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As cash drawdowns spike, bank analysts say robust buffers in place

Measures to stop the spread of the new coronavirus are slamming the brakes on a wide range of economic activity, and firms appear to be rushing en masse to secure cash resources that would help them weather abrupt declines in revenue and missed payments.

One source of ready cash is the more than $2.5 trillion in unfunded commitments, including credit lines, that banks had extended to commercial borrowers and other financial institutions as of the end of 2019, according to data from S&P Global Market Intelligence. If fully drawn, the more than $2 trillion of commitments to make commercial and industrial loans would approximately double the total amount of such loans that banks currently have outstanding.

In one prominent example, Hilton Worldwide Holdings Inc. disclosed on March 11 that it is maxing out its $1.75 billion revolving credit facility to build up a precautionary cash position because of the virus.

Banks also have more than $390 billion in unfunded commitments to provide commercial real estate and construction loans.

The dash for cash appears to have caused disruptions in the market for Treasurys, prompting the Federal Reserve to announce on March 12 that it would offer liquidity injections of more than $1.5 trillion over two days. The Fed acted even more aggressively to keep the spigots open when it announced it was slashing its policy rate to almost zero on Sunday, March 15, adding another round of bond purchases, and encouraging banks to tap its discount window and dip into their capital and liquidity cushions. On March 17, the Fed also rebooted a program to support borrowing through commercial paper, which firms use for short-term financing.

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Christopher Wolfe, managing director and head of North American banks at Fitch Ratings, said the extent of the line drawdowns remains unclear, but "funding pressures have been building" because of uncertainty about the amount of damage the coronavirus might cause. The Fed's dramatic intervention "helps alleviate, for now, those pressures," he added in an interview.

During milder economic disruptions, the pivot toward bank lines could be seen as a positive for the industry by boosting loan volume and net interest income. C&I lending jumped during the most recent previous bout of market turbulence that surrounded the government shutdown in late 2018 and early 2019. Year-over-year growth in seasonally adjusted C&I loans at commercial banks reached 10.3% in the first quarter of 2019, surging from a trough of less than 1% in the fourth quarter of 2017, according to data from the Federal Reserve Bank of St. Louis.

At a presentation in late February, Wells Fargo & Co. CFO John Shrewsberry predicted that disturbances in capital markets caused by the coronavirus could prompt firms to draw on bank lines of credit. "That's what we're here for, right? So that could be a benefit," he said.

Credit lines are designed to cover "cash flow shortages and, at times, for defensive purposes like this, where a corporate [borrower] might not be able to access the [commercial paper] market as efficiently or effectively as they had in a benign environment," said Bain Rumohr, senior director for North American banks at Fitch. However, Wolfe observed, "What is a little bit harder to handle is if you're a bank and all of your clients want to draw simultaneously."

The scale and speed of the coronavirus shock have raised concerns that credit drawdowns will strain bank balance sheets and saddle banks with vulnerable loans to imperiled businesses.

However, even before the Fed announced its actions late Sunday, analysts at Keefe Bruyette & Woods observed that banks can draw on loans from the Fed and the Federal Home Loan Banks if needed. Banks can also cancel some commitments without condition and invoke clauses protecting them from lending to financially troubled borrowers. Moreover, expectations for drawdowns are incorporated in regulatory stress tests and measures of risk-weighted assets, and banks are required to set aside reserves for unfunded commitments, including under the recently adopted current expected credit loss standard, Keefe Bruyette & Woods said in a March 12 note.

Rumohr said it makes sense that the line drawdowns made public so far have tended to be by companies in business sectors like hospitality and leisure that have been the first to take a direct hit from the pandemic. The performance of these loans will ultimately depend on how quickly "the economy can bounce back," he said.

The 20 U.S. bank holding companies with the highest levels of unused commitments to extend commercial and industrial, commercial real estate and financial institution loans had a median ratio of tangible common equity to assets of 9.3% at the end of 2019, according to S&P Global Market Intelligence data. If all those commitments had been instantaneously converted into outstanding loans, the median ratio would have fallen to 8.3%. Under this blunt exercise, banks including Comerica Inc., KeyCorp and PNC Financial Services Group Inc. would have experienced the biggest drops in tangible common equity to assets ratios, in the range of two percentage points.

Among these 20 banks, about half of all unused commitments, including to consumers, at the end of 2019 were reported to regulators as "unconditionally cancelable," with the proportion ranging from 0% at Morgan Stanley to 91.3% at Capital One Financial Corp. Credit card lines make up about half of the approximately $8 trillion in total unused commitments across the industry.

Analysts at Credit Suisse concluded in a March 12 note that banks are prepared to support their credit commitments "with substantial capacity," citing large increases in capital levels over the last decade, and the banks' performance in regulatory stress tests that contemplate severe recessions. The analysts estimated that JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Wells Fargo would be able to fund "91% of their unused commercial lines in an extreme scenario."

In a March 12 note, analysts at Janney Montgomery Scott estimated that among banks where C&I loans make up more than 20% of portfolios, drawdowns against all unused lines would lower median Tier 1 capital ratios by less than one percentage point, from 10.1% to 9.16%.

"This would be a profitable exercise and liquidity exists from the FHLB system and Federal Reserve to permit such activity," the analysts said. In another note, the analysts calculated that liquid assets, including cash and unpledged securities, had increased substantially since the financial crisis in 2007 and 2008, rising from 14% of total assets at banks with more than $50 billion of assets in the fourth quarter of 2008 to 20% in the fourth quarter of 2019. For JPMorgan Chase, the figure was 48% in the fourth quarter of 2019, according to the analysts.

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