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JPMorgan Chase has said that credit worries from the First Brands and Tricolor bankruptcies have driven up banks’ funding costs, with investors concerned about lenders’ hidden exposure to private capital firms and hedge funds.
The JPMorgan analysts made Monday’s comments about the implied cost of equity after last week’s sell-off of bank stocks, which was sparked by disclosures by two US regional lenders that they were exposed to alleged fraud by borrowers.
The high-profile collapses of car parts maker First Brands Group and subprime auto lender Tricolor Holdings within weeks of each other have highlighted the complex and often opaque financial arrangements between banks and “non-depository financial institutions”.
JPMorgan said banks’ lack of transparency about lending to such so-called NDFIs — a broad category that includes private equity groups, private credit firms and hedge funds — was pushing investors to demand higher compensation for owning their shares.
“The recent global banks sell-off was triggered by poor risk management, in our view, as shown by First Brands supply-chain exposures but more importantly, very poor disclosure in relation to [NDFIs] globally across the banking system,” JPMorgan analysts said in a note to investors. The note was titled “NDFI exposure analysis: lack of disclosure drives higher implied [cost of equity]”.
Regulators have become increasingly concerned about the interconnectedness of banks and NDFIs. The IMF earlier this month warned of the need for greater oversight of the sector. US and European banks are estimated to have $4.5tn of exposure to the wider category of non-bank financial institutions, equal on average to approximately 9 per cent of total loan books.
The collapse of First Brands and Tricolor has shown how banks remain exposed to corporate crashes even when a company’s borrowing is largely outside the domain of traditional bank lending.
Tricolor raised money from investors in the asset-backed securities market but also relied on credit lines from banks such as JPMorgan, Fifth Third Bank and Barclays to help it package subprime car loans into bonds. All three banks have taken impairments.
While First Brands primarily relied on private debt markets to borrow money, the asset management arms of investment banks such as Jefferies and UBS built up large exposures to its invoice-linked financing.
Disclosures from US banks “lack granularity” and do not “give an overall picture”, the JPMorgan analysts said on Monday. They added that European banks were even more opaque than their US peers, with loans listed under the broad umbrella of financial and insurance activities and no breakdown provided.
European lenders can also book lending to NDFIs in legal entities outside the US, as demonstrated by Credit Suisse, which booked risk associated to collapsed family office Archegos Capital Management in its UK business.
As a result, relying on European banks’ disclosures was difficult, JPMorgan said, adding to a valuation gap with their US rivals.
The analysts said they expected European banks to provide more detail on their exposure in their third-quarter earnings, which begin this week, as they sought to narrow the discount.
Despite the increase in the implied cost of equity, JPMorgan estimated that the figure would decline from its current level of approximately 11.5 per cent to 10 per cent over time because of solid fundamentals, and could fall further in the long term.
