Netflix disappoints; oil collapse puts focus on banks; Europe’s dividend abyss

Last week showed higher provisions for loan losses among US banks and this week the first European banks will report earnings. Today Svenska Handelsbanken reported a jump in credit losses to SEK 538mn SEK from SEK 288mn a year ago. Loan losses tend to go up over time as higher loan portfolios increases the provisions for loan losses which flows to the loan loss reserves. But Handelsbanken reported that SEK 400mn in additional provision requirements for expected credit losses. This is the direct impact from COVID-19 beyond what was set aside during normal times. The amount is still small and Handelsbanken is one of the best banks in Europe, but the loan loss reserve ratio is currently set to 0.2% against the peak of 0.21% in 2009. Given this crisis could become deeper, and especially for Sweden relative to the financial crisis of 2008, and thus a loan loss shock could come to Swedish banks.

Also today UniCredit reported €900mn in extra reserves as the bank is preparing for losses due to the extraordinary decline in economic activity from the lockdowns in Europe. Besides the general impact from the COVID-19 on loans the recent oil price collapse will have a significant impact on loans to the energy sector and according to Bloomberg the European banks with the highest exposure to oil companies are Natixis, Credit Agricole and DNB. European banks are flirting with the lows from March and our worry is whether the European banking sector is strong enough to weather the recession from COVID-19.

Clients have asked us to extend our dividend futures model on S&P 500 to European equities. Today we ran the model on STOXX 50 and we were a bit shocked about the result. STOXX 50 dividend futures for Dec 2021 trade future dividends at €64 against current dividends of €122.46. An almost 50% decline in dividends by 2021 and even more depressing the European dividend futures curve does not price in a rebound to the peak, so compressed profitability for many years.

Using the same methodology of historic dividend yields, earnings yields and payout ratios we can estimate the fair value of the STOXX 50 Index of the dividend futures. As the chart shows the current price in the STOXX 50 is significantly above the median (dotted line) and the mean at €1,800. In fact the fair value is 35% below the current price. Obviously the discrepancy could be a combination of both too positive sentiment in European equities and a mispricing in dividend futures. Nevertheless, it reinforces our negative on equities. Based on these number the STOXX 50 is valued at a 2.2% dividend yield against the average of 3.8% since 2004. Typically we observe a lower dividend yield when the economy is healthy and growing strongly.