hongkongen
This time, banks are part of the solution

This time, banks are part of the solution

22-04-2020 | Insight

Compared to conditions during the global financial crisis, the health of the banking sector and the environment for banking are now significantly different. This presents opportunities for financial credits – on a selective basis.

  • Jan Willem Knoll
    Jan Willem
    Knoll
    Credit Analyst
  • Jan Willem de Moor
    Jan Willem
    de Moor
    Senior Portfolio Manager Credit

Speed read

  • Banks are needed as part of the solution to ensure recovery
  • Regulators have acted swiftly and decisively to stem the crisis 
  • Credits – including financial credits – are now at extreme low valuations

The world economy has come to a sudden standstill, causing acute liquidity issues. Regulators, monetary authorities and governments have acted much more quickly and decisively these past few weeks than they did during the global financial crisis. And, unlike then, banks are not at the root cause of this crisis. Instead, we believe they are needed as part of the solution. This presents opportunities for financial credits – on a selective basis.

Stay informed on our latest insights with monthly mail updates
Stay informed on our latest insights with monthly mail updates
Subscribe

This is not a banking crisis

Compared to conditions during the global financial crisis, both the health of the banking sector and the environment for banking are significantly different this time around.

Banks now hold much more capital, are better funded and have more liquidity. From a macro perspective, the overall policy response has been supportive for financial markets. Regulators, monetary authorities and governments have acted swiftly and decisively, and with unusual like-mindedness. In Europe, the ECB has provided a powerful backstop for banks (via LTROs), for southern European sovereigns (through PEPP) and also for corporate bond markets (using CSPP). Furthermore, fiscal authorities have announced extensive support packages for the corporate and SME sector, which in Germany, for example, represents up to 20% of GDP. 

This time around, banks are not viewed as being at the core of the crisis. Rather, banks are critical in funneling liquidity into the real economy. Therefore, political and regulatory attitude to the industry is likely to be far more constructive. Given how tough regulators have been on banks since the global financial crisis, we believe there is now plenty of room for a lighter regime on banks. 

And indeed, we have already seen several examples of so-called ‘forbearance measures’, benefiting banks. The ECB and local regulators have effectively lowered capital requirements for banks by adjusting capital buffers. Next to that, the ECB has indicated it will allow banks to operate below minimum requirements on a temporary basis. This is an encouraging indication that there is no agenda for bailing in banks. Besides which, our view is that bailing in banks would not serve to improve the current economic situation. 

Enabling banks to help the economy

Other forbearance measures relate to the timing of credit provisions in banks’ P&L and the recognition of non-performing loans. Such measures will help spread non-performing loans and provisioning over a longer period and, more importantly, will give banks room to prevent good corporates from failing due to an acute drop in economic activity. In short, banks will be given the necessary regulatory flexibility to act as part of the solution.

Despite this relatively positive assessment amid the overwhelming turmoil, concerns remain. Over the long term, beyond the horizon of the current crisis, the intertwining of sovereigns and banks seems once again to be increasing. The cost of extraordinary support today will likely come tomorrow in the form of more directed lending, and increased holdings of sovereign bonds, for example. There is also an increased risk that today’s containment measures create conditions which are potentially damaging for banks, such as sustained low interest rates. This means that the actions taken now could likely lead to long-term reductions in returns on equity for the sector. This, however, is more of a worry for equity markets than a credit concern.

Can banks cope with the current slowdown?

While there is some hope in the fundamentals, the great speed at which circumstances have changed in the financial sector has raised some crucial questions. Notably, what are the risks of coupon cancellation on Additional Tier 1 bonds (AT1 bonds, also known as CoCos), and will issuers call back their bonds? 

In its forecasts for the European economy in 2020, the Robeco Macro team envisages a base case scenario in which real GDP contracts by 5% -- a massive slowdown. Additionally, one also has to factor in the consequences of the dramatically lower oil price. The most notable initial impact from the combined coronavirus and oil price shock will be felt via credit losses, with the most vulnerable sectors being oil & gas, metals & mining, transport & logistics and hospitality. On average, European banks have about 5% of their loan book exposed to these sectors. 

A further impact of this slowdown will come from a poor revenue environment, with the biggest negative driver here being lower interest rates. For banks, we expect net interest margins to drop for a prolonged period. Loan growth and fee income will also suffer from a drop in economic activity. 

Focusing on European banking risk, the credit analyst team at Robeco assesses the loss-absorbing capacity of banks through stress testing. This means looking at what happens to banks’ balance sheets under very stressed environments. The aim is to determine the break-even cost of risk and compare that to loan-loss scenarios equivalent to the Great Depression. The conclusion is that, in such a stressed scenario, banks fully burn through their first lost piece, which is their pre-provisioning profits. This implies that banks are currently operating at around break-even levels and that they will have to cancel dividends.

