Earnings season results shed a positive light on financials
Earnings season results are in for companies within the Euro Stoxx 50. The financial sector delivered one of the strongest earning surges across all sectors, 38% of company reported earnings beating concensus analyst expectations. Compared to the last quarter1, earnings growth for the consumer discretionary sector was strong, reflecting the return of the consumer this year following the covid-19 vaccine roll-out which has helped economies transition out of lockdowns. Financials also benefited from a robust pick up in earnings growth from last quarter with 48% of companies reporting earnings growth2. In this blog, we will explore one of the sectors that delivered strong first quarter earnings results and the implications this may have for the bond market.
What does earnings season tell us about the market’s perception of risk for corporate bonds?
Option adjusted spreads (OAS) for both US high yield and Euro high yield bonds were lower in May compared to the start of 2021. OAS is typically the spread above the risk-free rate that aims to compensate investors for liquidity and credit risk. High OAS levels indicate that the market is concerned about the credit or liquidity risk of a bond.
With the OAS for US high yield bonds falling by 16%3 this year, investors are signalling a more optimistic outlook for companies with higher credit risk. OAS peaked in March 2020 for corporate bonds and has fallen considerably since those peak levels, signalling cheaper borrowing costs for companies and a more supportive operating environment for corporates4. Similarly, in April 2020, OAS for European banks and their Additional Contingent Convertible bonds (AT1 CoCo) bonds recovered from a significant high. With the OAS for many corporate bonds at seemingly lower levels, investors have turned to relative value opportunities to optimise their portfolios. In this part of the investment cycle, sectors that could benefit from the improving macro backdrop are likely to gain more investor attention.
Considering the Q1 2021 earnings season, how are the CET1 ratios of European banks5 holding up?
Source: WisdomTree, Markit, Bloomberg, respective issuers financial results. Data as of 30 April 2021. CET1 change represents value change in CET1 ratios from data available as of 31 March 2021 (generally Q4 2020 available reporting) compared to latest data available as of 12 May 2021 (generally Q1 2021 available reporting). No change may indicate reporting cycle has not ended. CET1 ratio is the Common Equity Tier 1 Capital ratio reported on a fully loaded basis available on Bloomberg and from the issuer’s latest financial results, if not reflected on Bloomberg. Maximum trigger level is represented by the maximum trigger observed across all CoCo issues of a given issuer. The strategy is represented by the iBoxx Contingent Convertible Liquid Developed Europe AT1 Index.
You cannot invest directly in an index. Historical performance is not an indication of future performance and any investments may go down in value.
European banks6 maintain buffers to their maximum trigger ratios for their AT1 CoCos. Italian banks have increased their common equity tier 1 (CET1) ratios7 in Q1 2021 compared to Q4 2020 which is supported by stronger than expected Q1 results. Credit Suisse, which made headlines this year, reported a drop in their CET1 ratio by 0.70% for the same period but maintained a buffer to their maximum trigger ratio of 5.20%. Nationwide Building Society, which typically issues their AT1 CoCos in sterling, maintained a high buffer to their maximum trigger ratio of 27.50%.
While it is never easy picking the winners from the losers, the potential for one-off events like the Greensill debacle make it even harder to predict future returns. Strategies that provide access to a diversified basket of bank issuers may become a useful tool for investors seeking a yield pick-up relative to other corners of the fixed income market.
Sources
1 Source: Bloomberg, as of 17 May 2021, first quarter 2021 earnings reported compared to fourth quarter 2020 earnings reported for companies within the Euro Stoxx 50 price index (SX5E).
2 Source: Bloomberg, as of 17 May 2021, first quarter 2021 earnings reported compared to fourth quarter 2020 earnings reported for companies within the Euro Stoxx 50 price index (SX5E).
3 from January 2021 to May 2021
4 Source: Bloomberg, as of 17 May 2021, credit dashboard BI STRTE considering OAS since November 2019 to May 2021.
5 Source: European banks is represented by the iBoxx Contingent Convertible Liquid Developed Europe AT1 Index.
6 Source: European banks is represented by the iBoxx Contingent Convertible Liquid Developed Europe AT1 Index.
7 Source: Common equity tier 1 ratio aims to compare a bank's capital against its assets.
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