GovernanceMacroeconomicsTreasurers continue cautious outlook

Treasurers continue cautious outlook

Banks continue to build up capital reserves as corporates look for new lines of credit

Banks and corporate treasurers are pulling in two different directions says Sankar Krishnan, executive vice president of banking and capital markets at Capgemini.

“From the perspective of a treasurer, obviously the future is uncertain. You’re trying to draw down your credit lines as much as possible to stay liquid through the crisis. Especially because the interest rates are so low, you’re also trying to lock into long term loans because over a period of time the weighted average cost of capital would go down.

“But if you’re a bank, you’re doing the opposite, what they are doing is looking at the credit quality of each of these buyers, and then taking educated views based on a best case scenario in terms of how the risk model plays out on who they want to continue extending credit to, and who they don’t want to extend credit to.”

Banks are in a much better position now in terms of capital reserves than they were in the last economic downturn says Bill Phelan, senior vice president and general manager at PayNet.

“The financial crisis showed that a lot of banks did have the reserves they needed and they spent quite a bit of time building back reserves, post great recession. They’re in better shape, the capital ratios are up several percent and that’s a lot of money that is there to cushion any loan losses.”

He added, “It’s unprecedented so, banks are erring on the side of caution. Keeping your capital is like keeping your powder dry, it’s pretty smart move right now.”

Major banks in the UK, like HSBC, Lloyds and Standard Chartered have over the past month increased their ‘bad loan’ reserves.

The Bank of England’s Prudential Regulation Authority has also instructed UK banks to suspend dividend payments for 2020.

America’s largest bank, JP Morgan has increased its loan loss reserves to $8.3bn and has warned investors that it may suspend it Q2 dividend payout. It did however, payout a Q1 dividend of $0.90.

Krishnan believes that other US bank will follow JP Morgan’s lead if they suspend dividend payments.

“The US banking industry kind of stays together in terms of policies on dividends and buybacks and so forth. I think [they will suspend dividends] because it’s also bad optics. When the financial crisis happened, it became Main Street versus Wall Street. I think banks are doing a good job in terms of responding to the government stimulus plan.”

Like in the UK, the US government has instituted a raft of measures to help prop up the economy and much of that stimulus relies on commercial banks providing loans. The UK has both the Bounce Back Loan Scheme and the Coronavirus Businesses Interruption Loan Scheme (CBILS), while US firms have the Main Street Lending Program (MSLP).

Both CBILS and MSLP depend on commercial banks issuing loans to businesses with the UK and US governments guaranteeing loans in the range of 80-95 percent of the borrowed amount.

“To the extent that the credit can be backstopped by the government, banks are fine with lending because they’re changing the counterparty risk from a corporate counterparty to the government”, says Krishan.

Financial modelling carried out by PayNet found that up to five percent of US businesses could become insolvent, under the assumption of a 10 percent contraction and six percent unemployment rate. But the latest numbers from the US’s Bureau of Labor Statistics saw the unemployment rate surge to 14.7 percent. With news that unemployment could peak into the 20 percent range, Phelan says the US could see up to 1 in 10 business close their doors.

“The big unknown is how long is that lockdown going to go on for”, says Phelan.

“It’s also not just the lockdown. It’s when are people comfortable going back into the pub or going back into grocery or retail stores? Shopping and getting back together in big events like soccer matches.”

Krishnan says while there may be an increase in commercial bankruptcies, he is optimistic of the recovery.

“There are going to be a variety of chapter 11 type situations. But the reason I am optimistic is that while the short term is going to be painful. I think there will be a shake up, there will be new business models and I think each country will gravitate to a new normal.”

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