UK Credit Conditions
Whilst trading levels in bank debt have remained relatively flat in the month of April, having recovered the losses post Credit Suisse, they are still trading extremely heavily compared to February levels prior to the US regional banking crisis - with the CoCo index total return still down almost 10% since the start of March. However, the US bank earnings season began last Friday and with more US and European bank earnings over the coming weeks, we believe this could be a catalyst to help spreads begin to recover.
On Friday, JP Morgan, in their first quarter release, reported profits 52% higher vs. 1Q 22, with the bank beating revenue estimates by 7% and also increasing their Net interest income guidance for this year by 9.5%, from their last estimate made just a few months ago. Elsewhere, Citigroup reported similar trends with impressive revenue and net interest income increases, while Wells Fargo’s net interest income was up 45% from this time last year – hugely benefitting from the 475bp of Fed hikes in that time.
As we read across these results to European banks, we are expecting a continuation in the theme of strong revenues, profits and net interest incomes to uphold. Indeed the latter for European banks should improve dramatically throughout this year, as the ECB started their hiking cycle after the Fed, and are expected to continue beyond their US counterparts.
This strength in fundamentals is also highlighted by the recent actions of the rating agencies. We have seen rating upgrades for the likes of Barclays, Commerzbank and NatWest in Q1, and overall, Moody’s have given two and a half upgrades for every downgrade in European financials in the first quarter (this is in contrast to what we have seen in corporates as a whole, where downgrades have been outstripping upgrades ).
Deposits are still at the forefront of investor’s minds of course, however we have been encouraged by the dialogue we have had with UK and European banks who are comfortable with their liquidity levels and the deposit activity they have seen since the US regional banking crisis. In addition, there are indications that the BoE are considering raising the amount covered under the UK’s deposit guarantee scheme, which if it comes true, we think would also be a very positive development.
Overall, with rating migration and fundamentals remaining very strong for European banks, yet their bonds trading at very wide levels currently when compared to historic averages, we see the upcoming earning season as a potential positive catalyst to provoke some normalisation in bond prices, with the sector currently looking particularly cheap in our view.