UBS Explains: Private credit (12:20)
CIO's Antoinette Zuidweg explores the potential upsides and risks of direct lending, along with where some of the more attractive opportunities exist at present.

Thought of the day

The banking sector weighed on equity sentiment on Tuesday after Moody’s Investors Service on 7 August announced negative actions on US banks.

Moody’s downgraded 10 small- and midsize lenders, placed six banks on a review for possible downgrade, and changed the credit outlooks on 11 banks to negative. The rating agency cited three main factors: higher funding costs, regional banks’ comparatively low regulatory capital versus the largest US banks, and the large commercial real estate (CRE) exposures of certain banks. In Moody’s view, “these three developments have lowered the credit profile of US banks, though not all banks equally.”

Following the news, the US regional bank index fell by more than 4% but recovered to close 1.4% lower. The S&P 500 bank sector dropped 1.1%. Year-to-date, US financials have underperformed, rising around 3% through 31 July, while the S&P 500 rose roughly 19% over the same period. But despite this underperformance, we remain cautious on bank equities and see better opportunities in select bonds.

  • Moody’s actions should be viewed within the context of existing known challenges within a banking sector that still exhibits a generally sound financial profile.
  • Within equities, we hold a neutral view on global financials and a least preferred view on US financials. We maintain a cautious outlook on US financials for the next 12 months as higher funding costs combined with rising credit losses could dampen earnings growth and profitability over 2023–24.
  • Within fixed income, senior bank bonds continue to offer higher yields compared to those of similarly rated non-financial companies. In the US investment grade (IG) corporate bond market, US IG banks trade cheaply relative to their nonfinancial counterparts on a duration-matched basis. This holds true across both single A and BBB rated bonds. The spread pickup for moving down in credit rating from A's to BBBs is tight from a historical perspective, but it is wider for banks compared to industrials. Since 2010, the spread ratio of BBBs/A's stands at the 43rd percentile for banks but just the 29th percentile for industrials.

So, although sentiment for the banking sector is still likely to ebb and flow, we consider US globally systemically important banks to be core holdings in IG corporate bond and preferred security portfolios. When it comes to the large US regionals, we also find select opportunities in their bonds and preferreds.