After the financial turmoil…Calm is back

CORPORATE BOND STRATEGY

During the sell-off, financials were the underperformers (Chart 3) as investors turn attention to how rates in negative zone will impact the profitability and how the capital buffer will be compromised by lower net income as well as the exposure to US energy sector. Negative deposit rate will also increase the bank’s interest burden. All these elements have generated high volatility on the credit markets since the beginning of the year and Credit spreads reached a 3-year high in February.

But European bank fundamentals remained in the good shape with Core Equity Tier 1 ratio reaching 12.5% and non-performing loans decreasing to 4.6% end 2015. Since the beginning of the financial crisis in 2008, banks in the euro zone have increased their capital position by more than EUR 300 bn.

The European Institutions have demonstrated through the asset quality review (AQR) and supervisory review and evaluation process (SREP) that banks are now more resilient than in the past. Concerns about earnings, capital and asset quality have been exaggerated although some specific fears on an individual level could be justified regarding commodity exposure and business model.

All in all, from a bondholder perspective, the banking sector and, particularly subordinated debt is attractive.

Calm is back

The announcement on 10th March of ECB Bazooka outpaced the expectations and was very positive for risky assets, with European credit outperforming US credit. While the inclusion of non bank corporations in the asset purchase program (APP) is very positive for corporates established in Europe, the modest deposit rate cut and new attractive funding facilities will support the banking sector, principally peripheral names. Financial subordinated debts will benefit from the search for yield by extension. AT1 and T2 markets will certainly reopen thanks to this improving risk sentiment (BNP, HSBC, Santander, Unicredit do not yet fulfill the 1.5% bucket requirement for the time being). The pipeline in non financials companies looks also strong as the primary market volume was very low in the last 6 months. That is the reason why we prefer financials compared to non-financials.

Within the financial sector, we have a preference for subordinated debt (LT 2) compared to senior debt. The carry-to-risk is more attractive for LT2 in an environment where banking issuers are trading at lower levels than non-financial issuers.

In the non-financial space, we prefer sectors less sensitive to the cycle such as Telecommunications and Utilities. The former has experienced a positive growth dynamic during the last 4 quarters, with solid margins (around 40%). The latest consolidation trend has also pushed the price up. The latter is less dependent on commodity-exposed assets (the EBITDA derived from those assets falling from 75% at the top to 45%). It also offers exposure to non-core, high-beta issuers still offering an attractive yield pick-up.