?
The view that the U.S. should focus on R&D and services is completely flawed. Manufacturing is part of the innovation process and United States has to expand its manufacturing base to remain a world leader.
Following may be suggested to address the issue:
(1) Increase the tariffs on foreign goods so that they are more expensive than domestic goods.
(2) Demand the same level of quality in all foreign goods as American goods.
(3) Diplomatic measures should be taken to create pressure on foreign countries particularly China to stop manipulating their currencies.
Efforts should be made to open up foreign consumption markets adequately to U.S. producers so as to increase export and minimize trade deficit and should endeavor to combat predatory foreign trade practices aimed at undermining U.S. producers in their home market. Next big step is to promote small and medium enterprises to set-up manufacturing units.
SMALL & MEDIUM ENTERPRISES (SMEs); CATALYST OF SUSTAINABLE GROWTH
The issue of shrinking manufacturing base in the United States has been discussed by economist, policymakers, industrialists, and think tanks since economic integration and various measures to improve domestic manufacturing base have been suggested. But considering our free market dominance no sincere efforts were made to expand manufacturing base. Alarming rise in trade deficit and current economic and credit crisis which resulted in to massive industrial job loss has called for immediate intervention of private-public participation to protect and develop domestic manufacturing base for long term sustainable economic growth of United States. It is this time only that the role of SME manufacturers was felt inevitable to address this alarming issue.
President Obama during an interview said “We’ve got to make sure that we’re cultivating small businesses and entrepreneurs who are going to be driving employment growth,” the President said, “so that 20 years from now we can look back and we can say, ‘This was the pivot point, this is where we started to turn the corner.”
US need to change course at this point of time and need to develop a network of small and medium enterprises focusing on cleaner and green technology. The U.S. can explore strategies used in emerging markets for development of SMEs. According to Hau L. Lee, a professor at Stanford Graduate School of Business, “America needs large industrial zones devoted to specific industries–similar to zones in Taiwan, Singapore, Malaysia, and much of China. Such areas offer tax breaks, cheap or free land, workforce training, plenty of water and power, and agencies that serve as one-stop shops for all of the necessary permits and regulatory approvals.” A national level specialized financial institution may be created to provide low cost credit to newly setup SMEs in the manufacturing sector. US strength lies in high end technology, innovation, R&D, robust infrastructure, and know-how.
INITIATIVE FOR DEVELOPMENT OF SMEs
US govt. runs a number of programs for providing technological know-how, contracting opportunities, counseling and assistance, financing, and R&D facilities to small and medium enterprises. Some of the prominent programs run by US department of commerce are Manufacturing Extension Program, Advanced Technology Program, Technology Transfer, and Small Business Innovation Research (SBIR) Program. State govt. and number of govt. agencies are deployed for implementation of these schemes across the United States. SBA provides technical and financial assistance to SMEs through its partner lending institutions.
On November 17, 2009 The Goldman Sachs Group, Inc. launched 10,000 Small Businesses — a $500 million initiative for development of 10,000 small businesses across the United States. The plan envisaged to provide greater access to business education, mentors and networks, and financial capital to small businesses. Lloyd C. Blankfein, Chairman and CEO of Goldman Sachs quoted “Small businesses play a vital role in creating jobs and growth in America’s economy.” Warren Buffett, CEO of Berkshire Hathaway also mentioned “Our recovery is dependent on hard working small business owners across America who will create the jobs that America needs. I’m proud to be a part of this innovative program which provides greater access to know-how and capital – two ingredients critical to success.”
Sum2 LLC, a firm which assists SMEs in implementing sound business practices by offering a series of programs and products, announced The Hamilton Plan on Labor Day. The Hamilton Plan is a ten point program to foster the development of manufacturing in the United States by tapping the entrepreneurial energy of small and mid-size enterprises (SME). The Hamilton Plan requires concerted focus of investment capital to fund development and establishment of an SME Development Bank (SDB) which will focus, manage and administer capital formation initiatives to incubate and develop SME manufactures.
