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Subordinated Debt, cohabitating with COVID-19

06.10.2020

El contenido del presente documento va destinado a inversores profesionales en el sentido de la Directiva MIF.

By Paul Gurzal, head of Credit, La Française AM

Unlike the 2007-2008 financial crisis, banks are not “to blame” for COVID-19! On the contrary, they have a crucial role to play, that of continuing to lend in order to finance the real economy. And to counter the unprecedented economic and financial shock that we are experiencing, European legislators and regulators have granted banks unprecedented support measures, which are favourable to subordinated debt investors. The time has passed for regulatory punishment and banking is becoming a priority sector which should receive sustained support.

Supported by stabilising peripheral sovereign rates, AT1 subordinated bank debt has seen its performance recover significantly over the third quarter of 2020. The reassuring results published in the second quarter and the return of mergers and acquisitions, for example UBI Banca with Intesa San Paolo and Bankia with CaixaBank, should further solidify the sector. Alternatively, hybrid subordinated debt from non-financial companies performed less well due to more expensive valuations and uncertainties surrounding the strength of the European economic recovery. Nevertheless and regardless of persisting macro-political fears (further restrictions linked to the pandemic, the risk of a Hard Brexit, disruptive US elections), we believe that the unwavering support of central banks through very strong quantitative support measures largely shelters the European subordinated debt market from these long-term uncertainties. The risk of volatility remains, but the carry effect in an environment of very low interest rates offers a strong springboard for recovery.

The Cocos segment, compared to the European High Yield segment, is well positioned in our opinion, and offers performance potential. If we take the Bloomberg Barclays indices as they stood at 22 September, CoCos denominated in EUR have an average return of 6.1%, against an average return of 4.7% for European High Yield. We believe that this valuation gap does not reflect the fundamental differences between these two segments. Subordinated bank debt stands to benefit from strong and unprecedented regulatory support, whereas part of the High Yield market continues to suffer from concerns about rising default rates, namely cyclical industries.

Despite its good fundamentals and technical support factors, subordinated debt is unfortunately not impervious to macroeconomic hazards and market volatility. Until the health crisis is brought under control, the return to “normality” will only be gradual and the market will have to endure a bumpy ride along the way.

Disclaimer    

The Subordinated debt & Cocos investment strategy is suitable for professional investors as defined below. Execution only services can only be provided to professional investors. Retail investors are excluded from the positive target market.
Professional Investors have the following characteristics:
•    Good knowledge of relevant financial products and transactions
•    Financial industry experience 
The subordinated debt & Cocos investment strategy is not suitable for retail investors unless they have professional investment advice AND the investment is for diversification purposes only or have signed a discretionary portfolio mandate.

THIS DOCUMENT IS INTENDED FOR PROFESSIONAL INVESTORS ONLY WITHIN THE MEANING OF MIFID II. It is provided for informational and educational purposes only and is not intended to serve as a forecast, research product or investment advice and should not be construed as such. It may not constitute investment advice or an offer, invitation or recommendation to invest in particular investments or to adopt any investment strategy. Past performance is not indicative of future performance. The opinions expressed by La Française Group are based on current market conditions and are subject to change without notice. These opinions may differ from those of other investment professionals. Published by La Française AM Finance Services, head office located at 128 boulevard Raspail, 75006 Paris, France, a company regulated by the Autorité de Contrôle Prudentiel et de Résolution (www.acpr.banque-france.fr) as an investment services provider, no. 18673 X, a subsidiary of La Française. La Française Asset Management was approved by the AMF (www.amf-france.org) under no. GP97076 on 1 July 1997.
 

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