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How big might bank losses be?

Meaningful forecasts are difficult, but perhaps R35bn collectively.
There will be a contraction in the amount of credit across the banking sector, possibly of at least 2%. Image: Dean Hutton, Bloomberg

While bank bosses have cautioned that it remains far too early to forecast the impact of the lockdown and the Covid-19 pandemic on profits and balance sheets, at least one credible model has been published in the public domain.

The difficulty, for now, is that banks don’t have enough data (practically only one month-end) to give a real indication of stresses across the economy, nor is there any clear picture of what the lockdown trajectory is likely to be over the coming months.

In a webinar last week, Peter Attard Montalto, head of capital markets research at Intellidex, spoke of a “grinding crisis” and highlighted that this was “not a normal shock”. And although certain quarters (including cabinet ministers who seem rather far out of their depth) speak of a short, sharp V-shaped recovery, there is a growing realisation (acceptance?) that this is likely not going to be the case.

There is a temptation to look back at the global financial crisis and its after-effects as a guide, but this is a very different crisis.

We have no recent experience of what happens when you shut down an economy for a month, nor what the impacts are of the prolonged closure of certain sectors, such as hospitality and airlines. As China emerges, data points there – in the absence of any others – are useful but come with health warnings about the accuracy of the numbers. However, we are going to need to see the trend in a number of different economies before being able to accurately forecast how this plays out in South Africa across the remainder of the year.

Credit loss ratio (%) 2008 2009
Nedbank Group 1.17 1.47
– Nedbank Retail 2.47 3.08
– Nedbank Business 0.52 0.59
– Nedbank Corporate 0.12 0.24
Absa Group 1.19 1.74
– Retail banking* 1.72 2.34
– Commercial banking 0.28 0.75
FirstRand Group 1.28 1.81
– Retail 2.00 2.70
Standard Bank Group 1.55 1.60
– Personal and business banking 2.47 2.56

* Includes business banking

A large positive is that the country’s banking sector has entered this environment “significantly stronger than when we entered the global financial crisis,” says Mike Brown, CEO of Nedbank Group. Balance sheets are in much better shape and Nedbank’s core equity tier 1 (CET1) solvency ratio is 40% higher than it was in 2008. But as he highlighted in an update on Wednesday evening, the macroeconomic environment is likely to be “more challenging” than it was just over a decade ago. At this stage, he says, it “is not possible for anyone to forecast or predict outcomes”.

In a report from last week, Fitch Ratings agrees, saying “given the uncertainty around the duration and severity of the shock to the operating environment, it is difficult at this stage to provide meaningful financial forecasts or even to say which banks will perform better than others”.

‘Earnings will fall’

Fitch warns that bank earnings will fall and highlights the additional “pressure on margins from lower interest rates (100bp cuts in March and April 2020 in response to coronavirus, and more could follow)” and says this, together with a rise in credit impairments, will negatively affect operating profit. It says “weaker results from regional operations are also likely, due to lower oil prices and the fallout of the pandemic”.

Read:

In its report, it says the “the first-order effect on asset quality will come from personal lending (particularly in unsecured lending) and from SMEs directly affected by the coronavirus disruption, like tourism and hospitality, retail, or manufacturing linked to global supply chains.

The second-order impact on asset quality will come from companies unable to recover from the resulting economic downturn. These could include medium-sized retailers, commercial real estate firms or services companies. Prime corporates are likely to weather the downturn unless those are exposed to key economic sectors like mining.

GDP drop

The trajectory of earnings is easy to forecast at this moment. Despite the fact that the picture will look a lot clearer two months from now, the number of unknowns is decreasing for many variables. Many smart economists and analysts are beginning to confidently forecast an approximate 10% drop in GDP this year. There will be a contraction in the amount of credit across the banking sector (of at least 2%?) and, at this point, we know that the banks are giving three-month payment holidays to those clients who need it.

Read: You don’t qualify for bank assistance? Good, you’ve dodged a bullet

Intellidex chair Stuart Theobald makes the point that this pandemic has created, “in a sense, a financial crisis on top of an economic and health crisis”.

Banks are under extreme pressure. He says there will two drivers of increased provisions: first, the impact of a deteriorating economic environment and loan book; and second, the implementation of (International Financial Reporting Standards) IFRS 9. He adds that it is not a stretch to see a return to the levels of provisions we saw during the financial crisis (4% of their books increasing to 6%).