I contacted James McCallum, CEO of Sum2llc to discuss the issue of shrinking manufacturing base and how SMEs can help in restoring manufacturing base in the United States. In response to my comment here is what he stated “It is pretty amazing that the United States has not done more to specifically encourage and address the unique needs of this critical economic driver. Many Asian countries are miles ahead of the US in SME banking and capital formation. These banks have extensive portfolios of finance products and technical assistance they provide to SME’s. The reasons that the US lacks focus in this area are many. US commitment to free market forces has badly warped our economic infrastructure. SMEs in the US have primarily relied on community banks for financing. Most of which went for real estate and construction projects. SME manufactures have just about disappeared from the economic landscape of the US. The credit crash and the economic malaise are awakening our understanding of the critical nature of SMEs and our need to manufacture products. Goldman’s 10,000 Businesses Initiative coalesces nicely with the Hamilton Plan we developed in 2008.”
USA MANUFACTURING & SMEs IN YEAR 2030
With the concerted government efforts for promotion and development of SMEs and private sector initiatives such as “10,000 Small Businesses plan” by Goldman, SMEs will be largely benefited having access to innovative financial products and services from a network of financial institutions. Ten point program suggested in Hamilton plan, if implemented, will bring cluster based development of SME manufacturers. Cleaner and green technology will drive long term sustainable growth, increase national income and result in employment creation. Healthy SMEs will be focusing on export of goods thereby reducing the trade deficit and offer a new market for commercial banking sector. High-tech growth oriented SMEs will also have access to private equity investments and will offer a new avenue of diversification to private equity industry.
But the task of SME development is a challenging task and requires strong will on the part of different stakeholders. SMEs are considered to be the riskiest segment of borrowers from a financial institution’s perspective and thus struggle for timely and adequate credit. Access to technical and market information, financial assistance and trained and educated workers is the biggest challenge for SMEs. Future SMEs require sound business practices such as corporate governance, risk management, stakeholder communications and regulatory compliance.
I believe that SMEs are sine qua non for manufacturing sector & I can foresee a bigger space for SMEs in next 20 years from now. I am so intrigued with the idea of SMEs development and their contribution in the economic growth that in the long run I wish to work as a freelancer offering consultancy and advisory services on financial and strategic matters to SMEs. I would work with a network of financial institutions, venture capitalists, engineers, environmentalists, social workers, suppliers, and policy makers so as to offer SMEs a comprehensive set of services.
APPENDIX: REFERENCES
U.S. Needs to Return to Its Manufacturing Base
http://seekingalpha.com/article/119136-u-s-needs-to-return-to-its-manufacturing-base
Securing America’s Future: The Case for a Strong Manufacturing Base, A Study by Joel Popkin and Company, Washington, D.C. June 2003, Prepared for the NAM Council of Manufacturing Associations
http://www.pmihome.org/Popkin_Study_3-03.pdf
President predicts it will take decades to revive declining U.S. manufacturing base?
Manufacturing & Investment Around The World: An International Survey Of Factors Affecting Growth & Performance, ISR Publications, revised 2nd edition, 2002. ISBN 978-0-906321-25-6.
Economy Watch: Economy, Investment & Finance Report
http://www.economywatch.com/world_economy/usa/export-import.html
USA Manufacturing output continues to increase (over the long run), Curious cat, Investing and economics blog
Alliance for American Manufacturers http://www.americanmanufacturing.org/issues/manufacturing/the-us-manufacturing-crisis-and-its-disproportionate-effects-on-minorities/
Can the future be built in America? http://proquest.umi.com.remote.baruch.cuny.edu/pqdweb?index=28&did=1860761601&SrchMode=1&sid=2&Fmt=3&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1259505905&clientId=8851
TO SAVE AMERICAN MANUFACTURING: USBIC’S PLAN FOR AMERICAN INDUSTRIAL RENEWAL BY Kevin L. Kearns, Alan Tonelson, and William Hawkins
http://americaneconomicalert.org/USBIC_Save_American_Manufacturing_Jobs_Plan.pdf
Goldman Sachs Launches 10,000 Small Businesses Initiative
http://www2.goldmansachs.com/our-firm/press/press-releases/current/10-k-business.html
Goldman Sachs as Social Entrepreneur http://sum2llc.wordpress.com/
Hamilton Plan by Sum2llc http://sum2llc.wordpress.com/2008/09/03/sme-development-bank/
You Tube Video: Isley Brothers, Work to Do
Risk: SME, manufacturing, economic revitalization, social wealth
A Growing Contagion: One in Seven Companies Are a Credit Risk
The H1N1 Swine flu threat may be the big topic on CNN but a growing contagion of financial distress is widely infecting small and mid-sized enterprises (SME) with potentially fatal consequences.
