The second wave of COVID-19, the macroeconomic outlook and the US presidential election are likely to lead to increased volatility and increased risks in the banking sector. Bank bond spreads are expected to come under pressure in the coming months due to the second wave of COVID-19, the general economic outlook and the results of the US presidential election.
The size of the non-performing loans (NPLs) will depend on the expansion of fiscal support programs and debt deferrals. The Bloomberg consensus expects earnings to decline 48% in 2020 and rebound around 58% in 2021. Refers to this Barbara Mainieri, Buy-side Credit Analyst bei DPAM.
On the one hand, debt repayment moratoriums and other borrower-friendly measures support the quality of the loans granted by banks. On the flip side, the measures mask the underlying plight of many borrowers. As a result, the quality of bank assets could turn out to be much weaker than the numbers suggest. On average, European banks have credit exposures of 15-20% in sectors hardest hit by COVID-19.
With this in mind, it is advisable as an investor to prefer the safest part of the capital structure (senior bonds, although the proportion of negative yielding bonds is considerable) and banks with better profitability and a lower level of NPLs. At DPAM, the Nordic banks and retail banks from core Europe (mainly French, Benelux and Swiss institutions) are the preferred choice.
Bonds issued by the banking sector make up around 27% of the Iboxx Euro Corporate Investments Grade Index. Investing in banks is therefore inevitable for fixed income investors. After a massive widening in March / April 2020, bank bond spreads recovered quickly, mainly due to support from the ECB and fiscal measures taken by national governments. In September 2020, the investment grade universe accounted for negative yield bonds was 22% for financials versus 20% for corporations.
In the current market context, consolidation appears to be one of the few options available to ensure the stability and efficiency of European banks and to create international champions.
The detailed DPAM analysis of the European banking sector can be found here in PDF format.
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