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The fundamental resilience of banks
Investment grade financials specialist Marc Stacey, BlueBay Senior Portfolio Manager, reinforces that markets should be encouraged by the strength of the banking sector's underlying fundamentals. And while this positive outlook is not being fully reflected in markets, it is one we are confident will change.
It is safe to say that financial markets are experiencing a calmer environment after the turmoil in March when the banking crises at SVB, First Republic Bank and Credit Suisse brought back the bad memories of 2008. However, the truth is that the issues we are witnessing today are very different, though they are a clear reminder that aggressive policy tightening tends to cause something to break.
The strength of the banking sector
Over the last eight weeks, banks have been at the epicentre of a crisis of confidence. Nevertheless, we do not believe that investors need to worry about a global financial crisis being triggered any time soon. We are encouraged by the response of regulators distancing themselves from the decision in Switzerland, and to look beyond short-term volatility. Banks have continued with their share buy-back programmes, which we think is extremely important to underline both the strength in the sector and the regulators’ confidence in their view of that strength.
US regional banks have a mismatch
Fundamentally speaking, it seems that a simplistic mismatch between the maturity of assets and liabilities is at the heart of the issues of some US regional banks, with some basic echoes of the savings and loan crisis of the late 80s. For the less regulated smaller US banks, it is clear that some of their business models were nowhere near as diversified or robust as their larger, more regulated counterparts. The collapse of SVB and First Republic has raised serious questions about the regulatory oversight of these smaller institutions. In our view, there is no question that the regulation relaxed under the Trump presidency should be reinstated over time.
European banks have greater regulation
The situation in Europe is markedly different. We would expect further consolidation around the US regional banking sector, akin to what we saw in Europe over the last 10 years. It is worth reiterating that European banks are already regulated to a much higher standard and should not be vulnerable in the same way. Looking ahead, we continue to be encouraged by the banking sector’s underlying fundamental strength, particularly as European banks remain well-provisioned and should continue to benefit from the rising rate environment. We believe that the price action within banks is contrary to the fundamentals.
The resilience of banks ahead of any recession
We believe that the fundamental resilience of banks is not fully reflected in valuations, which continues to be a frustration, but one we are confident should correct over time. Even in light of a possible recession, the sector will be coming into the economic downturn from a position of strength and perhaps the most robust position it has ever been in at this point in the cycle. What is somewhat different in this recession is that central banks are raising rates to fight inflation, which is helpful from a bank earnings perspective, and should go some way in shielding any deterioration in asset quality. Capital levels remain close to all-time highs, while the stock of non-performing loans is close to the lows. Although we are conscious that these factors are often overlooked in stressful times, fundamentals always reassert themselves eventually. We believe European banks’ Additional Tier 1 debt (AT1) is likely to offer investors an upside, as the macro environment continues to prove challenging.
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