Apr 9, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

I'm in Washington, D.C., all week for the IMF-World Bank spring meetings. We'll have a number of items, quotes and insights from fund managers, government officials and global policymakers on the current and future outlook for financial markets.

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Situational awareness:

  • The Trump administration is proposing tariffs on around $11 billion in imports from the European Union, including helicopters, cheeses, wines, ski suits and motorcycles, in response to harm the U.S. says is being caused by EU subsidies to Airbus. (Bloomberg)
  • British Prime Minister Theresa May is scheduled to meet with German Chancellor Angela Merkel and French President Emmanuel Macron to discuss her request for a Brexit extension. (BBC)
  • U.S. casino operator Wynn Resorts made a $7.1 billion takeover offer for Australia’s Crown Resorts. (Reuters)
  • Saudi Aramco attracted orders of more than $85 billion for its planned international bond on what is expected to be just a $10 billion offering. (Reuters)
1 big thing: The debt market is littered with risky loans

Photo: Getty Images

There are worrisome trends developing in the lending market, reporting from the Washington Post and Bloomberg shows.

"Actions by federal regulators and Republicans in Congress over the past two years have paved the way for banks and other financial companies to issue more than $1 trillion in risky corporate loans," Damian Paletta of the Post writes, "sparking fears that Washington and Wall Street are repeating the mistakes made before the financial crisis."

Why it matters: Big banks and other financial institutions have originated the risky loans to "hundreds of cash-strapped companies, many of which could be unable to repay if the economy slows or interest rates rise."

  • One of the big worries about the so-called leveraged loans is that they are often provided to borrowers "who have access to less cash than others, and who tend to fall behind on payments with greater frequency when interest rates go up or the economy slows down."
  • “Over the past 35 years, these are some of the worst underwritten loans in the bank,” Timothy Long, a former chief national bank examiner at the Office of the Comptroller of the Currency, told the Post.

Further, there's also been a growth of so-called covenant-lite loans, which lack traditional loan requirements and offer less protection for lenders and investors than traditionally structured credits if borrowers default.

There's more: Financial institutions are lending to less-qualified borrowers as a result of "grade inflation," Adam Tempkin at Bloomberg reports.

  • "Consumer credit scores have been artificially inflated over the past decade and are masking the real danger the riskiest borrowers pose to hundreds of billions of dollars of debt," Tempkin writes, citing analysts and economists at Goldman Sachs and Moody’s Analytics, and research from the Federal Reserve.
  • “Borrowers with low credit scores in 2019 pose a much higher relative risk,” Cris deRitis, deputy chief economist at Moody’s Analytics, told Tempkin.

My thought bubble: There are a lot of bad bets in the global debt market. As the economy slows, borrowers may have trouble making payments, which could lead to a wave of defaults. Fortunately, much of the risk is not held by banks as it was during the financial crisis, so there's unlikely to be a repeat of the systemic failure we saw in 2007.

  • That doesn't mean the next recession won't happen, just that it won't look like the last one.
2. Americans use mobile payments less than checks
Expand chart
Adapted from CivicScience; Chart: Andrew Witherspoon/Axios

Despite well-documented pushes by Apple, Samsung and others into the mobile payments space, more Americans still write checks than use mobile payments.

The U.S. is growing increasingly out of step with the rest of the world. By 2022, mobile payments from companies like Alipay, WeChat Pay and others are projected to account for nearly 50% of global e-commerce sales.

Why it matters: Mobile payment transactions in China rose to nearly $13 trillion in just the period from January to October last year, according to official figures from the Ministry of Industry and Information Technology cited by the South China Morning Post.

  • Nearly 75% of supermarkets and convenience stores in Singapore, Malaysia and Thailand now accept mobile payments, a recent Nielsen survey shows.
  • Among online shoppers in countries like Italy, Spain and France, PayPal is growing faster than Mastercard and Visa among online shoppers.

