TwentyFour Asset Management
A few weeks ago Bank of America Merrill Lynch’s CEO, Brian Moynihan, said that loan losses were not coming through as thick or as fast as he would normally expect for a recession, in particular a recession of this magnitude.
Moynihan did say he expected losses to come through in due course, and we did not think too much more about the comment. After all, we had just heard from most of the listed banks reporting their Q1 numbers and attempting to predict the rest of the year, and it was still very uncertain how long the various economic shutdowns would last and how exactly they would translate into credit losses.
However, this week we have seen further informed suggestions that Q2 provisioning might not be as bad as once feared, and this has forced us to consider again how banks are tackling the crisis.
In dissecting the raft of Q1 bank results, the most challenging task for investors was to assess how aggressive the various banks had been in taking provisions for losses early, as this was the first time they had entered a recession with such high levels of capital. This meant they could afford to be aggressive, especially as dividends were retained. We knew losses would be bad going forward, but how early would banks look to take them?
Without naming names, it was clear to us that approaches were quite different across geographies and also from firm to firm. We would ultimately rely a lot on firms’ ‘DNA’ to assess how they would work through the crisis. For example, the Scandinavian banks are generally not risky credit lenders, nor are the Swiss or the UK mortgage banks. Some banks have a lot of diversity in their activities, whereas some have lower diversity, perhaps through sub-scale investment banking. Others might be commercial property specialists or have large exposures to the more risky SME sectors. This ‘DNA’ probably gives us the biggest clue as to how the crisis might impact each institution. Previous experience does in fact still help a lot in trying to work through this crisis.
All told, after Q1 we felt certain there were a lot more losses to come, though we were also confident that given the relative strength of banks’ balance sheets, we would avoid a financial crisis.
What we were absolutely not expecting was to hear from the CEO of the world’s leading banking franchise, JP Morgan’s Jamie Dimon, that according to his firm’s base case for 2020, the US banks may not need to add any further to the hefty credit provisioning they made in Q1.
I would normally dismiss this type of comment as unduly optimistic, and conclude that Dimon was simply talking his own book. However, given the size and scope of its business, JP Morgan is in an exceptionally good position to make this call based on what it sees day-to-day at the coalface from its customers, so we have to at least consider that the comments reflect lower-than-expected loan losses coming through, which is exactly what BAML’s Moynihan said.
So for the US banks our read is that Q2, which is now two-thirds done, could be surprisingly ok, especially when we consider that their investment banking operations should have had a good quarter too. It is therefore little surprise to us that stock values have jumped. From a credit perspective, we can thus expect bank capital levels to grow further as dividends are not distributed and profits are retained.
While it’s very hard to believe that provisioning really is behind us, Q2 at least might not be as bad as many participants in both the bond and equity markets have feared.