"This is a huge opportunity for the banks."
This comment, from a fund manager, is the most surprising comment I have heard since the start of the Covid-19 outbreak. What was shocking was not the callousness — investors are paid to be callous. What was surprising was his explanation.
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He does not think the banks will scrape extraordinary profits from desperate borrowers. The opportunity is "to prove how stable their businesses actually are".
More than a decade on from the global financial crisis, markets still demand a discount for bank shares, fearing that horrors are hidden on the balance sheet.
Should the banks make it through the coronavirus crisis, they will have passed the ultimate test, and that discount should disappear.
Markets are not looking that far into the future, of course. The shares of the biggest US banks have all dropped between a third and a half within the last month.
This epic sell-off has taken place before the banks have started to feel the impact.
Bankers all tell a similar story: as of the start of this week, spending on credit cards, delinquencies and requests for forbearance were not far off normal levels. Of course the bankers do not think that this will continue. But we are still in the calm before the storm.
The one large financial company that did publicly update the market this week — American Express — said that it still expected its revenues to rise in the first quarter.
So bank shares are priced on guesswork. There is much speculation about where the first blow will fall. The focus in the past few weeks has been on revolving credit lines. Several companies in the hardest-hit industries, from travel to energy, have tapped their facilities, and the headline numbers are large. AB InBev drew a US$9 billion ($15.9b) revolver all the way down, for example, and Carnival Cruise Lines took US$3b.
This means banks' effective exposure to corporate debtors in vulnerable industries is rising. This increases the banks' risk. But it is important to be clear about the type and scale of that risk.
The drawdowns will not, in themselves, leave the banks undercapitalised or drain them of liquidity. Non-financial companies rated by S&P have US$729b in available revolving credit lines.
But the four biggest banks in the country — representing perhaps a third of the American banking system — have at least US$140b each in tier 1 equity. Even a huge run of defaults on revolvers would not, in itself, pose a systemic risk.
Similarly, the liquidity risk is limited. Where does the cash go when it is drawn? Often back into a bank — and often the same bank from which it was borrowed.
If the money is spent instead, it gets recycled back into the system. If one particular bank gets more withdrawals than deposits, the US Federal Reserve has made cheap liquidity available to banks through its discount window.
The Fed also said in recent days that it "supports firms that choose to use their capital and liquidity buffers to lend".
The rush to tap lines is a measure of the dire situation of a few companies, and a sign of acute nerves at many others.
But making a big deal of the credit lines as a threat to the banks is too clever by half. It speaks to the well-earned neuroses of both investors and journalists, who remember how banks' hidden exposures to mortgage debt turned a house price bubble into a global financial calamity.
This time around, the problem is unlikely to be risks concealed in complex structures or hidden in the fine print of loan agreements. Instead the problem will be more simple.
Banks lend people and companies money. If the economy grinds to a halt for half a year or more, the banks are not going to be paid back. No liquidity crunch, no satanically structured securities, no mismatch of short- and long-term funding. Good old the-money-ain't-coming-back credit risk.
Markets are starting to recognise this. Some of the few stocks that have been hit even harder than the big banks are the speciality credit card lenders, especially those that lend to less affluent borrowers than Amex. Discover Financial, for example, has lost more than 60 per cent of its value in a month. Synchrony, which issues store credit cards to the likes of Old Navy and JC Penney, has dropped more than half.
Either the banks have enough capital to absorb the inevitable credit losses to come, or they do not. This will depend on the duration of the crisis, and how sensibly the banks have lent money in the years leading up to this point.
But if they do emerge solvent when the economy begins to grow again, the sceptics will indeed have been vanquished, and bank investors will be positioned to make a great deal of money.
Written by: Robert Armstrong
© Financial Times