CFO magazine reports that 14% of companies are struggling to pay their bills or are at risk for bankruptcy. These findings are the result of a study CFO conducted on 1500 Midcap companies. The 2009 Credit Risk Benchmarking Report indicated that 550 companies of the 1500 made the credit watch list and over 200 of the names were in or are entering a distressed financial condition.
The report measures each company on three factors: cash as a percent of revenue, days payable outstanding (DPO), and DPO relative to the DPO of that company’s industry. The last of these measures is intended to expose which companies are under performing regardless of the economic condition of their industry as a whole. A company scoring low in all three areas is rated a potential credit risk.
The strain of a two-year recession and limited credit access is taking its toll on small and mid-sized businesses. This development is not surprising. The recession has hurt sales growth across all market segments. Banks, still reeling from the credit crisis are still concerned about troubled assets on their balance sheets. Bankers can’t afford more write downs on non-performing loans. Banks remain highly risk adverse to credit default exposures and have drastically reduced credit risk to SMEs by shutting down new lending activity.
Reduced revenue, protracted softness in the business cycle and closed credit channels are creating perfect storm conditions for SME’s. Bank’s reluctance to lend and the high cost of capital from other alternative credit channels coupled with weak cash flows from declining sales are creating liquidity problems for many SMEs. As a defensive maneuver, SMEs are extending payment cycles to vendors to preserve cash. This same cash management practice is also being employed by their clients resulting in an agonizing daisy chain of liquidity pain. SME’s that have concentrated exposures to large accounts are at the mercy of the financial soundness of few or in some instances a single source of revenue.
The growing contagion of financial distress is also a major threat to supply chains. Buyers might prize their ability to drive hard bargains with their suppliers but the concessions won may be the straw that breaks the camels back driving a supplier into insolvency.
It is critical that managers understand all risks associated with clients and suppliers. It is critical that managers assess risks associated with client relationships and key suppliers. In this market, enhanced due diligence is clearly called for. The financial soundness of suppliers and clients must be determined and scored so as to minimize default exposures to your business.
CreditAides is a company that delivers SaaS based financial health assessments on SMEs. CreditAides reports that their clients are becoming more vigilant and thorough in their due diligence of customers and suppliers. They have noted a particular emphasis on the growing practice of reviewing the financial health of suppliers. Supply chain risk is a heightened risk factor for SME’s due to their over dependence on single source. Conducting a financial health assessment on key suppliers and other enhanced due diligence practices mitigates a risk factor that could have potentially devastating consequences. SME manager’s need to button down their due diligence practices to prevent the sickness from infecting their business.
CreditAides SaaS can be accessed here: www.CreditAides.com
You Tube Music Video: Bing Crosby and Rosemary Clooney, Button Up Your Over Coat
Risk: contagion, credit risk, counter-party, supply chain, client, recession, banking
Regulators Shut Doors on Three More Banks
Regulators have shut Warren Bank in Michigan and and two small banks in Colorado and Minnesota. These closures bring the total to 98 banks closed this year.
The FDIC took over Warren Bank with about $538 million in assets. The Huntington National Bank agreed to assume the deposits and some of the assets of the assets of the failed bank. The FDIC will retain the remaining assets for later disposition. The failure of Warren Bank is expected to cost the deposit insurance fund an estimated $275 million.
Regulators also moved to shut the much smaller Jennings State Bank, in Minnesota. Central Bank agreed to assume the bank’s $52.4 million in deposits and essentially all the bank’s assets. The FDIC estimates the closing of Jennings State Bank will cost the deposit insurance fund about $11.7 million. A third bank, the Southern Colorado National Bank in Colorado was also clsoed. Legacy Bank agreed to assume the deposits and essentially all the assets of Southern Colorado National Bank. The FDIC said the closing will cost the deposit insurance fund about $6.6 million.
