Everything was looking perfect for the banks at the start of 2020. Interest rates were expected to remain stable for the year, business was booming, equities and other assets were rising in value and regulators seemed to be easing up on the banks. Then came the COVID-19, and the raging bull market quickly turned into a roaring bear market and an instant recession. After a major sector sell-off, banks suddenly find themselves in a new quagmire in which investors may not be prepared for what is coming, despite having already seen large losses in their stock values.
There are three very specific and common trends that investors have been used to seeing for multiple years heading into 2020. That was strong stock buybacks, rising dividends and a steadily rising book value per share. The major U.S. banks already have shown that they will suspend buybacks during the economic malaise, but investors need to be concerned about potential announcements about dividend cuts, along with shrinking book values.
One issue that will be very difficult to judge, and with earnings acting as a benchmark for dividends, is what the earnings picture will look like in 2020 and 2021. Banks do not offer guidance, and the only known is that the earnings picture obviously will be “worse rather than better.” Moreover, earnings are likely to go drastically lower in the months ahead.
To factor in a worse environment, these are just some of the obvious items that will hurt bank earnings per share ahead: lower net interest margins, lower earnings on cash reserves, lower management fees on financial assets under management, a sharp decline in spending on credit cards, higher delinquencies and charge-offs on credit cards and loans, fewer car loans, lower mortgage activity, lower (safe) loan activity, lower investment banking activity, and so on. That’s even before getting into mortgage forgiveness and other deferred or missed payments that will start in April.
On top of major U.S. banks suspending share buybacks, the current period is only through the end of the second quarter. It seems unlikely that the Federal Reserve will want those banks to go out and aggressively start buying back stock after the end of June. Many politicians also are calling for major companies not to conduct stock buybacks, and the portion of the public that does not invest in stocks does not exactly view stock buybacks as an overall good.
Some of these risks may not be factored into the likes of Bank of America, Citigroup, Goldman Sachs, JPMorgan, Morgan Stanley, Wells Fargo and other key banks.
With an upcoming stress test coming from the Federal Reserve, the boom to bust in the course of a month has created an environment wherein the “severely adverse scenario” is no longer viewed as completely unrealistic. The banks just haven’t had to model for what could be 10% or 20% hits in gross domestic product. U.S. unemployment of 3.5% in prior months is also set to skyrocket due to the mandatory closure of businesses, followed by the overall weakness in the economy.
The banks in the United Kingdom are perhaps a benchmark for what else may be coming down the pipe in the weeks ahead. The major banks agreed to stop paying dividends and to halt stock buybacks for the rest of 2020 under a “request” by the Bank of England. This included the likes of HSBC Holdings PLC (NYSE: HSBC), Royal Bank of Scotland Group PLC (NYSE: RBS) and Barclays PLC (NYSE: BCS). The Bank of England already expects an increase in bad loans due to the coronavirus adding more pressure on top of the Brexit woes. These shares all traded lower in London trading, and this was the reaction in the New York-listed shares on Wednesday: −5% for RBS, −9% for Barclays and −9% for HSBC.