Monthly review and performance
Market sentiment deteriorated in April, with EUR investment grade (IG) spreads widening by more than 20 bps on the month to around 150 bps. Weak sentiment was driven by both macro headwinds, ongoing geopolitical tensions and more recently lockdowns in China. In signs of worsening macroeconomic conditions, the US yield curve briefly inverted in early April (2-year US versus 10-year UST), and the US 1-year recession probability forecast rose to 25%. Inflation remains very much in focus as March CPI prints came at multi-decade highs, and both potential disruptions in the energy market in Europe from the Russia/Ukraine conflict and Chinese lockdowns are likely to put further pressure on prices. Expectations of more aggressive monetary policy from major central banks as a response to inflationary pressures led rates to move sharply higher on the month, for example the 10-year bund yield rose +39 bps. Higher rates weighed on EUR IG total returns, which have now delivered a fifth consecutive month of negative total returns. The risk off environment led to underperformance of more subordinated parts of the capital structure, with spreads on EUR additional tier 1s (AT1s) around 80 bps wider and subordinated insurance around 45 bps wider on the month.
Issuance of green bonds of European financials was in line with seasonally low levels of April at EUR 1.5 billion, due to both challenging market conditions and black-out periods ahead of first quarter earnings releases. This compares to EUR 1 billion in March 2022 and EUR 1 billion in April 2021. We expect issuance to pick up, as most large European banks have released first quarter results, and are set to take advantage of the issuance window ahead of summer.
European banks kicked off first quarter earnings season, with results overall beating estimates. As an example, BBVA’s first quarter results came well ahead of consensus estimates, delivering a 15.9% return on equity from both better revenues and lower loan loss provisions. The group remains strongly capitalised with a 12.7% common equity tier 1 (CET1) ratio, 410 bps above requirements, or EUR 13 billion of excess capital. European banks are also well positioned to benefit from higher rates, which will likely be supportive for earnings.
We continue to see strong value in green bonds of European banks and insurers. With an average yield of around 3.0% on the fund and around 220 bps of spread we are capturing around 1% pick-up in yield compared to 2.1% on EUR IG corporate bonds. This is also achieved by taking less interest rate risk compared to the EUR IG index, with a 4.4 duration on the fund compared to around 5 on the index. We remain biased towards high quality issuers (BBB+ average bond rating).