Ninety-eight banks have failed so far this year due to mounting losses on mortgages, commercial real estate and small business loans. The failures have cost the FDIC Insurance fund about $25 billion and the fund needs to raise cash to remain solvent.
Risk: FDIC, banks, credit, SME
Banking is Getting Expensive
The severity of the banking crisis is evident in the 95 banks the FDIC has closed during 2009. The inordinate amount of bank failures has placed a significant strain on the FDIC insurance fund. The FDIC insurance fund protects bank customers from losing their deposits when the FDIC closes an insolvent bank.
The depletion of the FDIC Insurance fund is accelerating at an alarming rate. At the close of the first quarter, the FDIC bank rescue fund had a balance of $13 billion. Since that time three major bank failures, BankUnited Financial Corp, Colonial BancGroup and Guaranty Financial Group depleted the fund by almost $11 billion. In addition to these three large failures over 50 banks have been closed during the past six months. Total assets in the fund are at its lowest level since the close of the S&L Crisis in 1992. Bank analysts research suggests that FDIC may require $100 billion from the insurance fund to cover the expense of an additional 150 to 200 bank failures they estimate will occur through 2013. This will require massive capital infusions into the FDIC insurance fund. The FDIC’s goal of maintaining confidence in functioning credit markets and a sound banking system may yet face its sternest test.
FDIC Chairwoman Sheila Bair is considering a number of options to recapitalize the fund. The US Treasury has a $100 billion line of credit available to the fund. Ms. Bair is also considering a special assessment on bank capital and may ask banks to prepay FDIC premiums through 2012. The prepay option would raise about $45 billion. The FDIC is also exploring capital infusions from foreign banking institutions, Sovereign Wealth Funds and traditional private equity channels.
Requiring banks to prepay its FDIC insurance premiums will drain economic capital from the industry. The removal of $45 billion dollars may not seem like a large amount but it is a considerable amount of capital that banks will need to withdraw from the credit markets with the prepay option. Think of the impact a targeted lending program of $45 billion to SME’s could achieve to incubate and restore economic growth. Sum2 advocates the establishment of an SME Development Bank to encourage capital formation for SMEs to achieve economic growth.
Adding stress to the industry, banks remain obligated to repay TARP funds they received when the program was enacted last year. To date only a fraction of TARP funds have been repaid. Banks also remain under enormous pressure to curtail overdraft, late payment fees and reduce usurious credit card interest rates. All these factors will place added pressures on banks financial performance. Though historic low interest rates and cost of capital will help to buttress bank profitability, high write offs for bad debt, lower fee income and decreased loan origination will test the patience of bank shareholders. Management will surely respond with a new pallet of transaction and penalty fees to maintain a positive P&L statement. Its like a double taxation for citizens. Consumers saddled with additional tax liabilities to maintain a solvent banking system will also incur higher fees by their banks so they can repay the loans extended by the US Treasury to assure a well functioning financial system for the republic’s citizenry.
Risk: bank failures, regulatory, profitability, political, recession, economic recovery, SME
$700 Billion is a lot of Guacamole!
An article in today’s Forbes online entitled Trouble with TARP, reports a growing concern by the Congressional Oversight Panel (COP) about the effectiveness of the $700 billion program. The COP reports that the effectiveness of the program is difficult to determine due to lack of transparency of how funds were spent. The COP report also states that the absence of any reporting guidelines for TARP participants impedes effective oversight.
The 145 page report starts with a retelling of the extreme conditions confronting the banking sector as the credit crisis exploded last autumn. It also outlines the choices confronting regulators, legislators and industry executives as the crisis deepened. We were led to believe by Treasury and Federal Reserve officials that the global banking system was in imminent danger of collapse. Nothing less then immediate and drastic measures taken by sovereign government officials and industry executives would prevent the catastrophic consequences of global economic carnage. The report makes it clear that these market conditions were so extreme that regulators were navigating through uncharted waters. Any remediation measures taken had little historical precedence to guide actions. Hence Paulson was given carte blanche to handle the crisis with unprecedented latitude and executive facility.
