La Française: Wider quality allocation in senior and subordinated bank debt portfolios
By Jérémie Boudinet, Head of Financial and Subordinated Debt, Crédit Mutuel Asset Management
Banks are often considered to be a “proxy” for the health of their reference sovereign state, and bank bonds therefore tend to trend according to the disparities in their sovereign spreads. While we do not call into question the cyclicality of the banking activity itself, we have shown above that the European sector was now largely controlled by anti-cyclical regulatory and accounting policies, which were in the past the exclusive domain of sectors such as insurance or utilities.
On the other hand, the ECB – this time in its role as central bank – has also managed to limit the surge in peripheral country spreads in recent years, and although this “put” is mostly theoretical, it is nevertheless important for the unity of the eurozone, and therefore for access to the market for “peripheral” banks. Not only do we believe that the health of “peripheral” banks should not deteriorate excessively and to a greater extent than that of “core” banks if the health of their local economy ever suffers from a recession, we argue that they now have the necessary robustness to prevent any potential major deterioration in their balance sheets. Coupled with the strong consolidation of the Spanish and Italian banking sectors, this trend reinforces their credibility and ease of access to the bond markets.
These fundamental trends have concrete implications in terms of asset allocation on financial, senior and subordinated debt:
Widening of allocations to include issuers with improved quality and bonds with better liquidity. We have always focused our investment philosophy on the liquidity of the securities in which we invest, whether in senior or subordinated debt. As a result of the MREL requirements, “peripheral” banks must now regularly issue securities, and in particular senior debt (Preferred and Non-Preferred), which makes it possible to have more liquid curves, which reduces trading costs and facilitates dynamic allocation. On the other hand, significant rating upgrades mean that most banks have debt now rated investment grade or BB, which attracts more investors, as does their inclusion in indices and ETFs, which also improves their liquidity.
The possibility of investing in less well-known but high-quality banks, particularly subordinated debt.
The corollary of the previous point is the opening up of the bond market to banks that were absent from it, hitherto content to issue covered bonds and benefit from the ECB’s TLTROs. Now that smaller “peripheral” banks have easier access to the primary market, we expect potential inaugural AT1 CoCos issues from Banca Monte dei Paschi di Siena, Cajamar, National Bank of Greece or Novo Banco (particularly to optimise their capital structure in the latter case) in the near future, if they deem the conditions favourable in terms of issue spreads.
The opportunity to benefit from industry consolidation trends.
We regularly mention in our bi-weekly publications the various rumours and developments of mergers and acquisitions in Europe, and particularly the largest one in recent times – namely BBVA’s hostile takeover bid for Banco de Sabadell, which is still ongoing.
Investments in banks that may be the subject of M&A have timings that remain uncertain, but this is less problematic since fundamental trends remain buoyant and reassuring. Several names regularly appear in merger rumours: Novo Banco, Monte dei Paschi, BPER Banca, BP di Sondrio, among others. For the time being, cross-border mergers are still too complex from a regulatory point of view, with the exception of the Iberian region, where several Spanish and Portuguese banks are already linked (Abanca, Bankinter, Santander, CaixaBank each have a local subsidiary). We therefore view these potential mergers in a positive light, given that mergers are firmly controlled and do not lead to excesses in goodwill differences on acquisition, due to regulatory constraints. UniCredit's acquisition of a 9% stake in Commerzbank, which leaves open the possibility of going further, is the first concrete example of a desire for cross-border M&A, with a strong symbolism in that it involves an Italian bank, albeit one that already has a presence in Germany, acquiring a German bank. The reaction of Commerzbank’s trade unions, which are calling for an opening with a French bank rather than with Italians, does little to disguise the latent contempt for the reputation of the Italian banking system, which is no longer justified.
For the time being, the final consequence is probably more an instance of wishful thinking than a reality: lower volatility for “peripheral” bank spreads over time compared to non-financial bonds, particularly in senior debt. Bank spreads naturally tend to widen further compared to comparable non-financial strains, due to their perceived cyclicality, as well as by a greater correlation during periods of stress with “peripheral” sovereign rates or equity markets. We believe (and hope) that investors’ perception will ultimately reflect the paradigm shift of European banks, and particularly “peripheral” banks, in terms of robustness.