Along with this, there will be a “fall in new business flows on the non-interest revenue side of the income statement”.

“Measures from the [South African] Reserve Bank to decrease capital adequacy requirements and liquidity coverage ratios are accommodative of what banks are facing, rather than in any way stimulating the banking sector to increase lending.”

Covid-19 impact on banks Baseline Positive Negative
Total cost to banks R120.7bn R61.8bn R279.8bn
Total cost as % of equity 23.97% 12.28% 55.54%
Cost as % of latest year profit 142.16% 72.83% 329.40%
Average total capital adequacy before 16.44% 16.44% 16.44%
Average total capital adequacy after 12.50% 14.42% 7.31%

Source: Intellidex

In its baseline model, Intellidex sees a total cost to banks of R120.7 billion. In this instance, it factors in 5% of banks’ books taking up the 90-day forbearance (payment holiday) option, with new provisions of 20% being raised on these loans. On the remainder of lending books, it sees new provisions of 2% being raised. On the non-interest revenue side of the equation, it has used a 10% decline in the baseline model.

“That’s going to leave the banking sector in a loss position overall of R35 billion. That R35 billion is accommodated within the Reserve Bank’s capital adequacy changes.”

“It is easy to imagine scenarios that are worse,” says Theobald, adding “We can also see better, of course.”

Theobald notes that there is still “extreme uncertainty”. How banks are going to deal with increased provisions is going to be very difficult.

Says Fitch: “We expect loan performance to deteriorate for all the banks this year. This will be more pronounced for banks with higher exposure to lower income households and industries that are most affected by the pandemic, such as hospitality, tourism and SMEs, especially those reliant on uninterrupted supply chains.

“We expect Investec’s loan quality to hold up better than its peers’ given its lack of SME lending and focus on higher income and high net worth individuals, which we consider to be more resilient customers. However, our view of Investec’s overall asset quality is balanced against greater exposure to riskier non-loan assets, such as equities and property investments”.

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When the domino’s start falling in rapid succession the losses could be staggering.

GDP dropping rapidly as is consumer spending-so loan growth down a lot

Property values plummeted to less mortgages

AUM for asset management side impaired through market losses and redemptions or switching into lower profit margin products

Bad debts on unsecured debt and lower recoveries on cars/houses due to weak market and job destruction

Cash being externalized by rich clients

Credit downgrades mean issuing of bank bonds will squeeze margins further due to higher CDS costs

In short banking is not a happy space!!

Banking is geared speculation in the lending market. The maximum gain is capped at the interest rate while the loss is unlimited. This risk/reward ratio is similar to “picking up pennies in front of a steam-roller”. With a capital adequacy ratio of 10% and a reserve ratio of 2.5% for the banking system, if the bank experiences a delinquency or default ratio of 3% of the borrowed funds, then by implication, all depositors have lost all their money. If the delinquency ratio rises to 11% of loans, then the bank itself has lost all its capital.

If, as some economists predict, the GDP will contract by 6% to 10%, then the ability of individuals and businesses to service debts are destroyed to the same extent. Lockdown is a highly destructive self-inflicted contraction in the money supply that will spill over to the Lender of Last Resort. As in all nations, the stupidity of leading politicians always ends up on the lap of the Governor of the Reserve Bank. That is where the buck stops, on the desk of the Governor.

Every myopic, naive and ignorant covid warrior wants to “save lives”, until he realises that he has to foot the bill, either through the loss of his deposit at the bank, or by the similar loss of purchasing power caused by the actions of the Reserve Bank.

We had an earlier lockdown experiment in South Africa. This was in 1856 when the “specialist” Nongqawuse used models and data of similar sophistication as was used now, to motivate the “leaders” to order the complete lockdown of the Xhosa economy by destroying all the cattle and by burning the maize crop. Those who do not learn from history are bound to repeat it.

But don’t worry! The Chinese will bail us out and we’ll all be indentured slaves to Beijing forever, living of $20 per month like professionals in Cuba do.

Proper PK in the offing here methinks

Pamplona: What is a “PK”?

You don’t want to know. #stayassweetasyouare #treasureyourinnocence #hoesklap

The banks losses might soon be big enough to justify a bail in. Look to Cyprus. Stock up on Vaseline !

End of comments.

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