Context: The impact of the Covid-19 outbreak will most probably create an uptick in Banks NPL in the coming quarters
Impact for the fund: Positive thanks to our strong issuer selection and exposure to the best issuers
Historic and up-to-date NPL of the European banks
European Banks’ NPL ratios have declined by more than 50% since Dec-14, from around 6.5% to below 3% (2.7% as of FY19). During banks’ 1Q20 earnings releases, the Covid-19 situation has not yet led to any increase in NPLs yet and we have seen NPL levels stable to still declining. Also note that the 2.7% is an average number at the aggregate level, and therefore includes countries such as Italy, Portugal or Greece where NPLs are significantly higher. As you can see, for the Core European countries (where the fund is exposed), the average NPL ratio are lower than average, and the outliers remain countries like Portugal, Italy or Greece where we are not exposed. For the banks were hold, the starting position in terms of NPLs is very strong and reflects de-risking of balance sheets since the GFC.
In 1Q20, we have not yet seen any significant impact of Covid-19 on bank’s NPL ratios. This is due to extraordinary support measures taken by governments and central banks, with payments holidays and moratoriums on repayments as well as extraordinary measures to provide support to retail (unemployment benefits, etc.) and corporates (liquidity lines, guaranteed loans). We do expect some NPL increase in the coming quarters (likely to start in the last two quarters of the month), however with the impact being more limited than in previous cycles. Note that in the chart above, the 6.5% starting NPL point was post the GFC and Eurozone crisis, which were more significant economic shocks and with less fiscal and monetary response.
Banks have already started provisioning for potential future uptick in NPLs, with Barclays for example recording a 5x increase in loan loss provisions to £2.1bn, which is equivalent to 2.2% of the group’s total loans on an annualized basis. This is based on the assumption that US GDP will decline by 45% in 2Q20 and unemployment will spike to 17% in 2Q20, clearly very harsh assumptions. Away from the technical details, the key point is that despite a very large surge in loan loss provisions, banks remained profitable – therefore without touching excess capital positions.
- – Latest capital ratio of the European banks
The average CET1 ratio of the sector is around 14.8% as of FY19, and as of 1Q20 this number slightly declined due to RWA inflation (banks supporting their clients and the real economy by increasing their lending), while excess capital positions were higher due to regulatory easing. From a credit perspective bank’s excess capital to protect bondholders is at record highs, very supportive for our markets.
- – Current ECB Policies
In tandem with global coordinated fiscal easing in the European Union and worldwide, the ECB has launched an unprecedented monetary stimulus program which has been recently upsized to a total amount of €1.35tn. This will be split between purchases of government bonds and corporate bonds (investment grade bonds, commercial paper, and others) which is a very strong technical for the market. As yields and spreads on mainstream government and IG credit products will decline with ECB purchases, we expect subordinated debt from corporates and financials to benefit significantly as investors seek high income from strong companies that can absorb the Covid-19 shock. In our view technicals in general, with very limited supply expected in the second half of the year plus strong ECB buying is a very strong catalyst for the market in the near-term.