Looking for opportunities in the financial subordinated debt market

Looking for opportunities in the financial subordinated debt market
Looking for opportunities in the financial subordinated debt market

• a very good corporate earnings season, which buoyed equity markets
• a significant rise in sovereign rates
• a stabilization of outflows in the credit markets
• very weak and bearish market positioning in June, which reinforced the rally in July by covering short positions, despite very moderate buying flows
• valuations that had become extreme in credit and wholly segment-specific and decoupled from equity markets

The “technical” aspect of this rally in terms of the factors that favored it may cast doubt on its sustainability. Indeed, the volatility of sovereign rates remains high -which is never good for credit- and markets are torn between inflation and lower growth. Strong valuations and fundamentals are often cited as arguments to trigger a buy signal, but this becomes uncertain in an environment where even central banks are drifting.

Now, it is time to shift our attention from yield curves to calls on subordinated debt segments, which remain dislocated, with bank securities likely not to be redeemed, due to lack of replacement by new issues (Banco Sabadell, Raiffeisen Bank International, Shawbrook and Bank of Nova Scotia in AT1 CoCos; BCP and potentially several Tier 2 Italian banks) . Although investors are already relatively aware of no-calls (in the last three months there have already been two European Tier 2 calls by Deutsche Pfandbriefbank and Volksbank Wien, that is, small issuers), their growing number could weigh on the resilience of this asset class in the next two months. Finally, primary issues with higher coupons and reset spreads may tend to widen the spreads of existing securities with lower coupons.

Although valuations are less attractive in relative terms, especially when taking into account currency hedging costs, we like European AT1 CoCos denominated in USD from core countries, that offer greater liquidity and historically more contained spread movements, as well as the AT1 of developed countries outside the European Union.

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Despite excellent financial results and still attractive valuations, the environment is too uncertain for us to increase our positioning in subordinated debt. We prefer the dollar AT1s of the big European banks in relative terms.

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