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Weekly Manager Views

01 November 2019

At GAM Investments’ Weekly Investment Meeting held on 30 October 2019 the speaker was Patrick Smouha who provided an update on the credit opportunities within the financials sector.

Developed market credit

Patrick Smouha

  • With the universe of negative yielding bonds now in excess of USD 13 trillion, the search for yield continues to intensify. Capturing yield therefore often requires taking either additional duration risk or more credit risk. An alternative option, however, is to look for quality income further down the capital structure, particularly within the financials sector, with yields of up to 4% for euro-denominated bank subordinated debt.
  • In this space, we see opportunities, particularly within European financials. While profitability in the financials sector has been under pressure, and has experienced a number of negative headlines in this latest reporting season, to us this is more of an equity story. From a credit perspective, results have been strong, capital ratios are stable and deleveraging continues. Royal Bank of Scotland (RBS) and HSBC are recent examples. On 24 October, RBS reported a headline Q3 profit loss but its common equity tier-one (CET1) ratio – which measures a bank's core capital to its total assets – was in at 15.7%, which is well above capital requirements. Moreover, on an underlying basis, they have generated more than 90 bps of capital during the year. Meanwhile, on 28 October, HSBC missed Q3 profit expectations but was still profitable and it maintains its CET1 ratio at a healthy 14.3%. Additional results from Credit Suisse, among others, further reinforces this trend and is positive for holders of banks’ subordinated debt as we are seeing stronger balance sheets.
  • In the last two months we have also witnessed strong performance among so-called grandfathered / legacy debt securities issued by banks and insurers under Basel II and Solvency I respectively. Over time, these bonds are becoming inefficient. Therefore, there is a lot of optionality in terms of having issuers tendering or calling these bonds over the coming quarters / years at a significant premium to current prices, as has been demonstrated by Santander.
  • For example, at the end of September Santander called one of its floating rate notes at par (the bond was trading at 67% prior to the call at par). This had a positive impact on other legacy bonds. We believe there will be more activity in this area going forward.
  • Another segment of interest is the insurance market. On 17 October, French insurer LaMondiale issued EUR 500 million of restricted tier-one debt – a junior security – with a spread of 441 bps. Those securities are rated BBB by S&P, while La Mondiale as an issuer has an A- rating. S&P has a positive outlook, meaning the Paris-based insurer could also benefit from an upgrade going forward. The bond ended up being more than 10 times oversubscribed and is currently trading more than 3 points above the issue price, illustrating the ongoing market appetite.
  • Overall, while asset class performance has been robust year to date, we believe there is a lot of potential for continued positive performance among subordinated debt of financials. The fundamentals of most banks and insurers are solid and getting stronger. On top of that, we believe there are a lot of interesting opportunities within the legacy debt securities market, as well as attractive opportunities within the insurance sector.

Important legal information
Source: GAM unless otherwise stated.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. Reference to a security is not a recommendation to buy or sell that security.