The growing trend of bricks-and-mortar retailers to declare bankruptcy has some investors worried about the stability of their bank and financial stocks. In truth, banks are reasonably insulated from loss when retailers go under thanks to the use of “asset-based loans.”
These loans are typically backed by both inventory and accounts receivable of these stores. When a chain or store closes, banks are first in line.
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Retail Troubles Are Real
Thanks to the dominance of Amazon.com Inc. (NASDAQ:AMZNC) and online shopping in general, mall traffic has decreased and foot traffic in physical stores has slowed down. In fact, retail bankruptcies have increased to a high of 21 so far this year – the fastest pace since the financial crisis.
With well-known brands such as Payless Shoes and Limited Stores declaring bankruptcy, clearly many chains are saddled with debt. That does not mean there are no assets. Those assets are used to pay off bank debt.
Asset-Based Loans Are RepaidOf the 21 retailers that have filed bankruptcy this year, 15 carry asset-based loans from major banks. All of those loans have been repaid or are expected to be repaid according to documents filed with various courts involved.
Unlike with the drop in the price of oil and financial hardship that placed on oil production companies – and the banks that loaned to them – when retailers fail, the banks that loan to them are often only mildly affected.
Major Banks Well Protected
Thanks to their ability to take on reserves when they lend to risky retailers, plus the advantage of asset-based loans, major financial institutions such as JPMorgan Chase & Co. (NYSE:JPMC), Bank of America Corp.’s (NYSE:BACC) and Wells Fargo & Co. (NYSE:WFCC) know they have a realistic opportunity to recover 100% of their exposure.
In fact, commercial loans to retailers are larger than energy-related loans at many large banks. These banks have also lent to troubled retailers that have not yet filed for bankruptcy including Sears Holdings Stock not found SHLD and BonTon Stores Inc. Stock not found BONT.
Small Banks Not So Much
Small banks, lacking the resources of larger institutions, may have as much as 20% of their commercial real estate loans out to retailers making them vulnerable in ways larger banks are not.
Furthermore, small banks have to deal with regulatory hurdles just like larger banks – but without the staff or resources needed to do so. This has led to a decrease in the number of small banks nationwide. In California alone there are fewer than 180 banks with headquarters in the state. In 1994 there were almost 500.