European Credit Outlook 2019: Keep Calm, Carry On

CORPORATE & INSTITUTIONAL BANKING December 2018 European Credit Outlook 2019: Keep Calm, Carry On VIKTOR HJORT, PAOLA LAMEDICA, PIERRE-YVES BRETONNIERE, JAMES SPARROW, STEVEN CRAIG AND TEAMS CREDIT STRATEGY AND TRADING DESK ANALYSTS THIS IS MARKETING MATERIAL FROM THE CREDIT STRATEGY & TRADING DESK ANALYST TEAM AND IS NOT RESEARCH What you will find here and where 2 1.Themes, outlook and forecasts for 2019 3 2.Where we are in the Credit Cycle 8 3.The Supply vs. Demand Dynamic 15 4.Political risks are high: Italy and Brexit 25 5.Relative Value themes 30 6.European Investment Grade: strategy outlook 36 7.European Investment Grade: sector outlooks 41 8.European High Yield: strategy outlook 50 9.European High Yield: sector outlooks 56 Five Key Themes for 2019 3 1. The Credit Cycle has longer to run •Theme: US is late cycle albeit not yet extreme, while the European Credit Cycle is younger. •View: European Investment Grade is attractive. We forecast positive returns. 2. Credit conditions are getting gradually tighter •Theme: reduced credit availability will, as in 2014-15, result in a gradually higher default rate. •View: High Yield is not yet attractive. We forecast moderately negative returns. 3. Political risks are high in Europe but so are risk premiums •Theme: Brexit and Italy are unresolved but at these prices there is upside as well as downside. •View: Italian Credit is attractive. UK Credit is fairly reflecting Brexit risks. 4. Growth uncertainty is high but so are the risk premiums •Theme: a meaningful slowdown is priced in but a rebound needs Brexit and/or Trade resolved. •View: Hybrids (Non-Cyclical) are defensive vs. Cyclical Non-Financials. 5. Net supply to increase driven by Financials •Theme: net supply will increase for Senior Banks and decrease for Non-Financial Corporates. •View: technical support for Energy, Materials, Hybrids; headwind for Banks. The Cycle will become more challenging but valuations have improved materially in 2018. We are more positive than the consensus. European Credit Outlook: Muddle Through 4 Base case: credit conditions tighter and idiosyncratic risk on the rise but valuations already capture an ‘ECB taper tantrum’, Europe remains early in its Credit Cycle, a TLTRO3 is likely and global flows will increasingly benefit European Fixed Income. Source: Bloomberg, BNP Paribas Spread represents the Bloomberg Barclays Pan-European Aggregate Index. Viktor Hjort, Pierre-Yves Bretonniere, Paola Lamedica Bear case: Europe in Recession (+60bp) Base case: Muddle Through (-15bp) Bull case: Triple Boost (-50bp) 3080130180230280Jun-12May-14Apr-16Mar-18BB EuroAgg Corporate index (OAS) European IG Credit 2019 FY Spread Forecast Growth stabilisation (GDP: 1.4%, CPI: 1.8%, default rate: 2.5%) + soft Brexit + TLTRO3. Trade deal + Soft Brexit + Italy market friendly govt as well as TLTRO3 substantially reduces macro uncertainty, setting the stage for a growth rebound. Europe into recession (GDP: 0%, CPI: 0%, default rate >5%) = trades at historical average US BBB recession levels. BNP Paribas London Branch Forecasts and Sector Recommendations 5 We forecast low returns but better than 2018 and likely better than the consensus expects. Quantitative tightening, sluggish growth, a moderate increase in Financials bond supply and a moderate rise in the default rate will weigh on returns but are offset by better valuations, stable IG balance sheets, global flows and a healthy negative sentiment.  Sector allocation: favour defensives such as Energy and Hybrids. Cyclicals are cheap but not out of the woods yet. * Bloomberg Barclays Pan-European Aggregate Index. ** Bloomberg Barclays Pan-European High Yield Index. (1) Forecast 2018. Source: BNP Paribas Viktor Hjort, Pierre-Yves Bretonniere, Paola Lamedica BNP Paribas’ forecasts 2019F 2018E Credit spread and excess return € IG spreads (bp)* -15bp +69bp € IG excess returns 2.3% -3.1% € HY spreads (bp)** +100bp +215bp € HY excess returns -0.2% -4.1% € HY default rate 2.5% 1.9% € net supply (IG) €205bn €195bn Growth and inflation Eurozone GDP(1) 1.4% 1.9% Eurozone HICP(1) 1.8% 1.8% FX and rates EURUSD FX(1) 1.25 1.14 ECB depo rate -0.20 -0.40 2y Bund yield 0.00 -0.55 5y Bund yield 0.50 -0.05 10y Bund yield 1.00 0.55 BNP Paribas’ sector recommendations for 2019 € IG Non-Financials  Autos Metals & Mining = Energy  Real Estate Retail and Consumer / = TMT Utilities  Corporate Hybrids  € Financials = Senior Financials Lower T2 = AT1  € HY Retail Food Energy  Packaging = Construction Chemicals Source all charts: BNP Paribas BNP Paribas London Branch € IG and HY Picks and Pans 6 Source: BNP Paribas INVESTMENT GRADE PICKS PANS Banks UBS, ING, ABN, Nordea, SEB NWIDE, LLOYDS, SANUK, BACR, COVBS Tier 2 Italian banks Autos ASTONM, RACE, GKN TTMTI