Will GOP plan to slash unemployment aid trigger wave of loan defaults?
WASHINGTON — As lawmakers debate another round of stimulus to ease the economic effect of the pandemic, some in the industry say a GOP proposal to scale back unemployment benefits tied to the coronavirus could come back to bite financial institutions.
Senate Republicans unveiled follow-up legislation this week to the Coronavirus Aid, Economic Relief and Security Act that would cut the enhanced unemployment benefits to $200 per week through September, down from $600.
While the unemployment aid combined with other relief has up to now helped Americans stay current on their debt and maintain consumer spending, many worry that slashing the amount of the unemployment coverage will put a strain on credit quality.
Reduced unemployment benefits could lead to higher delinquencies in the mortgage sphere, some industry representatives said.
“It is something we’ve been concerned about," said Bill Kilmer, senior vice president for legislative and political affairs at the Mortgage Bankers Association. "We believe that all the evidence points to the fact that the income supports that were put in place by the CARES Act, whether that was the first wave of stimulus checks, or certainly the altered unemployment insurance benefits have helped people continue making mortgage payments.”
The Republicans’ $1 trillion bill — called the Heath, Economic Assistance, Liability Protection and Schools Act — would also provide another round of $1,200 stimulus checks to many Americans, make more funding available for the Paycheck Protection Program and allow student loan borrowers without any income to continue deferring payments, among other things.
The GOP legislation will likely open up further negotiations on a final plan with House Democrats, who in May passed the Health and Economic Recovery Omnibus Emergency Solutions Act, a $3 trillion plan that would extend the $600 in weekly unemployment insurance to Jan. 31.
Ian Shepherdson, chief U.S. economist at Pantheon Macroeconomics, said consumers facing a reduction in unemployment benefits under the GOP plan may decide to skip certain loan payments.
“There’s no question that it’s going to push some people, who at $600 a week can afford to maintain all of their loans payments — their credit card, their car loan, the mortgage, the rent — ... into making decisions about which payments to miss, or whether to seek forbearance on the mortgage or whether to try and renegotiate with their landlord,” Shepherdson said. “So it’s material.”
Many of the provisions of in the CARES Act, which Congress passed in March to aid people struggling with the economic impact of the pandemic, are set to expire this week, including the extra $600 per week in unemployment insurance.
Banking industry representatives say the enhanced unemployment coverage has been a lifeline for borrowers.
“The additional federal unemployment benefits pretty much made a lot of folks that were on unemployment almost whole and being able to meet their financial obligations,” said Paul Merski, group executive vice president for congressional relations and strategy at the Independent Community Bankers of America.
On top of providing enhanced federal aid of $200 per week, the Senate GOP bill would also establish a system for state governments to provide additional relief, but many analysts are still trying to understand the details of the proposed state-run coverage.
Isaac Boltansky, a policy analyst at Compass Point Research & Trading, said in a note that provision "appears too complicated, reinforcing our belief that flat payment [is] still likeliest."
"The proposal ... envisions states shifting to provide 70% of a worker's income, but the government's contribution is effectively capped at up to $500," Boltansky said.
Some observers said slashing the extra federal unemployment insurance could make it more difficult for borrowers to repay loans as COVID-19 cases are surging in many parts of the U.S., putting banks at risk should delinquencies rise.
“Many assets on banks’ balance sheets are loans ultimately tied to consumers paying an obligation,” said Aaron Klein, a fellow at the Brookings Institution. “This extended increase in unemployment insurance is a lifeline for many consumers to be able to pay their rent, pay their car loan, pay their credit card. Should this go away, the potential for defaults rises substantially.”
Without knowing the path of the virus, it’s also impossible to predict how many people who have lost their jobs due to the pandemic will be able to find new ones, said Gerron Levi, director of policy at the National Community Reinvestment Coalition.
“It's a real gamble,” she said. “It's a rolling of the dice with so many people unemployed and so many people facing a situation where they really can't return to work because there is not a job available.”
Shepherdson said the GOP proposal for $200 a week could be an "opening shot" for Senate Republicans to negotiate with Democrats on an amount somewhere in the middle between their two proposals.
"My working assumption is that actually the cut will be something like to $400, so it will be cut by a third, but that’s a lot less than being cut by two-thirds,” he said. “There are some people … for whom the entire $600 has been completely essential for enabling them to maintain their rent payments or their mortgage payments.”
Particularly in high-cost cities where wages are higher, Shepherdson said cutting the weekly amount from $600 to $400 would "make a material difference."
The enhanced unemployment coverage in the CARES Act is believed by many to have softened the blow of the pandemic on the mortgage sector.
