Pekao – Shock April Rate Cut Fully Priced In

The latest surprise rate cut by Poland's central bank forces us to again revise the outlook on our financials universe, previously updated just two weeks ago. On April 8th, 2020, the Monetary Policy Council announced it would cut its benchmark rate by 50bp to 50bp, and reduce the deposit rate to zero. According to our calculations, the cuts indicate a reduction to 2.76% in 2020 from 3.02% a year ago in the aggregate interest margin of our rated banks, accompanied by a +PLN 1.8bn fall in interest income. Nevertheless we do see potential for most banks to make back at least a half of lost margins within three years, owing to their already-robust solvency, additionally bolstered by state emergency programs offered to corporate borrowers. The way to expand squeezed rates would be to substitute deposits with current accounts. That being said, any further reductions in benchmark interest rates that would turn the deposit rate negative will be much harder to get over. We keep unchanged our expectations as to costs of risk (155bp), likely to be kept at manageable levels with banks currently encouraged by European and domestic regulators to use "flexibility and pragmatism" in assessing the necessary levels of loan loss provisioning. The state aid offered to businesses will act as an additional risk mitigator. The NBP is unlikely to cut rates again in the coming months considering the deteriorating financial standing of domestic credit unions and co-op banks, and because a deposit rate turned from zero to negative would be counterproductive as a stimulus. In addition, by reintroducing speculation about further easing, the central bank would make it harder for itself to coordinate monetary policy with fiscal policy, and it could drive up costs of financing. Unfortunately, the monetary council's current rhetoric only extends interest rate uncertainty from the point of view of financial markets. After incorporating the freshly-cut rates into our models, we currently expect rated banks to experience net earnings contraction at annual rates of 19% in 2020 and 14% in 2021, followed by a narrower decline of 10% in 2022, when the negative impacts of the rate cuts should be art least partly passed onto customers. The WIG-Banks index took a plunge after the NBP's announcement, bringing stocks to levels which leave most of our previous recommendations valid, but which pare the aggregate upside potential of our bank universe down to 11%. Below we also update our worst-case scenario for lenders, which analyzes worse-than-expected economic contraction and longer lockdown measures.