My suspicion is that until fairly recently the ups and downs of the stock market were largely based  on pure guess work – hopes and expectations. Frankly, none of us had any idea how bad things might get and what impact the wider economic downturn would have on corporate profits and dividends. We knew it would be bad in the short term – collapsing dividend payouts reminded us of that – but what impact that might have on Q2 and later quarters for 2020 was just finger in the air stuff. Thankfully, there’s a decent chance we are now past peak uncertainty and form now on the guidance on profits (and dividends) should/might improve.

We are now entering a new earnings season (Q2) here in Europe, between now and the 31st July which will mean we hear from over $5tn of Market Cap on 2Q results, after which time the pace of reporting will slow down.

And what are those numbers telling us in Europe? According to a report last week from equity analysts at Morgan Stanley the initial very early take on 2Q numbers isn’t too bad. They have tracked 36 companies so far and found that 64% have beaten EPS estimates, while 18% have missed so far, giving a strong ‘net beat’ of ~46% of companies. Weighted earnings have beaten by 12.2% (on limited numbers), and the median stock has also surprised positively so far (+15.6%). At the sector level Financials and Commodities are currently seeing some of the best earnings revisions in the market with Value stocks seeing some modest upgrades vs Growth stocks too – largely a function of improving commodity prices.

According to the MS analysts given that initial 2Q guidance for many companies “was likely struck at the height of the crisis/economic disruption we remain of the view that 2Q should deliver a solid net beat… with European earnings revisions hovering around neutral territory any continuation of the broad-based EPS beats we are seeing could allow for some modest upgrades to consensus expectations for 2020 and/or 2021.”

Bad debts – how much is enough

For anyone who’s followed the world of online or peer to peer lending, the $64 trillion question has always been what happens in a downturn? For most of the time as an online lender you should be making a fairly steady income (say between 4 to 6%)  but we all know that as sure as night follows day, bad debts spike upwards in a recession. Because we didn’t really have a full, diverse online lending market during the last recession in 2009, most of the estimates of likely losses in a future recession were just that ……. guesses.

For me, the key issue was always the quantum of increase i.e given a base level of bad debts, how much would they increase in  a recession. 2, 4 or maybe 10 fold?? Again, my best finger in the air guestimate has always been around 5 times the ‘normal’ level but that was just a hunch based on existing credit card data from the last few decades.

Now though we are beginning to see contextual data from big banks emerging which gives us some measure of potential losses. As a very rough guide, most online lenders have guided to an average loss rate across a book of between 1 and 2% pa with some outliers either side. Again, my guess would be that in any recession, the increase in that loss rate would be in excess of that we would expect from banks. One has to allow for the fact that banks are established lenders who have – one would hope – decent risk and credit loss processes. So, how big an increase are the banks seeing in losses?

A contact last week sent me over some pulled together data which I think is very revealing. Here is the summary:

  • CLOSE Brothers -an annualised bad debt ratio of 2.3% versus 2019: 0.6%
  • RBS Q1 – 90 basis points of gross customer loans, compared with 11 basis points in Q1 2019. Impairment losses in Q4 2019 was £160m, 5x increase in provisions.
  • HSBC Q1 2020 – Change in expected credit losses and other credit impairment charges increased to $3,026bn from $722m in Q4 2019, 4.2x increase.
  • Lloyds Q1 2020 – “The Group’s impairment charge increased by £1,036 million to £1,311 million in the three months to 31 March 2020 compared to £275 million in the three months to 31 March 2019…” This is an increase of 4.76x.
  • JPM Q1 2010 – “Firmwide total credit reserves of $25.4B – net build of $6.8B driven by the impact of COVID-19”. Total credit costs were $8.3bn in Q1 of 2020 vs $1.4bn in Q4 of 2019. This is a nearly 6x increase in credit losses

On this analysis a four to five-fold increase in the quantum of losses seems about right for the banks, at this stage.

I would assume that the losses from online lenders will be a greater quantum than this, possibly 5 to 7 times. Thus, if we assume an industry average of say 1.5% bad debts in a ‘normal’ year, then I think 9 to 10% for 2020 feels about right.