It’s a sector which we’re positive on, for several reasons ranging from regulation and valuations to fundamentals.
11.12.2024 | 05:55 Uhr
It’s a sector which we’re positive on, for several reasons
ranging from regulation and valuations to fundamentals. Let’s break it
down: We see bank fundamentals as strong – with capital and
profitability at decade highs – and the cost of risk remaining below
normalised levels. In addition, the wider economic backdrop has been
broadly supportive. Third-quarter earnings were strong with profitability either
in-line or better than expected. This was buoyed by resilient net
interest margins, strong non-interest income and moderate levels of cost
of risk. Asset quality indicators remain solid and we see no real signs
of potential deterioration in banks’ results. In addition, liquidity remains adequate and capital ratios are
strong. This is despite significant payouts to shareholders through
dividends and extraordinary share buybacks – we expect European banks to
pay back up to 80% of profits to shareholders through dividends and
buyback over the next two years. The guidance for 2024 given by the
banks at their 9M24 results was either stable or slightly better than
anticipated. So, while bank profitability has peaked, it should still be
strong for the foreseeable future. Despite interest rates falling, net interest margins are holding
up well. This is because banks have been reducing their sensitivity to
lower rates through hedging, and competition for deposits has not been
intense. We expect to return to a more normalised rates environment,
which is good for banks as lending should begin to pick up at rates that
are still attractive for them. The outlook for asset quality has been benign given this
declining rate environment and low levels of employment. Our two-year
default forecasts for high yield borrowers, which is a good proxy for
bank SME loan books, are below normalised levels which is reassuring. If there were any deterioration in non-performing loans, European
banks still have overlay loan loss provisions built up during the
Covid-19 pandemic, equivalent to more than half-a-year’s cost of risk,
that could be released, plus ample profitability and capital that could
also be used to absorb any unexpected shocks. The impact of the new US government and the possibility of higher
tariffs on European corporates exporting into the US is as yet unclear,
but could weigh on European GDP with Germany and France flirting with
zero or negative growth. However, we believe banks are generally well
placed to absorb any emerging risks here. Regulation within eurozone and UK banks has strengthened steadily
since the global financial crisis of 2008/09 – in fact we are close to
peak regulation. Although there is limited appetite to soften
regulations, European banks will likely lobby hard for concessions in
applying Basel 4 regulations around credit risk, especially if US bank
regulations are rolled back or they fail to adopt Basel 4. Spreads are tight within European investment grade, and senior
unsecured bank debt has outperformed year-to-date on a spread-per-unit
of duration basis, offering a much-reduced premium relative to history.
Pockets of value can still be found in parts of the bank capital
structure, for example in higher beta Tier 2 debt. These are broadly supportive as capital stacks are fully built
out and while loan growth has been modest it should begin to pick
up. Banks have made good progress on supply this year, with most having
completed their funding for 2024 and are pre-funding 2025. Demand for IG
credit remains strong with positive net AUM inflows on a monthly basis
throughout 2024. In conclusion, we are comfortable with the outlook for banks on a
fundamental basis, and we see them as well placed to absorb any
economic weakening. In addition, technicals are currently supportive.
However, valuations have come a long way with bank cash spreads having
outperformed the corporate IG index year-to-date, so we have trimmed
exposure in recent weeks and are focused mainly on Senior Preferred
debt, the safest part of banks’ unsecured debt capital stack, as well as
select relative value opportunities in Tier 2.As we approach year-end it’s a good time to run the rule over the European banking sector
Fundamentals
Regulation
Valuations
Technicals (supply and demand)
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