COVID-19 has generated significant instability and high volatility in global capital markets. While the full impact is yet to be determined, it’s expected that the adverse impact are likely to continue from the virus’ knock-on effects. As part of our Global banking M&A outlook H2 2020 report, we explore the areas of the overall banking sector most likely to be impacted, including valuation and profitability.
The low interest rate scenario, along with the significant impact of the COVID-19, is reducing the core banking profitability in mature markets. Financial institutions are thus shifting towards commission-based income from the likes of payments and tech businesses.
One of the immediate effects of the health emergency on the real global economy is the increased credit risk of corporate and retail clients of the banks. In order to continue financing the real economy and support its recovery, banks are called to distinguish between purely temporary phenomena, destined to be reabsorbed in a short time, and longer lasting impacts which would require actions of management and reclassification.
The primary aspects to be considered are:
The contraction in economic activity is having adverse consequences on credit quality as banks are increasing loan loss provisions. A few European banks, have already posted significant losses in Q1'20 (Jan-Mar) to face a potential surge in bad loans.
COVID-19 has generated significant instability and high volatility in global capital markets. The financial sector has been one of the most affected, with bank valuations dropping in all countries around the world (P/NAV multiple experienced a severe downfall from 1.00x on 31 December 2019 to 0.69x on 30 April 2020). At the regional level, North American banks are still trading at P/NAV equal to an average 1.15x, while Asian and European banks (with the exception of the Nordics) are currently trading at significant discount levels (with average P/NAV at 0.56x and 0.52x, respectively).
Banking stocks were impacted during COVID-19. In the period from 01 December 2019 to 30 April 2020 -- most banks saw a price slump in mid-March. European banks were adversely impacted as the Euro STOXX banks index saw a massive decline of 40.18 percent followed by STOXX North America 600 banks index (31.23 percent) and STOXX Asia/Pacific 600 Banks Index (26.09 percent) for the given period.
A strong correlation between bank valuation and profitability is envisaged by the regression analysis. North American banks in particular are experiencing higher valuations due to a relatively higher profitability, mainly driven by the diversification of the business activity (e.g. investment banking services), with RONAV equal to 11.4 percent on average, compared with 10.9 percent and 7.5 percent in Asian and European banks, respectively. At a regional level, assuming a RONAV equal to 10 percent, the implied P/RONAV is equal to 1.0x, 0.8x and 0.5x in North America, Europe and Asia respectively.