What is the outlook after the rebound?
Subordinated debt issued by banks, insurance companies and non-financial companies has logically been very strongly impacted by the health and economic crisis of recent months, but has seen its valuations recover significantly in recent weeks, as per the equity and high-yield bond markets.
On closer inspection, the picture is becoming more complex, however, with various issues relating to subordinated structures: suspension of coupon payments, exercise of call options, changes in banking regulations and legislation.
Here we consider current market valuations, as well as issues specific to subordinated bonds and the
fundamental trends of issuers.
Change in total return, normalized as at the end of 2014, of the iBoxx subordinated debt indices (total
return; in %)
Sources : Markit, Bloomberg, La Française AM. Data as at June 10, 2020.
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As can be seen on the above graph, the performance of subordinated debt indices was quickly and heavily affected by the spread and consequences of Covid-19. Additional Tier 1 (AT1, also known as CoCos) bank bonds suffered an unprecedented 29% decline between February 21 and March 19, compared to -16% for subordinated insurance debt, -15% for non-financial corporate hybrid debt and -11% for Tier 2 bank debt over the same period (iBoxx € indices taken as a reference). The significant underperformance of the AT1€ is due to several factors, including a "High Beta" characteristic compared to other segments, higher exposure to Italian and Spanish issuers and massive repricing of the issues according to the call probability of the securities. However, during this period, we once again observed that CoCos remained more liquid in times of stress than other subordinated debt segments, and even more liquid than parts of the Investment Grade segment, despite their potentially more volatile nature.