From a Dresdner note sent to clients on Tuesday, looking at the comparative merits of Barclays and RBS:
Corporate credit quality set to deteriorate significantly and peak next year: Reliable long-term relationships between corporate insolvencies and GDP growth and the corporate debt service burden suggest 2009 as the worst year for credit quality, with some improvement in 2010. We foresee around 20,000 corporate insolvencies next year, which would be 60% up on last year but 17% down on 1991’s peak. Weak sterling should provide a degree of respite for exporters but the overall macro picture is still very tough.
Property writedowns are so last season. Plain vanilla insolvencies are the new black (or red, in financial terms). And it’s a trend all financialistas feel comfortable with: if GDP shrinks, companies go bust and unemployment rises. Period.
Dresdner has published a 50 page analysis of corporate credit quality at Barclays and RBS, coming to the conclusion that while Barclays has moved up the risk curve, RBS appears to have moved down. Not surprisingly, analysts at the bank favour the latter over the former.
RBS is much cheaper: Barclays is much more expensive, valued at 1.7x tangible book value per share versus 1.2x at RBS. While we view Barclays as having a more attractive business mix, we think that the premium is far too high and would expect it to narrow significantly. We see a similar disparity in P/E ratios, with RBS trading at 7.1x 2009E earnings versus 9.9x at Barclays. We have upgraded RBS to Buy (from Add), with a price target of 275p and downgraded Barclays to Reduce (from Hold), with a target price of 350p.
But keep an eye out for this corporate crunch theme. From JPMorgan research on the UK banks as a whole on Monday:
On our estimates, for every 10% fall in UK house prices this implies 3% more capital needs, whereas a 10% fall in corporate recoveries would imply 8%.
Now, from an American perspective, consider this chart from Calculated Risk:
This is the spread between high and low quality commercial paper and is traditionally used as a gauge of lower quality issuers defaulting. Over the past year the readings have been skewed, of course, by the lack of liquidity in the system. But right now this default alert has jumped to a record 280bp.
David Rosenberg at Merrill Lynch notes that in the week ahead of the US Treasury’s rescue of AIG, the commercial paper market shrank by $52bn as money market funds yanked back assets to meet their own redemption demands. The corporate sector needs buyers of its commercial paper to fund day-to-day working capital requirements.
This is where Wall St and Main St intersect. And there’s gridlock.
