Edison Research: Impact of coronavirus on financial services

Edison Research: Impact of coronavirus on financial services

Release Date: 09 March 2020

Fear, not the coronavirus. might be the UK economy’s biggest enemy as supply chains recover more quickly than expected

A spending drought makes extraordinary spring sales likely, with some retailers going to the wall

More will be known next week and there are reasons to be cheerful

We’re in a state of uncertainty right now. And unless infection rates start to fall quickly, we can’t exclude further declines in stock markets.

Our experts are predicting the potential for extraordinary spring sales as retailers, travel agents and even restauranteurs discount heavily to avoid going bust. Not because they cannot source stock or deliver services - but because their customers are too paralysed by fear to spend.

While much has been made of the potential disruption to manufacturing and transport, triggering collapses which leave companies without components and shops with empty shelves and racks, initial evidence suggests production disruption can be limited to a few short weeks within each affected country.

Two US-listed fuel-cell companies, Plug Power and Ballard, reported last week and neither of them were badly hit, despite relying on Chinese suppliers. They reported some initial disruption but employees are going back to work and production is ramping up again.

Plug Power is headquartered in New York. During its Q419 results call on Thursday, the CEO noted “We saw a two week to three week disruption in China, but you know at the moment all of our Chinese suppliers are operating and we see many of them are working over-time. We’re also tracking our other suppliers that have dependencies in China and their reports are similar to our experience. We don’t see the issues having any impact on the first quarter and we don’t expect any revenue impact for the year. We’ve seen no changes with our customers.”

Ballard held its Q419 results call shortly afterwards and the message from its CEO was very similar “at this time were not expecting a material impact to our 2020 financial results.”

Whilst gold has increased as investors rush to it as a haven from stocks, many raw materials and commodity prices remain relatively unscathed - with markets yet to react to a massive drop in demand or sudden increase that cannot be met by supply.

So the real economic impact of the virus may be akin to terrorism and the fear it spreads. In times of uncertainty the mortgage will be paid for - along with food and power - but more discretionary spend is currently at risk.

Our experts believe those on zero hour or other temporary contracts will already be reducing spend. Restaurants, retailers, entertainment venues and schools are already openly discussing cutting hours or closing entirely.

And given this risk, who really needs that new shirt, dress, night out or weekend away? Companies which have a high level of seasonality in their offering, including clothing retailers and travel companies, are likely to be worst affected.

The likely result is a deep round of high street and online sales, with businesses carrying the highest levels of debt likely to discount most deeply. This could put the most vulnerable at risk of not surviving the fear of coronavirus.

However, it is also possible that, as the crisis drags on, new impacts may reveal themselves.

Gaps in Chinese supply chains might take up to 12 weeks to work through the system. This is likely to be replicated in every country hit by the virus. And as many industries rely on a highly international supply chain, the results could be chaotic with different components going out of stock in a staggered way - effectively crippling production for many months. The more complex the product, the longer it will take for the full impact to emerge.

The impacts are also likely to hit smaller companies harder. When stocks are running low, larger clients will be prioritised. However, prices will increase. So whilst smaller companies could be left entirely bereft, larger companies will still struggle to retain profit margins.

The extent and likelihood of supply chain impact is set to become clearer next week.

Building materials such as taps, tiles, hinges and handles do not have complex supply chains. So, if Chinese imports are quickly restored, it will support the theory that production delays will be blips rather than full-scale collapses. In the meantime, companies outside of China are likely to be enjoying higher prices for their goods.

And there are other reasons to be cheerful - the practice UK companies have had with managing supplies and stocks given the uncertainties around Brexit will have sharpened their abilities to deal with coronavirus.

It certainly seems that one predictable trend seems is that the world is becoming less predictable.

Impact of coronavirus on Financial Services:

- Banks – lower interest rates and lending volumes will reduce revenues and credit losses will rise (with some delay) as a result of weakening economic activity. In addition revenue from trading activities could be negatively impacted from falls in the value of financial assets such as corporate bonds, and credit and interest derivatives. This will lower profitability.

- Asset managers – falling markets lower the value of assets under management and reduce fees but cash flows and balance sheets are generally very strong in the industry.

- Real estate – weakening economies lead to higher vacancy rates thus lowering rental income and raising costs. This tends to impact secondary space more than primary – Regional REIT are most exposed here. In addition, for overleveraged companies difficulty in rolling debt can create problems especially if there is a large development pipeline to fund

- Investment companies

  • Standard equity trusts relatively immune from a financial angle – assets will fall in value and NAV discounts will widen.
  • Private equity trusts – higher liquidity risk in these as they all have commitments to the underlying funds. Most have a controlled policy these days following the financial crisis, with back up liquidity lines too.
  • Credit vehicles – more risk here from defaults, especially in LBOW (higher LTV property backed lending), VTA (CLO equity and debt), MPLF (CLO equity and debt), EJFI (credit instruments in financial companies). These have generally quite diversified portfolios so you would need a large negative credit shock with high correlation to really damage them.
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