Strong Fundamentals, Selective Opportunity: The Case for Financials

The last six months have been eventful for markets, driven largely by developments under the Trump administration and the campaign promises on which it was elected. From a macroeconomic perspective, this has made long-term forecasting particularly difficult, whereas we would normally have a bit more clarity. In the US, the situation revolves mainly around the fiscal bill, and it remains hard to fully understand what the net stance of fiscal policy will be, particularly once tariffs are accounted for.

In Europe, the growth environment is slower—perhaps more subdued—but we are also seeing significant shifts. For example, the German government has expressed its willingness to loosen its fiscal stance by €1 trillion, which is a very large move.

All of this is broadly positive for the companies and banks we invest in. The backdrop of the past three years—marked by higher inflation and rising interest rates—has proven that the efforts to rebuild Europe’s financial sector have paid off. Today, the sector is enjoying its highest levels of profitability and capital buffers on record, supported by very clean balance sheets.

Even in a tightening environment—where European rates have moved from -50 basis points to 4%—we have seen almost no deterioration in asset quality and continued strong profits at the bank level. Bank profits in Europe are now approximately 70% higher than in 2019. In some parts of southern Europe, they are two to three times higher. This represents a significant and encouraging development.

As credit investors, we focus on buffers. Profits are the first line of defence for any investment; capital is the second, should our base case prove wrong. Currently, we are invested in companies that are distributing high dividends, generating capital, and sitting on record-high capital buffers—levels we haven’t seen since we began this strategy.

Financial credit spreads remain attractive on an absolute basis, and we see room for selective compression. Within the index, dispersion is still wide, meaning there is potential for alpha generation. However, we are cautious in the primary market, having been much more selective over the past 12 months. Reset spreads for new perpetual bonds are tight, and since we already hold a strong vintage of bonds in our portfolio, we don’t see the need to extend maturities by one or two years just to buy lower-quality paper.

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