27th November 2018

🏦 BNP – Credit is not where equity is? | Bank Capital

BNP – Should credit investors look at equity?

For all the attention on DB & its inability to generate decent ROE and the consequent equity underperformance this year, BNP is another large cap national champion bank that seems to have lost its way with its equity which is down almost 35% YTD.  Looking through the reported Q3 figures, although not that obvious at first glance, equity investors seem to have focussed on some disturbing underlying trends.

Fundamentals are….

To start with, the bank, like its peers, is struggling to generate decent revenue growth in its corporate and investment bank, especially in its FICC business.   On top of that, the bank’s cost-to-income ratio is in the 70% area.   Loan losses have come down but that is due to benign economic conditions in Europe. Yes, it reports an acceptable 9% to 10% ROE for now but earnings are now exposed to multiple headwinds.

BNP: Wholesale funding reliance?

Asset quality and risk management used to be strong points – but with a reasonably large stock of NPLs and presence in Italy, Turkey and other Emerging Markets as well as exposure in personal financial services, future credit-related costs may yet go up. And additional provisioning may yet be needed at a time of decreased revenues and a stagnant cost base.

Overall funding metrics seem fine with a loan-to-deposit ratio around 94% and a highly diversified funding base. But that cannot mask the bank’s reliance on wholesale funding (?) given its large balance sheet size. As a large and frequent issuer of debt securities, the bank has very good access to capital markets and is able to issue debt at satisfactory spread levels.

Capital is where I find that the bank has really not kept pace with global peers. Yes, CET1 ratio is a decent 11.7% and leverage ratio at 4% (and it was at 4.6% at end of 2017) but in the event of a large tail risk event, these ratios drop sharply. In the recently concluded EBA stress test, the bank’s CET1 ratio dropped to 8.64% in a hypothetical adverse scenario.  The bank seems to have levered up its balance sheet in recent periods, especially in the investment bank.

Is credit leading or just ignoring for now?

Given the leverage situation and potential for headline risks stemming from a presence in Italy and Mediterranean countries, in my personal view, the bank’s AT1 securities and LT2 debt seem to trade tight. I think that this is a function of the bank’s French domicile and perceived strong risk management strengths.

Relative to equity, I wonder if AT1 holders have more confidence in the bank’s overall business strategy, past track record and current fundamentals despite the recent underlying trends and issues.

Only time will tell if this comfort factor of credit investors is justified.

GJ Prasad

A senior European bank research specialist with significant breadth/in-depth sector knowledge, GJ has researched bank capital instruments extensively - having covered the asset class for more than 15 years as an analyst and 7 years as a risk taker in buy-side roles. His specialisation includes carrying out detailed financial modelling work on the European banks focusing on asset quality, earnings and capital adequacy metrics. His deep-dive work focuses on single name selection and extensive risk analysis on capital securities, especially on structural features, issuer credit profile and equity/AT1 valuation.