Paul Gurzal, Head of Credit, La Française AM, presents his convictions.
What was the impact of the Turkish crisis and the Italian crisis on the subordinated debt segment?
August was a difficult month for the asset class, particularly in the emerging countries and Italy.
However, the impact of the Turkish crisis on banks’ fundamentals is less important than it seems. Their exposures do not, in our view, jeopardise their credit profile. We believe that if the value of their Turkish subsidiaries were reduced to zero, banks' capital ratios would remain firm in relation to regulatory requirements.
Regarding Italy, banks and insurance companies hold local public debt, which links them financially to the performance of the debt. The volatility of Italian public debt is not really a problem for the banks if we exclude the restructuring of the latter. Indeed, a significant part of the public debt held is not valued. The solvency of Italian banks such as UniCredit and Intesa Sanpaolo, could, in our view, absorb the losses from the volatility of BTP bonds, without this challenging their compliance with the regulatory requirements of the ECB, or coupon payments on Additional Tier 1 CoCos.
In addition to the sector being weakened by macroeconomic and political events, a number of important funds in this asset class have suffered outflows for the past six months, automatically creating selling pressure, particularly on CoCos and Legacy Tier 1. These outflows peaked during the summer period, a time when liquidity is always lower.
This strengthens our conviction that positioning on the liquid part of the segment, along with sector diversification (banks, insurance and non-financial issuers), is essential.
Is the newsflow on the asset class negative?
No, quite the contrary.
From a risk perspective, the current trend is good: banking risk is falling sharply.
The results period has been positive overall for the banking sector. Banks’ solvency remains strong with regard to the regulatory requirements. (Source: Credit Suisse - "Attractive Relative Value -Taking profits on low backend AT1 shorts" - 23 August 2018 ).
The decrease in bad debts on balance sheets is positive for the credit quality of the peripheral banks.
We observed a sharp fall in Non-Performing Loans in Q2 for Spanish and Italian banks, with an acceleration in sales of part of their bad loans portfolios.
In our view, banks are therefore on a positive trajectory in terms of improving the quality of their assets and their solvency.... There remains the question of profitability. Do you consider the asset class to be attractive?
We believe that in comparison with other segments of the credit asset class, subordinated debt does remain attractive.
The widening of spreads has been greater with subordinated debt than with High Yield, and banking and insurance subordinated debt is now significantly discounted, with higher-rated issuers.
Liquidity has indeed made a comeback to this segment: investor appetite for CoCos has been reflected in recent issues from Rabobank, Credit Suisse and Bankia, which were largely oversubscribed. The good performance of the market reflects the market's confidence in the asset class.
Lastly, in a context where the ECB's first rate hike is not expected until October next year, the asset class remains a potential solution.
Following the recent repricing, we can expect a return in euros of about 4%, which may be of interest to investors seeking returns.
Disclaimer:
This document is intended for professional investors 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. 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 as an investment services provider, no. 18673 X , a subsidiary of La Française. La Française Asset Management was approved by the AMF under no. GP97076 on 1 July 1997