Opinion Leaders
European Credit Market: Banks vs. Industrials – What’s Happening?
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Howard Woodward
Co-portfolio manager of the Euro Corporate Bond
T. Rowe Price
Recently, the European credit market has seen a change in how investor’s view banks compared to industrials, the companies that make goods and provide services.
For the past few years, banks were seen as riskier investments, with higher spreads compared to industrials. But since early 2023, banks have seen stronger relative performance, and their spreads have come closer to the levels of industrials.
In February, for the first time in nearly 3 years, senior banks became more expensive to invest in than industrials. This change has led to discussions about whether bank debt is now overpriced. However, looking at the long-term history, we see that these current levels, despite looking expensive on a short timeframe, were normal for many years before the COVID-19 pandemic. When we look at a 10-year period, we see that, on average, senior bank debt has traded more expensively than industrials, close to the levels we are seeing today.
Banks are in a strong position with robust capital and stable regulations. Even though 2024 might be the peak for bank earnings due to high interest rates and low consumer defaults, banks can manage lower rates through the use of hedges and the interest rates they offer customer. They are also less affected by tariffs compared to industrial companies that rely on exports. Any progress towards peace in Ukraine will also help banks.
Rating agencies are positive about European banks, which could lead to their spreads and yields lowering further. Additionally, the supply of bank investments in 2025 is expected to be lower than in 2024, which supports tighter spreads.
Investor confidence in banks has grown, as seen in the lower volatility during French political uncertainty in November. We did not see this uncertainty lead to volatility within peripheral banks, showing the market is less connected in extreme events. This trend may continue into 2025.
Overall, while the difference in spreads between banks and industrials seems less differential compared to recent history, looking at the long-term and considering both fundamental and technical factors, further tightening is possible. Current levels are closer to long-term averages, and strong fundamentals support this trend. We believe banks could continue to tighten relative to industrials, moving back to pre-COVID levels when banks regularly had lower spreads than industrials.