As this blog reported earlier this week, the TARP was originally designed to acquire troubled assets from banking institutions. TARP funds were earmarked to purchase mortgage backed securities and other derivatives whose distressed valuations severely eroded capital ratios and stressed banks balance sheets. Hank Paulson later shifted the strategy and decided to inject TARP funds into the banks equity base. This has done wonders for the shareholders of the banks but troubled assets remain on the banks balance sheet. As the recession continues, unemployment, home foreclosures, SME bankruptcies and the looming problem with commercial mortgage backed securities (CMBS) are placing a new round of added strain on the banking system.
The TALF program is designed to draw private money into partnership with the government to acquire troubled assets from banks. So far the program has received a tepid response. I suspect that the principal factors inhibiting the expansion of the TALF program are numerous. Chief among them is the inability of FASB to decide upon valuation guidelines of Level III Assets. Banks holding distressed securities may also be reluctant to part with these assets because they have tremendous upside potential as the economy improves.
The COP also questioned the effectiveness of TARP because stress tests were only conducted on 19 banks. The report states that additional stress tests may be required because the previous tests failed to account for the length and depth and length of the recession. Community banks are also of concern. They face a perfect storm in challenging macroeconomic conditions. Of particular concern is commercial real estate loans. Many economists are concerned that high rate of loan defaults in commercial loan portfolios pose great threats to the community banking sector.
Though interest rates remain low due to the actions of the Federal Reserve, lending by banks still remains weak. SME’s are capital starved and bankruptcy rates are quickly rising. SME’s are critical to any economic recovery scenario. A strong SME sector is also crucial for a vibrant and profitable banking system. Perhaps a second round of TARP funding may be required to get more credit flowing to SME’s. If banks start failing again it would be devastating. The Treasury and the Federal Reserve don’t have many bullets left to fire because of all the previous expenditures and a waning political will of the people to continue to fund a systemically damaged banking system.
Risk: banks, SME, economy, credit, market
You Tube Video Music: Billie Holiday with Lester Young, Pennies from Heaven
Waiting for the Other Shoe to Drop
According to a recently published report by a Congressional Oversight Panel reviewing the effectiveness of the Troubled Asset Relief Program (TARP), many banks remain vulnerable due to questionable commercial loans still held on their balance sheets. This is a looming problem for community and smaller banking institutions. Smaller banks are being adversely effected by the the rise of commercial loan defaults. Many community banks have large loan exposures to shopping malls and other small businesses hard hit by the recession.
The report states, “Owners of shopping malls, hotels and offices have been defaulting on their loans at an alarming rate, and the commercial real estate market isn’t expected to hit bottom for three more years, industry experts have warned. Delinquency rates on commercial loans have doubled in the past year to 7 percent as more companies downsize and retailers close their doors, according to the Federal Reserve.
The commercial real estate market’s fortunes are tied closely to the economy, especially unemployment, which registered 9.4 percent last month. As people lose their jobs, or have their hours reduced, they cut back on spending, which hurts retailers, and take fewer trips, affecting hotels.”
Defaults in sub prime and other residential mortgages precipitated last years banking and credit crisis. The TARP program succeeded in stabilizing a banking system that was teetering on collapse. The $700bn infusion into the banking system appears to have buttressed depleted capital ratios and severely stressed balance sheets of large banking institutions. But many banks are still carrying troubled assets on their balance sheets. Commercial Mortgage Backed Securities (CMBS) values are tied to the cash flows generated by renters and lessors of the underlying mortgaged properties. As occupancy rates of commercial properties fall cash flows dissipate. The market value of these securities plummets creating a distressed condition. This places additional strain on the banks balance sheet driving capital ratios lower and places a banks liquidity and ability to lend at risk.
The TALF (Term Asset Backed Loan Facility) was instituted in March to extend $200bn in credit to buy side financial institutions to purchase troubled assets and remove them from banks balance sheets. So far only $30bn has been allocated through the program. Clearly banks balance sheets remain at risk due to their continued high exposure to this asset class.
