Who will be lending? It was clear from late January that the Coronavirus-induced mess was a supply-chain issue and an intercompany credit issue. In China, the true extent of the mess will be measured only when the government starts to communicate about how responsive its state-dominated banks would have been when it comes to providing working capital assistance to small businesses. It is less than clear from anecdotal evidence that banks are playing ball.
As fear reached western shores, the same issues crop up. Forget credit markets as closed now as the widening spreads suggest. So how will that reasonably-select restaurant in Paris Montmartre settle its bills now that Chinese (and Italian and US and Japanese etc.) tourists are nowhere to be seen? It can let go staff, at a substantial cost both now and tomorrow when rehiring, it can try to push back the monthly rental and delay payment to suppliers who may decide not to supply any longer or provide supplier credit. Whichever, the intercompany credit will snap when the tax man collects its due as a priority creditor. Eventually small businesses wherever they are will require working capital assistance, something that most banks will not want to do as it amounts to asking them to shoulder the only unknown, which is the timetable of the health crisis.
European-listed banks are well capitalised, seemingly did well in the last stress test and thus would face a global slowdown and a market hit reasonably well. This will not help the Montmartre restaurant, so the next step is for the governments to provide the banks with such backing that they would not lose on any working capital funding extended to SMEs. Governments have made the right noises so far from Italy to the UK but the speed of execution is of the essence. This is not a given.
Inbetween, smaller companies will go belly-up, thereby pushing up loan losses as well. As a reminder, European banks are facing new regulations whereby they no longer wait for a payment default to move a loan in the ‘non-performing’ box. Suspicions that this is bound to happen justify provisioning now rather than later. In effect, banks are bound to record in 2020 a surge in loan losses and earnings will have to be trimmed. We assume that it will be a long way before core capital bases are being eroded but dividends might.
As far as loan losses go, the outlook in basis points is as follows…
Loan losses, too low to last
Assuming that the 20bp average in 2020 becomes 40bp would imply a c. €86bn hit to profits, pre-tax of course, for the 39 banks coverage of AlphaValue. As a reminder, 2020 earnings are foreseen at €114bn so that they would halve… Dividends are (were?) expected to amount to €56bn paid in 2021. Banks may end up just covering their pay out or more likely take no chance and cut dividends altogether. It is interesting to observe that Banks will thus not manage to pay out as much as they did in 2007.
Banks’ dividends could have reached a new high
It is a fair bet that the 15% or so correction experienced by Banks over the last two weeks does not open a 6.7% bargain on the yield front, as this will have to be trimmed substantially.
Banks’ valuation essentials
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