Why are bank stocks suffering from the Corona Virus?
Should we worry about the weak performance of bank stocks?
While initially financial markets were surprisingly relaxed about the outbreak of the Corona Virus in China, market sentiment has completely turned over the last two weeks. Bank stocks were hit particularly hard and have lost 20% or more since their highs in early February. What are the reasons why bank stocks reacted so strongly and should we be worried about it?
In my view, the impacts of the Corona virus on bank stocks are manifold
1. Risk of global recession: The interruption of global supply chains, cancellation of travel and leisure activities as well as the reluctance of consumers are likely to negatively impact the economy and have increased the risk of a global recession. As a consequence, banks may in the coming quarters see a higher amount of credit losses, in particular in vulnerable areas like the overheated leverage loan and sub-investment grade corporate sector.
2. Interest Income: The FED’s prompt reaction to cut interest rates by 50 bps is possibly the starting point for a series of further rate cuts so that banks may with USD lose their last bastion were they still could generate sufficient net interest income.
3. Financial Markets: The return of volatility into financial markets has two effects. On the one side, investment banks temporarily benefit from higher trading volumes and hedging activities of clients. On the other side, uncertainty tends to adversely impact market sentiment and may discourage wealth management clients from investing their money. Further, the sharp decline in equity market prices reduces the value of invested client assets, which are the basis for the recurring fee and commission income for wealth and asset managers.
4. Impairments: Should the challenging conditions prevail, there is also increased risk for impairments of assets. Following the implementation of IFRS 9, banks may need for the first time to increase their credit provisions due to a potential worsening of the economic outlook. In a prolonged recession, banks may also need to impair goodwill or intangible assets, albeit this would remain without impact on the bank’s CET1 ratios.
Which of the above factors dominates is difficult to say. Personally, I would interpret the strong market reaction mainly as a concern on banks‘ future profitability. Clearly, the fact that most bank shares trade again with a discount to their book value is not a positive sign and could point to more severe structural problems in the sector. Clients and investors are therefore well advised to carefully monitor the price of outstanding AT1 instruments. So far, there was only limited impact on the price of these instruments, which I regard as an encouraging sign that the market does currently not expect another doomsday scenario like the 2007/2008 financial crisis.
Volatility in bank stocks is likely to remain high over the next days and weeks, but I see increasing buying opportunities in the sector.