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Debt Load & Coronavirus Cripple Markets: Here's How to Play It

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A gyrating stock market is currently grabbing headlines as the coronavirus outbreak persistently dents corporate profits and deters economic growth. Policymakers are now struggling to contain the spread of this deadly virus and eventually its adverse impact on the economy.

The Fed’s move to cut rates did little to improve investors’ sentiments. It’s because a rate cut simply reduces borrowing costs. But in the case of the coronavirus pandemic, the bigger problem lies with demand contraction due to widespread travel restrictions as well as supply chain disruptions. Evidently, such issues can’t be tackled merely by rate cuts.

In fact, the base-case estimate of the Organization for Economic Cooperation and Development for global economic growth now stands at 2.4% while its worst-case estimate is pegged at 1.5%. Alarmingly, both are below the 2.5% mark that indicates a global recession.

What’s more, the coronavirus-led demand and supply disorder couldn’t have surfaced at a tougher time when the world is already grappling with an enormous debt crisis. Sovereign borrowers are currently reeling under a massive $72.7 trillion debt load. Non-financial lenders and borrowers aren’t spared either! They are now burdened with $69.8 trillion debt, mirroring their distress. In order to meet such debt requirements amid a virus-induced economic slump, the corporates will most likely lay off employees, restrain further investments and take adequate cost-cutting measures. And all these steps will further aggravate the economic downturn.

Investors now fear that companies that borrow heavily like energy players will find it difficult to repay their loans. To top it, many companies don’t even have enough cash inflows to bank on for covering interest payments on their debts. After all, amid the ongoing price war between Riyadh and Moscow coupled with the coronavirus threat, nearly $110 billion of US energy company bonds plummeted into distress territory.

Rating agencies too have set the alarm bells ringing for the already cash-strapped firms that are further exposed to the impact of travel cancellations, supply shortages and deferred discretionary spending due to the coronavirus pandemic. Companies within this bracket mostly include airlines, lodging and cruise operators. Meanwhile, carmakers, electronic goods makers and chemical companies also remain vulnerable to supply chain interruptions. At this critical juncture, the wise advice should be to steer clear of parking the hard-earned money in such companies.

Some may argue that these companies owe a lot to banks and other creditors, which make lenders even more susceptible to risks. Moreover, the central bank’s initiative to keep credit flowing encumbered bank’s net interest income. As a result, several banks are trading below their book value.

Still, optimists note that banks are currently far better placed than they were during the subprime mortgage crisis, occurring between 2007 and 2010. This is primarily because the Federal Reserve has stepped up its daily short-term lending to help business houses meet short-term financing requirements including meeting payrolls.

And let’s admit that during the banking crisis, banks took a beating as the institutions couldn’t renew their charged-off real-estate loans because collateral properties shed a significant amount of value. But this time around, collateral is no longer a problem.

Fed’s annual Comprehensive Capital Analysis and Review known as CCAR too confirmed that banks are well-prepared to combat the coronavirus crisis. The regulatory test proved that these financial institutions do have the necessary cushion to withstand a “severely adverse” economic condition.

For instance, Ian Lapey, portfolio manager of the Gabelli Global Financial Services Fund, pointed to Citigroup Inc. (C - Free Report) and said that “if you compare their capital position now, to what it was going into the last financial crisis, it is remarkable. Assets to tangible book value in 2007 were 43 times and now it’s 13 times.” In fact, such a strong capital position fuels growth through acquisitions.

Jason Goldberg, analyst at Barclays, added that the banking industry “has consistently passed Fed stress tests, which assume a severely adverse scenario”. And even in a challenging scenario, banks under his coverage continue to remain profitable.

Legendary investors, namely Bill Nygren, Charlie Munger and Warren Buffett too have allocated more than 30%, 90% and 45% portion of their respective portfolios to the financial sector this year, especially the banks. Noninterest expenses of banks are increasing at a slower rate than total assets, which should boost profits margins. Significant improvement in operational efficiency helped banks curtail expenses.

Hence, it won’t be a bad idea to invest in fundamentally sound bank stocks that can weather a downturn. Notable among those  are Investors Bancorp, Inc. , American River Bankshares , Opus Bank , South Plains Financial, Inc. (SPFI - Free Report) and Metropolitan Bank Holding Corp. (MCB - Free Report) .

Investors Bancorp has a Zacks Rank #2 (Buy). The Zacks Consensus Estimate for current-year earnings has increased 3.2% over the past 60 days. The company’s expected earnings growth rate for the current quarter and year is 22.2% and 24.7%, respectively.

American River Bankshares carries a Zacks Rank of 2. The Zacks Consensus Estimate for current-year earnings has inched 1.8% up over the past 90 days. The company’s expected earnings growth rate for the current quarter and year is 35% and 19.2%, respectively.

Opus Bank sports a Zacks Rank #1 (Strong Buy). The Zacks Consensus Estimate for current-year earnings has been raised 2.5% over the past 60 days. The company’s expected earnings growth rate for the current and next quarter is 21.9% and 17.1%, respectively. You can see the complete list of today’s Zacks #1 Rank stocks here.

South Plains Financial flaunts a Zacks Rank of 1. The Zacks Consensus Estimate for current-year earnings has been revised 4.4% upward over the past 60 days. The company’s expected earnings growth rate for the current quarter and year is 31.3% and 11.2%, respectively.

Metropolitan Bank is Zacks #1 Ranked. The Zacks Consensus Estimate for current-year earnings has moved 5.5% north over the past 60 days. The company’s expected earnings growth rate for the next quarter and current year is 49.3% and 23.6%, respectively.

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