Monday Musings: August 10, 2020

Aug 10, 2020

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Public Trust Credit Team
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The vast majority of Yankee banks have reported second quarter earnings with mixed results as expected

Earnings reports for the large international banks continue to be noisy as provisions for future credit losses were again the most prominent driver of profit decline versus the prior year. The expected credit losses framework for European banks (IFRS 9) has a shorter time horizon than new Current Expected Credit Losses (CECL) standards for U.S. banks, meaning that loan loss reserves are less front-loaded and provisions are likely to remain elevated over the coming quarters. Positively, many Yankee banks benefit from highly diversified business models that have proven resilient in the face of COVID-19 headwinds. In general, franchises with strong market operations like various French, Swiss, and U.K. banks have been able to drive revenue growth as they have capitalized on market volatility specifically with respect to fixed income, currencies, and commodities (FICC) trading. In Asia, gains on the sale of securities for Japanese banks should continue to help offset rising credit costs in the second half of 2020 while solid wealth management operations and loan growth continue to bode well for Singapore lenders. Most importantly, liquidity metrics remain strong and capital levels are holding up well across all geographies as suspended payouts to shareholders have allowed banks to organically grow their capital reserves.

Executive orders break through the stalemate on fiscal stimulus

Over the weekend, President Trump released a flurry of executive orders aimed at bridging the gap between the Senate and House bills that are still under discussion and have yet to reach a compromise. The key items of the order are a $400 additional unemployment benefit that is to be funded at 75% by the Federal government and 25% by the states. The Federal portion of the benefit is to be paid by the disaster relief fund. The second order calls for the Housing and Urban Development (HUD) department to identify funds to provide temporary assistance to renters and homeowners who are struggling. The order does not, however, reauthorize the temporary eviction moratorium that was in the CARES Act. Next, the President directed the Treasury to defer the 6.2% employee-paid payroll tax for incomes less than $104,000 per year that helps fund Social Security. Finally, the orders also extended the payment and interest moratorium on student loans that was part of the CARES Act.
 
Compared to a $3.5 trillion House bill or a $1 trillion Senate bill, the executive orders will likely only provide limited relief. The unemployment benefit (about two-thirds of the previous benefit) should help in the meantime, though it is possible the administration could face a legal challenge on the source of funds. The $100 portion to be paid for by the states seems unlikely to make it because most states are already facing budget gaps that will prevent them from being able to pay out the extra benefit without hampering their fiscal flexibility. The housing order will ideally help renters, but it does not have much in the way of teeth and could just fall to the wayside if HUD cannot source funds and regulators do not step in. Likely one of the most meaningful items, the payroll tax is only a deferral; Americans that receive the benefit would see it come back on their 2021 tax return though President Trump claimed he will cancel the tax if reelected. The executive orders certainly made headlines over the weekend, but we expect they will likely have little effect on credit markets until a larger congressional stimulus is passed.
All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.

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