But, for bond holders, the important point is that banks have ample distance to their respective Maximum Distributable Amount (MDA). This is the level at which regulators automatically restrict earnings distribution, and is triggered if a bank's total capital falls below the sum of its Pillar 1, Pillar 2 and other buffer requirements. 

This implies that, as things are today, European banks can continue to pay AT1 coupons. This analysis was undertaken for most large European banks, with all showing similar degrees of resilience.

Furthermore, political pressure from regulators is to focus on dividend payments and bonuses, and not the cancellation of AT1 coupons, as the latter are relatively insignificant in a bank’s profit and loss statement. So, with AT1 coupon cancellations not on politicians’ radar, they are likely not on regulators’, either.

The opportunity in financials

Credit markets reacted in an unprecedented fashion during March and are currently pricing in a deep recession. Price action has been exaggerated by a lack of liquidity in global credit markets. The speed of the sell-off has been unmatched and spreads are now at levels that are rarely seen. This has created interesting value opportunities across the capital structure of the banking sector. It is essential to be selective, however. Although we do not expect widespread bail-in of financial institutions, idiosyncratic bail-ins cannot be excluded. Therefore, issuer selection is key to benefiting from the extreme value opportunities which have arisen in the bank credit space.

Important information

The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.

Logo

Disclaimers

1. General
Please read this information carefully.

This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.

2. Important risk disclosures
2. Important risk disclosures Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:

  • Some Funds are subject to investment, market, equities, liquidity, counterparty, securities lending and foreign currency risk and risk associated with investments in small and/or mid-capped companies.
  • Some Funds are subject to the risks of investing in emerging markets which include political, economic, legal, regulatory, market, settlement, execution, counterparty and currency risks.
  • Some Funds may invest in China A shares directly through the Qualified Foreign Institutional Investor (“QFII”) scheme and / or RMB Qualified Foreign Institutional Investor (“RQFII”) scheme and / or Stock Connect programmes which may entail additional clearing and settlement, regulatory, operational, counterparty and liquidity risk.
  • For distributing share classes, some Funds may pay out dividend distributions out of capital. Where distributions are paid out of capital, this amounts to a return or withdrawal of part of your original investment or capital gains attributable to that and may result in an immediate decrease in the net asset value of shares.
  • Some Funds’ investments maybe concentrated in one region / one country / one sector / around one theme and therefore the value of the Fund may be more volatile and may be subject to concentration risk.
  • The risk exists that the quantitative techniques used by some Funds may not work and the Funds’ value may be adversely affected.
  • In addition to investment, market, liquidity, counterparty, securities lending, (reverse) repurchase agreements and foreign currency risk, some Funds are subject to risk associated with fixed income investments like credit risk, interest rate risk, convertible bonds risk, ABS risk and the risk of investments in non-investment grade or unrated securities and the risk of investments made in non-investment grade sovereign securities.
  • Some Funds can use derivatives extensively. Robeco Global Consumer Trends Equities can use derivatives for hedging and efficient portfolio management. Derivatives exposure may involve higher counterparty, liquidity and valuation risks. In adverse situations, the Funds may suffer significant losses (even a total loss of the Funds’ assets) from its derivative usage.
  • Robeco European High Yield Bonds is subject to Eurozone risk.
  • Investors may suffer substantial losses of their investments in the Funds. Investor should not invest in the Funds solely based on the information provided in this document and should read the offering documents (including potential risks involved) for details.

3. Local legal and sales restrictions
The Website is to be accessed by “professional investors” only (as defined in the Securities and Futures Ordinance (Cap.571) and/or the Securities and Futures (Professional Investors) Rules (Cap.571D) under the laws of Hong Kong). The Website is not directed at any person in any jurisdiction where (by reason of that person’s nationality, residence or otherwise) the publication or availability of the Website is prohibited. Persons in respect of whom such prohibitions apply or persons other than those specified above must not access this Website. Persons accessing the Website need to be aware that they are responsible themselves for the compliance with all local rules and regulations. By accessing this Website and any of its pages, you acknowledge your agreement with understanding of the following terms of use and legal information. If you do not agree to the terms and conditions below, do not access this Website or any pages thereof.

The information contained in the Website is being provided for information purposes.

Neither information nor any opinion expressed on the Website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.

4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.

5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.

6. Third party websites
Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage.

7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.

8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.

9. Privacy
Robeco guarantees that the data of persons accessing the Website will be treated confidentially in accordance with prevailing data protection regulations. Such data will not be made available to third parties without the approval of the persons accessing the Website, unless Robeco is legally obliged to do so. Please find more details in our Privacy and Cookie Policy.

10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong. 

Please click “I agree” button if you have read and understood this page and agree to the Disclaimers above and the collection and use of your personal data by Robeco, for the purposes for which such data is collected and used as set out in the Privacy and Cookie Policy, including for the purpose of direct marketing of Robeco products or services. Otherwise, please click “I Disagree” to leave the website.

I Disagree