High yield supply points to buoyant market
The earnings season has finally kicked off in Europe with the banks leading the way, and given the volatility in US regional banks, with First Republic currently battling for survival, and the fallout from the Credit Suisse (CS) take over, it’s no surprise that a lot of attention was going to be focused on their results.
So far, we have heard from, among others, Deutsche Bank, Barclays, Santander, Standard Chartered, BBVA, Sabadell, Nordea, Swedbank, Danske, Svenska and SEB, and very much as we expected the results have been stellar. We’ve seen them, by and larger, beating on the top line revenue and bottom line net income, reporting strong and stable/increasing capital levels, low non-performing loans and giving encouraging outlooks on cost of risk. One of the more pleasing aspects of the earnings is that many of the banks did well because of increasing net interest margins, driven by higher rates; taking deposits and lending being the bread and butter business for most banks. Net interest income is stable and repeatable, which is why it is so important, and doesn’t rely on the banks having to outperform when trading fixed income, equities or commodities etc. Or similarly on them having to beat their competitors to win mergers and acquisitions business, although, of course, this is also valuable business for a lot of banks.
Amongst the earnings, it’s worth noting that Deutsche Bank, which was the focus of much negative speculation in the aftermath of the CS collapse, reported robust earnings and one of their best quarters in a decade, which must be very pleasing to management.
In addition to the earnings announcements, we also saw an announcement this morning from UniCredit that they were calling their 6.625% AT1 bond. This is the first AT1 bond to hit its call window since the CS collapse and with the market looking closely on, we think it was important to see UniCredit call as a sign of strength for both the name and wider sector. Lloyds are next up, with their call window opening tomorrow, Friday 28th April, and markets are very much expecting a call from them as well – and if they do so we think this should help bring further confidence to the AT1 market.
UniCredit are due to announce their earnings next week, but they had already informed the market that the ECB had approved their €3.34bn share buyback. In our view, a share buyback and calling bonds on their first call date, be that AT1s or Tier 2s, are very strongly linked. Permission must be received to call an AT1, as it must before attempting a share buyback, and being allowed to do this is a very strong vote of confidence by the regulator, signalling that the bank is in good health. It is interesting that the bank is not replacing the AT1 at the current time, saying: “UniCredit has limited need for TLAC/MREL funding for the remainder of this year and no need to issue AT1 instruments in the foreseeable future”, and with a Maximum Distribution Amount (MDA) buffer of 554bps, it is no surprise the regulators approved both the buyback and AT1 call.
UniCredit are not alone in announcing a share buyback and we wouldn’t be surprised to see even more banks go down this route – Euro bank shareholders have suffered from poor equity markets for a long time, with banks often having very low Price to Book ratios. One way to reward owners, when equity prices are staying stubbornly low, is to return some of the excess capital, as demonstrated by UniCredit. However, as mentioned, we think there should be a strong read across to likely actions on AT1 calls. If a bank were to buy back shares and shortly afterwards tell their debt holders that they weren’t calling a bond because they needed the capital, this would naturally be viewed very negatively by debt investors. Although, we also think it’s unlikely that a regulator would allow a bank to take this decision.
For now, despite the very strong earnings so far, and the call by UniCredit, bank debt remains at very high yields. For example, sticking with UniCredit, its 8% AT1 bond, which is callable in June next year, is still trading at double digit yields (by trading, I mean there are numerous bids at ~12% yield, and no offers). With bank earnings over the coming days likely to remain strong, we continue to see European bank debt, from Senior to AT1 bonds, as offering very attractive value opportunities.