A strong economic recovery will address this problem. A prolonged recession will resurrect the banking and credit crisis we experienced last autumn. It would appear that TARP II may be a necessity if more private sector investors don’t step up to the plate and participate in TALF.
You Tube Video: David Byrne, Life During Wartime
Risk: CMBS, commercial real estate, banks, credit risk
Unemployment Driving SME Bankruptcies
Two news items concerning the health of of the United States economy crossed my desk today. This morning ADP published its monthly National Employment Report for June. ADP announced that nonfarm private employment decreased 473,000 from May to June 2009 on a seasonally adjusted basis. Monthly employment losses in April, May, and June averaged 492,000. That equates to over 1.5 million jobs that were lost over the past 90 days.
The trend indicates that the rate of job losses is slowing; but the massive evaporation of jobs represents a serious erosion in buying power. The United States is a highly developed consumer oriented economy that is highly dependent on the discretionary buying power of consumers. Significant loss of jobs and the severe contraction of credit availability are severe headwinds that the US economy must overcome.
In recent years US job growth was fueled by small and mid-size enterprises (SME). Home based companies, specialty retailers and service oriented companies has fueled economic expansion and job growth. No more. The trend has been decidedly reversed due to the evaporation of consumer buying power, credit and capital constraints and other macroeconomic factors that conspire against the limited balance sheets of SMEs.
The USA Today reports, “The first five months of this year have shown a 52% increase in the total number of commercial bankruptcy filings (36,106) compared with the same period last year (23,829), according to the Automated Access to Court Electronic Records. On average thus far in 2009, some 350 commercial enterprises file for bankruptcy daily — an increase of 240% from 2006.”
The two attributes that distinguish the US economic colossus are the work ethic of its people and a deep abiding commitment and belief in a entrepreneurial culture that rewards hard work and risk. It would seem that these two virtues are under siege and are being stressed to a breaking point due to the depth and pervasiveness of the global recession. One thing is clear, the indomitable spirit of the American people are being put to the test. In time this great nation of great people will rise to meet and surmount the challenges posed by this great recession. It remains to be seen however how this will change the spirit and character of the American psyche and how future generations of countrymen will view the generations that left them with a debt laden legacy.
You Tube Music Video: George Gershwin, Three Preludes, #2
Risk: work ethic, entrepreneurial spirit, economic recovery, depression
US Economy Bleeding Jobs
The ADP National Employment Report was just released. The US economy is bleeding jobs. Over 693,000 jobs were lost during the month of December 2008. The report shows steep declines in all market segments that include, small and mid-size businesses, large businesses, manufacturers, service businesses and construction. The Report shows that job loss is accelerating more rapidly then observed levels during the 2001 recession.
Full ADP report and an explanation of their methodology can be accessed here.
You Tube Video: Johnny Cash, The Ballad of John Henry
Risk: economy, jobs
Economy Sheds 157,000 Jobs
Lost in the euphoria of Barack Obama’s electoral triumph is today’s rude reminder of the the continued deterioration of the economy. ADP published its monthly report on employment yesterday revealing that the US economy shed another 157,000 jobs during the month of October.
According to the report, “large businesses, defined as those with 500 or more workers, saw employment decline 41,000, while medium-size companies with between 50 and 499 workers declined 91,000. Employment among small-size businesses, defined as those with fewer than 50 workers, declined 25,000. This is the first outright decline in small business employment reported by the ADP Report since November of 2002, and the largest percentage decline since the economy was emerging from recession in early 2002.”
The recession is now enveloping small businesses. This is a most ominous sign. It should be born in mind that the ADP report usually reports numbers that are not as severe as numbers that the Department of Labor will issue later this week.
Not surprisingly manufacturing lost 85,000 jobs during the month. This was the 26th consecutive monthly decline for the sector.
The full ADP Employment report can be accessed here.
President elect Obama will have a tough row to hoe. The revival of the economy will be a prolonged and difficult effort requiring patience and careful attention to undo three decades of erosion to the countries industrial infrastructure. Sum2 advocates The Hamilton Plan as a recovery program for the economy and SME manufactures.
Music Video: Bruce Springsteen, Pay Me My Money Down
Risk: recession, industrial capacity, unemployment
