26th February 2019

Negative Yields Do Wonders | Bank Capital Insights

KBC issues EUR Perp NC5 at yield of 4.75%

KBC (the Belgian bank assurer) apparently are issuing a EUR 500 million Perp NC 5 AT1 with a yield of 4.75%.  This despite Santander’s decision not to call their 6.25 EUR AT1 a couple of weeks ago and general economic uncertainty.

KBC has a good credit profile as reflected in its fully loaded CET1 ratio 16%, leverage ratio of 6.1%, very low credit costs (in fact negative 4 bps for 2018) and strong earnings as reflected in the ROE of 16%.  But, even still, given the bank’s business model…

… and its operations in CEE countries (Czech Republic, Slovakia, Hungary, Bulgaria), one would expect a much higher COE.   And the bank still has a NPE ratio of 4.3% and a large government bond portfolio.

Also, if one were to factor in the risk premiums for the embedded options sold by the investor, the overall yield needed to own this AT1 should be a lot higher. However, when core European government bonds and especially German bunds are trading with negative yields and no prospect of rate hikes any time soon, suddenly it feels that these bonds are not that bad to own, more so if the expectation is that they will get called in five years.  But when risk comes off, this AT1 is likely to underperform significantly.

Standard Chartered – Still trying to transform

Standard Chartered Bank (STANLN) – the EM specialist with a UK base – reported in line with earnings primarily driven by broad-based revenue growth and tight cost control.  Underlying profit before tax was 28 per cent higher and statutory profit before tax, which includes restructuring and other items was up 6 per cent.   The bank took a 900m provision in Q4 in respect of legacy financial crime control matters and FX trading issues.

Similar to HSBC, STANLN’s strength is its retail banking presence in fast-growing Asian markets with a solid deposit franchise and any pick up in lending results in decent pre-provision income.  Customer loans-to-deposit ratio of 68% is where the strength of the retail banking franchise comes from.  Though overall profitability is still relatively low to the double-digit returns in yesteryears, it seems the bank is starting to move towards its 10% ROTE target by 2021.

STANLN reports a CET1 ratio of 14.2% a big improvement from 13.6% reported at the same time in 2017 reflecting organic capital growth and reduction in RWAs.  A leverage ratio of 5.8% is strong to absorb any unexpected large loan losses from an economic slowdown in its key Asian markets.

From a credit investor perspective, although the bank’s fundamental profile continues to improve, the risk premium for EM exposure is what is going to determine valuation in terms of spread.  And equity investors probably will want to see further stabilisation of the earnings momentum to re-rate its valuation.

Barclays – A relative winner in markets business

Last Thursday, Barclays reported a very decent set of results and in fact outperformed the European IBs both in equities and FICC.  FICC revenues were down only 6% and equities, in fact, were up 4%. Profitability is still on the lower side and I guess more costs are on the way. Large UK and US credit card portfolios mean impairments may go up if economic growth comes off. Plus, litigation and conduct charges to contend with.

Having said that, current ROTE of 8.5% means the bank is on track to generate decent returns. CET1 ratio came in at 13.2% and Leverage ratio was at 5.1% and both these numbers look decent (though relative to other UK banks looks on the lower side).

Barclays seems to be a relative winner amongst the European banks in the markets business. Within capital structure, think Holdco Senior is probably with most value followed by AT1s.

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.