The U.S. saw less than 1% of China's total, at $49.3 billion in estimated total mobile payment transactions, according to data from eMarketer.

Why it's happening: Debit and credit cards continue to dominate Americans' wallets. John Dick, CEO of CivicScience, says it really comes down to trust.

  • "Americans have long-standing faith in the banking system and much less so in Big Tech. When we've surveyed people on this topic before, U.S. consumers trust their banks more than digital solutions by over 6-to-1. And that gap has widened since 2017." 
  • "While carrying paper money around is an inconvenience, people feel safer with a bank-provided card than Silicon Valley-provided app." 

The bottom line: There's a clear opportunity here. Apple appears to be trying to close the trust gap through its new Apple Card with Goldman Sachs.

3. The good news and bad news about this earnings season

Twenty-three companies — or about 5% of the S&P 500 — have reported first quarter earnings so far, Axios' Courtenay Brown writes.

  • Based on guidance from those companies, more than half have seen their second quarter profit expectations lowered, according to research firm The Earnings Scout.

The good news: This is actually an improvement. At this point in last year's earnings season, even more of the same group of companies (about 74%) saw profit estimates cut for Q2 2018.

  • The magnitude of the cuts were bigger too. This year, companies' profits, on average, will be 3.44% lower next quarter than initially estimated, analysts say. Last year that number was nearly twice as much.
  • Be smart: As analysts at Bank of America point out in a recent note, companies "typically set a low bar" in the first quarter, so overall lower guidance isn't too surprising.

The bad news: The likelihood of an earnings recession — or 2 straight quarters of year-over-year earnings declines — is increasing.

  • If analysts' predictions are right, the S&P 500s will have negative earnings growth this quarter. Expectations for Q2 profit growth have fallen from 5% in January to 2% as of yesterday.
  • Based on early first quarter reports, "it is very likely the 2Q 2019 EPS growth estimate falls to negative -1.0% to -3.0% in the weeks ahead," Nick Raich, CEO of The Earnings Scout, wrote in a note to clients.
4. Big bank CEOs will tout change during Congressional hearings

Courtenay writes that the CEOs of big U.S. banks will spotlight the way their companies have transformed since the financial crisis at Wednesday's House Financial Services Committee hearing — and they'll say the system has become less risky thanks to regulations, released testimonies show.

The backdrop: It's the first time the heads of America's biggest financial institutions will testify together since the aftermath of the financial crisis. It's "part of an opening salvo in House Democrats' plans to examine the industry’s activities," the Wall Street Journal points out, and it comes amid heightened scrutiny of capitalism's effectiveness.

The highlights:

  • "Since the crisis, Citi has become a smaller, safer, stronger and far less complex company. We have transformed our institution, not just in terms of capital ... but also in terms of our controls, which include risk management, audit, and compliance," Michael Corbat, Citigroup's CEO, writes in prepared remarks.
  • "Since 2009, we have devoted substantial resources across the firm to not only improve the resilience and resolvability of Goldman Sachs, but also to reduce complexity in our structure and make our firm more efficient," Goldman Sachs' CEO David Solomon, whose been at the helm of the bank for less than a year, will say.
  • "Through regulatory reform efforts, we have fundamentally improved the safety and soundness of our financial system," JPMorgan CEO Jamie Dimon plans to say.

The message is similar to that being laid out by the Financial Services Forum — a trade group whose members are all testifying, with the exception of Wells Fargo's interim CEO.

  • "[The testimony] is an opportunity for industry leaders and Members of Congress to take stock of the massive improvements to our nation’s financial stability," Kevin Fromer, president & CEO of the Financial Services Forum, wrote in a memo obtained by Axios.

According to a memo from the House Financial Services Committee, chaired by Rep. Maxine Waters (D-Calif.): “A number of questions remain regarding whether America is being well-served by the largest and most systemically important banks, and whether there is appropriate accountability."

Dion Rabouin