Although the CARES Act offered borrowers with a federally-backed mortgage the option to enter into forbearance if they had encountered financial hardship due to the pandemic, many homeowners that have entered into forbearance have actually continued to make mortgage payments.
As of the end of May, 26% of loans in forbearance backed by Fannie Mae were current, a trend that has also been reflected in the private market. But some Democrats have speculated that those borrowers may have only been able to meet their debt obligations thanks to the benefits provided for in the CARES Act.
"We have to extend unemployment compensation, because many of the people who are still paying [their loans back] are doing so only because they're getting enhanced unemployment compensation,” said Sen. Jack Reed, D-R.I, at a Senate Banking Committee hearing in June.
That speculation is heightening the concern that mortgage losses could increase as the extra unemployment benefits are winding down, said Bill Kilmer, senior vice president for legislative and political affairs at the Mortgage Bankers Association.
“We believe that all the evidence points to the fact that the income supports that were put in place by the CARES Act, whether that was the first wave of stimulus checks or certainly the altered unemployment insurance benefits, have helped people continue making mortgage payments,” said Kilmer.
Jordan Van Rijn, senior economist at Credit Union National Association, added that delinquency rates at credit unions haven’t climbed substantially since the pandemic forced people out of work, but admitted that it’s largely due to the benefits provided by Congress.
“Our monthly credit union estimates through May show that delinquency rates haven’t climbed that much at credit unions yet compared to the previous recession,” Van Rijn said. “The delinquency rate according to the monthly estimates is only about 70 basis points, up just a tiny bit from February when it was 64. And we really do attribute that to the strong fiscal stimulus that the government has implemented.”
The unemployment benefits along with the $1,200 stimulus checks sent to most Americans beginning in April also helped to buoy consumer spending, which bounced back in May after dropping in March and April, said Ed Mills, a policy analyst at Raymond James.
“A large percentage of the stimulus check went to mortgage and rental payments and facilitated a boost to the economy, because it boosted consumer spending,” said Mills. “Commercial real estate in the retail space needs people to be spending to have any hope of recovery.”
Klein agreed that a drop in consumer spending could hold back the swift economic recovery hoped for by the Trump administration.
“What we know is that unemployment insurance benefits are spent. They are not saved,” said Klein. “Cutting that spending out of the economy will slow growth, will increase loan defaults, will increase forbearance programs, and ultimately be bad for the economy and for banks’ balance sheets.”
Many of the nation’s largest banks in second-quarter earnings reports warned that delinquencies and defaults on credit card, auto and other consumer loans could spike in the second half of the year if Congress does not come through with another round of government stimulus.
“So far our customers are making their payments,” Discover Financial Services Chairman and CEO Roger Hochschild said July 23. “We do worry that if [government aid is] pulled back too quickly it’ll both impact not just those who were getting support” but also slow overall consumer spending.
Lenders have been padding reserves in anticipation of weaker government aid and faltering borrowers. A report from Accenture found that U.S. banks are planning to set aside $320 billion this year to cover potential credit losses from the pandemic.
“Of course, credit unions, probably like some banks to some extent, have tried to really step in as well to try and do a lot of loan modifications, restructuring,” Van Rijn said. “The vast majority of credit unions are doing things of this nature for up to three, four months. But obviously, no financial institution can kind of do that indefinitely. If this kind of continues and unemployment benefits were not extended, we would expect delinquency rates and charge-off rates as well to increase.”
Even if Democrats are successful in keeping the enhanced unemployment benefit closer to the $600-per-week level, firms could still see an uptick in customers skipping payments or seeking loan modifications, according to some analysts. There will likely be a lag in time between the expiration of the $600 benefit and whatever new coverage amount Congress enacts. Republicans only came out with their proposal Monday evening.
That benefit is set to expire July 31 under language in the CARES Act. But because many states distribute the payments on a weekly basis, the bonus may only apply to the last full week of the month, meaning that many workers who have filed for unemployment are already missing out on that extra federal support.
“The last checks have already been sent out under the ... CARES Act for the $600 a week,” said Shepherdson. “Even if they reach a deal this week, a lot of people are not going to get paid the benefit next week. So there’s going to be some interregnum no matter what.”
Still, the fact that negotiations are gaining speed is a good sign, said Kilmer. Treasury Secretary Steven Mnuchin and White House Chief of Staff Mark Meadows met with House Speaker Nancy Pelosi and Minority Leader Chuck Schumer Monday night to discuss the next phase of legislation.
“You’d obviously like to have as smooth a transition as possible,” Kilmer said. “But I think we're encouraged by the fact that negotiations are starting in earnest and that there's going to be a consensus reached on this sooner rather than later.”