20 March 2020 by jbchevrel
The SubFin s32 index is closing 100bp off the wides, in the area of 280bp. The sub index is comprised of 20 banks and 10 insurance/reinsurance companies. Useless to say that the covid19 outbreak is the key current risk for the European financial industry. The sector enters this new crisis in a stronger capital / liquidity position than in 2007 by a wide margin, but will be in the first line, along with some other sectors. Banks will feel the negative effects on the real economy through loan losses. Cosst of risk will be higher. Banks will need to use some capital to face the crisis, helped by less stringent regulators (stress tests delayed, increased tolerance on capital ratios). In banks, one technical focus has been potential AT1 coupon skips vs potential dividend skips. The amount of capital that would be ‘saved’ by skipping AT1 coupon is much lower (for example: BNP ~E0.5B) than by skipping dividends (BNPP ~E4B so 8x more). Skipping AT1 coupons would also be a strong input for investor confidence in the asset class, and would then imperil banks’ ability to fund themselves across their cap structure. Dividends look more likely to be hurt or skipped altogether. European big banks’ dividends represent c€50B, and c€12B have already been paid (HSBCHD ~E9B, BACRPLC ~E1B, STANLNPLC ~E1B) on top of some interims. Since the period when 2019 dividends were announced (Q419), some European banks have explicitly flagged that the announced figure is up for question, especially among the Scandies (DNB, SEB). It is also possible that the choice AT1 coupon vs div is dictated by regulators. Asking banks to skip AT1 coupons would save some capital + would improve lending capacity, but only a little bit compared to a dividend skip. As in previous periods of economic stress, the European insurance sector is also under pressure. Inco sub CDS have taken part in the widening of SubFin index. AEGON sub, the widest inco, came from 100bp on Feb 19 to the area of 350bp this week. Since Feb 19, the SXIP equity index has fallen by almost -1/2 versus -1/3 for the low in SXXP index. But wait, both retail /institutional customers will continue to purchase insurance, and, in the future, the covid19 may even make them purchase more! The concern isn’t about the business, but the assets they have on their balance sheet. Credit spreads have widened, and equity markets are lower. And because rates have been so low in Europe since the 2011 crisis, insurers have been ‘constrained’ to hold higher-yielding riskier assets. ASSGEN SUB has been particularly eventful. Looking at it in RV vs SubFin s32 index, the 5y CDS of ASSGEN SUB has been underperforming +80bp in just past 2/3 weeks. This RV move stopped on the ECB yesterday. The 1:1 RV started at 0bp(!) and came to +90bp intra-day. Now post ECB and post roll, it is still resisting in the +60/70bp area. In parallel, the 10y BTP-DBR spread, reflecting the main risk that ASSGEN holds on its balance sheet, has come off from +320bp pre-ECB to the area 200bp at the close today. At a more systemic level, the consensus is that the current global markets move may trigger a -10%/-20% drop in Solvency 2 ratios of incos. On average we are now close to 200%, we may well go toward 175-180%. What is important to bear in mind, is that corporate bonds tend to be held to maturity by these guys. So an only-temporary spread widening ultimately has no impact. They didn’t throw their paper out of the window on the pre-ECB stress. Defaults do matter, however. But it is good to recall that incos’ corporate bond books tend to be quite diversified and high quality (single-A on average).