In the banking sector, quality beats quantity
3 JUL, 2024
By L&G
AUTHOR: Marc Rovers, Head of Euro Credit at LGIM
No investor can approach the world of credit without paying particular attention to the performance of financial markets and, in particular, to banks. In fact, although their weight, in percentage terms, has undergone fluctuations within the index on European corporate bonds, they have still maintained their position as a dominant segment.
According to data provided by Bloomberg, currently banks represent 30% of the assets underlying the index, far from the record of 45% in 2010, having ceded part of their share to other segments that have grown more rapidly; two above all, real estate and the healthcare sector. However, this does not mean that the banking sector is in crisis; on the contrary, its fundamentals are very solid, strengthened especially by a return of profitability due to the increase in interest rates (after a long period of very low or even negative returns). Other contributing factors have been the greater resilience of balance sheets and the positive moment they are experiencing in terms of credit rating upgrades.
What emerged above, however, should never make us forget that the banking sector, just like many others, is not a single, monolithic and homogeneous block and the quality of the assets within it can vary greatly. For this it is important to be selective. If, on the one hand, it is true that the favorable macroeconomic context has represented a significant boost, both for small and large institutions, the credit of regional banks has reached a point where valuations always appear higher than fundamentals. For this reason, although there are still M&A opportunities, linked to the good stock performance of potential buyers, we at LGIM prefer to expose ourselves to top-tier institutions, well diversified and well capitalized. In particular, we look with interest at Italian and Spanish banks, some of which have recently seen their credit rating increase; moreover, compared to their German counterparts, in these countries the percentage of commercial real estate debt is much lower.
Furthermore, despite the rally experienced by bank credit recently, we prefer to stand firm on the companies in which we have already invested and focus more on quality. Generally, at the time of writing, our position towards the sector has shifted from overexposure to neutrality, as we are convinced that the compression of financial spreads compared to non-financial ones has already created the opportunity to make profits. Moreover, the fact that the sector has proven to be in good health over the last 15 months, seems to confirm our long-held theory, according to which the small crisis that led to the default of Credit Suisse was more of a hiccup, rather than the beginning of a systemic collapse.
As responsible investors, we would not be doing our job if we did not also carefully observe the potential risks that can lurk around the corner. Today, the performance of banks is highly correlated with the trend of interest rates; this means that the operations of reducing these latter by the ECB, will certainly have an impact on their profitability. From a more bottom-up perspective, recently the sector has also stood out for a certain increase in mergers and acquisitions, as in the case of BBVA that has absorbed Banco Sabadell. However, although there is still room for greater synergies and consolidation, we believe that cross-border M&A operations will remain difficult in the future.
