Banks have more capital than before, and new risks

June 30, 2021

Banks are trying to adapt

* According to the Bloomberg Barclays Global Aggregated Credit Index, as of June 11, 2021.

Lending doesn't pay what it used to

Banks' net interest margins have tracked interest rates to cyclical lows
The image shows average net interest margins in percent for North America, European, and Asia-Pacific banks generally trending down from 2006 to the present (mid-2021). North American banks started the period at around 3.7% and declined to 2.7% by the end of the period. European and Asia-Pacific banks started with lower net interest margins than North America and ended the period at around 1.2%.  The image shows short-term interest rates from 2006 to the present (mid-2021) for three central banks: The U.S. Federal Reserve, the European Central Bank, and the Reserve Bank of Australia. The lower bound of the federal funds target rate for the Fed, the effective one-week minimum bid refinancing rate for the European Central Bank, and the daily cash rate target for the Reserve Bank of Australia began the period rising, but subsequently trended down to zero or slightly negative.

In response, banks have been racing to innovate and transform

Profitability at U.S. banks has proved resilient; European banks still face some structural issues
The image shows average return on equity in percent for North America, European, and Asia-Pacific banks from 2006 to the present (mid-2021). For all three regions, return on equity fell in 2008–2009 and again in 2020, but has trended upward more recently.

How changing business models have complicated credit analysis

Banks, especially in Europe, have significantly boosted their capital positions since the GFC
The image shows average Tier 1 common capital ratio in percent for North American, European, and Asia-Pacific banks from 2006 to the present (mid-2021). The percentages for all three regions rise from a range of around 6%–8% at the beginning of the period to a range of around 11%–16% by the end of the period. The increase was greatest for European banks.

Where we see value now in the banking sector

How will lower-for-longer rates affect banks?
The impact of low/negative rates for U.S. banks: Manageable. Having more of their income come from fees than from interest has helped profitability.  Their credit outlook: Positive. These banks have strong balance sheets and business models, as well as solid structural profitability and superior fundamentals. Rates are likely to rise sooner in the U.S. than elsewhere.  The impact of low/negative rates for Australian and Japanese banks: Manageable. Some repricing is underway. Thanks to accommodative central bank policies, Australian and Japanese banks continue to benefit from low-cost funding.  Their credit outlook: Positive. Execution of sustainable cost initiatives, asset repricing, and the release of loan loss reserves are helping drive profitability. Balance sheets are robust, with capitalization above pre-COVID levels.  The impact of low/negative rates for Nordic, Swiss, Belgian, French, Dutch and Luxembourg banks: Manageable. Having more fee income (wealth management for Swiss banks) than interest income has helped profitability. The banks also operate in concentrated markets and have better pricing power.  Their credit outlook: Compared with other European banking systems, these banks have fewer structural issues. With high capitalization and decent profitability levels, their starting point is strong.  The impact of low/negative rates for U.K., German, Spanish, and Italian banks: Negative. These banks rely heavily on net interest income. They have limited room for improvement from deposit pricing and cost cutting.  Their credit outlook: Neutral. The ultra-low rate environment will likely persist longer for these banks. Their profitability, which has been plagued by legacy structural issues, is expected to remain relatively weak.
Active Fixed Income at Vanguard
The image shows that Vanguard taxable bond assets under management are $273 billion and municipal bond assets under management are $216 billion. There are more than 25 portfolio managers, 35 traders, 60 credit research analysts and 130 dedicated team members who are part of Vanguard Fixed Income Group.

Fixed Income Team Members

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