Blain’s Morning Porridge – July 15 2020: Look to the Banks…

Blain’s Morning Porridge, July 15 2020 – Look to the Banks

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

I wonder what can possibly be wrong with the world when someone paid £325,000 for a beach hut on Mudeford Spit – which is half-way between Southampton and Bournemouth. Its sans-conveniences, and you can’t stay in it. It’s a garden shed with a nice view.

Back in the real world….

One of my readers sent me a kind but rather brutal comment y’day – warning me I have become too optimistic; “seeing the world too much through the lens of the market.” He told me to get back on track and resume my questioning of every assumption the market makes, and focus on the detail to paint the big picture. He’s probably right – I’ve been relying a little too much on gut feel in recent weeks, and perhaps not enough on the grim reality unfolding around us.

As the facts change, I will change my view accordingy.

We’ve got the Fed’s Lael Brainard warning “downside risks predominate”, while the UK singularly failed to post a meaningful recovery in May – the expected 5.5% snapback came in as a deeply shocking 1.8% inchback… taking the economy back to where it was in 2004!

Despite the fears, for the moment I remain convinced the global economy is not heading for Armageddon, or the much anticipated “reset”. As the UK shows, the virus effects on economy are going to be long-lasting and deep, but let’s be pragmatic – we will eventually see recovery. It will be a messy and gory path, but it’s going to happen. It’s the collateral damage that’s going to matter – unemployment, banking weakness, global trade tensions, politics and geopolitics, plus whatever else rises out the coming storm.

I’m going to ignore the economic surveys – which say less than 14% of market participants believe in V-shaped recovery. Let’s try and look for clues as to what’s likely to happen – and draw our own conclusions.

Banks: Wherever there are banks – there is pain.

There is much to be learnt from bank results and comments in recent days. Yesterday the three US banks, Citi, JPM and Wells put $28 bln in the provisions pot to cover looming losses as the Covid-Recession bites through the second half of the year. The US banks aren’t particularly bothered – what Citi and JPM lost on the swings on loan provisions, they made up on the roundabouts of bond trading – more on that below.

European banks are going into the recession after seeing their capital levels already impacted by the immediate virus effects in H1. S&P recently warned lower capital levels will threaten their ability to lend, while “most also saw their liquidity capacity to meet financial obligations weakened.” Even though the ECB and BOE relaxed regulatory capital rules – like the countercyclical buffer – in order to boost lending, but it still raises the stigma of banks looking capital stressed. On the other hand, banks were able to raise nearly €9 bln of additional tier 1 capital (AT1) through Q2.

As the Americans show… Q2 lending losses weren’t that bad, but they expect things to get much worse in H2. As JPM’s boss Jamie Dimon said: “This is not a normal recession. The recessionary part of this you’re going to see down the road.” More pain to come.

Just how bad will it get? It’s how much the European banks are still to set aside that will really interest me. Lots of them have been issuing reassuring statements about how well they’ve pre-provisioned, are adequately capitalised and have access to liquidity. Time will tell. I think the outlook looks bleak. S &P said: “Most banks saw a fall in capital in the first quarter as they took loan loss provisions in anticipation of coronavirus-related impairments. For banks already burdened with low capital levels, such provision had a significant effect.”

For instance, Commerzbank took a thumping in Q2 as it hiked provisions because of the virus. The ailing German bank then saw its Chairman and CEO ousted in a Cerberus coup over its lack of direction, and new CEO Bettina Orlop has warned: “the bulk of the problems will materialise in second half.” Crashing major chords sounding in the distance?

Or how about Santander? It was already looking skinny in terms of its capital – 11.58% in March. It’s been lending to support Spain’s Covid recovery programme, but mounting losses could further dent its capital reerves. Bloomberg recently carried a story hinting at increased provisions on it lending will have to be announced.

The Italian banks are at the top of most people’s danger lists. Tourism and hospitality are the sectors hardest hit by the virus – and are the largest exposures of the banks. The big banks set aside over €1.5 bln in Q1, and wrote down a further €2.5 bln. A raft of tier 2 banks could be wiped on mass defaults. I went looking for quotes from Italian bankers on hiking their loan loss provisions into H2, but as they already have massive NPL problems.. no one is saying much.

We could go round every European bank to try to estimate just how deep the coming recession will bite. It will, but it’s unlikely to break most banks. That’s why they have high capital levels! They have capital to absorb the pain, and the ECB is there to do whatever it takes, but it is also a political issue.

The amount of money the Spanish and Italians are throwing at the banks through SME guarantee schemes is huge. These are designed to keep the economy functional, keep business intact, and support the banks. They skirt ECB/EU rules in terms of potential government support and liabilities- and that’s why the Frugal 5 northern nations are unwilling to write cheques to allow the mutualisation of European debt via an EU Recovery Fund – to bail out Italian and Spanish banks.


Even as JPM was announcing sadly loss provisions of $10.47 bln to cover loan loss, it still made a profit of over $4.6 bln!! Its trading revenues surged 80% to $9.7 bln! Over $7.3 bln of that came from the fixed income bond trading desks! (Citigroup also posted a profit and a massive gain in trading.)

These trading wins may prove to be short-lived windfalls.

The last quarter was the biggest bond issuance orgy in bond market history. It was easy money. Investors were buying because they see rates going lower and negative. Moreover, the know the FED is there to backstop by purchasing corporate debt. The Wall Street sausage factory was pumping out new issues with healthy fees making the banks rick on the back of the perceived Fed bond put. If they are going to be paying their bond traders massive bonuses, should not Jerome Powell be in the bonus pool as well?

If the public understood just how much Wall Street is taking out….. better stay shush about that one then…. But check out this morning’s quote….

Five Things Too Read This Morning

FT – Spain looks for jobs boost from EU pandemic recovery package

FT – US tech stands out as investors’ “most crowded” trade

BBerg – A $44 Billion IPO Isn’t the Win Softbank Needs

Bberg – Dividend Crisis Has UK Income Funds Fighting for Their Future

WSJ – Fed’s Brainard Sees Substantial Economic Risks and Slow Recovery

Out of time… and back to day job…

Bill Blain

Shard Capital