GAM Star Credit Opportunities (EUR)

During the month of April, financial markets showed some positive momentum, as reflected by the beginning of a recovery in prices for the securities within our fund. This has been a positive reaction to the support showed by central banks, governments and regulators, all of which took extraordinary measures to support the economy throughout this period of uncertainty. It is also a reflection of the Q1 results published by some of the major banks, which were overall positive from a credit perspective and shed some light on the uncertainty related to the economic ramifications of the Covid-19 outbreak. The credit quality of our issuers continues to be strong, as reflected by the average rating of BBB+ at the issuer level. Financials remains one of the strongest sector within credit markets, and, in our view, they are able to pursue their role of lending to the real economy and being part of the solution (compared to being part of the problem during the global financial crisis). As we progress through banks’ Q1 2020, we are starting to see the impact of the Covid-19 situation on results. As expected, Covid-19 had a significant impact, reflected by a surge in loan loss provisions as banks brace for a sharp deterioration in the macro environment. Nevertheless, we maintain the view that this remains an equity story and not a balance sheet story – demonstrated by lower profitability and suspended dividends, while banks’ excess capital positions remain very strong. Pre-provisions profits, we believe the first line of defense against credit losses are currently sufficient to absorb the Covid-19 effects. Excess capital positions remain strong, bondholders are very well protected, and in particular we see coupon risk as broadly unchanged given very large buffers. For further details on the Q1 20 results from some of the major issuers we hold in the funds, please refer to the following Spotlight. Despite the partial recovery, we feel current valuations remain attractive, as we are able to capture spreads of more than 650 bps. On top of that, 90% of the subordinated debt of financials is still trading to perpetuity – with a large upside for bondholders on a re-pricing to call. Moreover, the fund is capturing high and predictable income.

Spotlight: Q1 2020 banks earnings, good for our banks so far.

Focus: HSBC

HSBC’s results were sound for the first quarter of 2020, despite a surge in loan loss provisions. From an earnings perspective, pre-tax profits were down 48% year-on-year to USD 3.2 billion, equivalent to approximately 4% RoTE, which was mainly driven by loan loss provisions rising by USD 2.5 billion to USD 3 billion, or a 5x increase. Nevertheless, the group remained profitable in a challenging environment, and more positively showed its ability to absorb significantly higher loan loss provisions of USD 6 billion, or twice those of Q1 20. Management has commented that loan loss provisions are expected to be USD 7-11 billion for 2020, therefore Q1 20 provisions are 30-45% of the total expected for the year, reflecting conservative provisioning assumptions. Moreover, USD 7-11 billion compares to USD 22-23 billion of annual pre-provision profits, a very strong buffer to absorb losses. From a bondholders’ perspective, total CET1 capital was up USD 1 billion to USD 125 billion on the quarter, although the group’s CET1 ratio was down 10 bps at 14.6% due to higher risk-weighted assets (RWAs) as corporates drew on their credit lines and the group continues to support its customers during this time of uncertainty. Given the reduced capital requirements, the group’s MDA buffer increased to USD 32 billion from USD 29 billion in Q4 19 – therefore, bondholders benefit from higher excess capital. Overall, the group’s results have shown the ability to absorb losses from pre-provision profits while capital remains rock solid and excess capital is increased on Q1 20.

Focus: Barclays 

Barclays reported strong results for Q1 20, benefiting from very strong tailwinds in its corporate & investment bank (CIB) that partly offset higher provisions due to deteriorating macro conditions. While the group’s headline RoTE of 5% and net income decline of 42% year-on-year is weak on the face on it, this includes a whopping GBP 2.1 billion in loan loss provisions (equivalent to 2.2% of outstanding loans). Interestingly, the group discloses its assumptions underlying the GBP 2.1 billion loan loss provisions that reflect a deep recession followed by a recovery in 2021. For example, the group assumes a decline in UK GDP growth of 51.5% at the worst point with a rise in UK unemployment from 1.1% to 8%. Similarly, the group expects US GDP to fall by 45% at the worst point and unemployment to rise from 3.8% to 17%. This reflects the very conservative stance towards loan loss provisions, and positives from a bondholders’ perspective are likely to cover more than future actual credit losses. The group’s capital metrics remain strong, although CET1 ratio is down 70 bps to 13.1% as RWAs grew by 10% on the quarter (due to higher loans as corporate clients drew on credit lines and the group supported its customers through this period of uncertainty), offsetting CET1 capital growth of GBP 1.7 billion to GBP 42.5 billion. The group’s buffer to MDA grew by 30bps QoQ to 160 bps as requirements fell by 100 bps, equivalent to GBP 5 billion of excess capital. Overall, the group’s underlying performance has been very strong due to tailwinds in CIB operations, and frontloading of loan loss provisions is credit positive. Capital positions remain strong with a sound maximum distributable amount (MDA) buffer, credit positive.

Focus: UBS

UBS reported strong results, delivering a 13% return on tangible equity and 30% rise in pre-tax profits. The group benefitted from strong performance in its investment banking division (mainly sales & trading), while wealth and asset management continued to perform strongly. While the group’s loan loss provisions were up 13 times compared to the first quarter of 2019, at USD 268 million these remain modest compared to the group’s approximate USD 2.3 billion of pre-provision profits. This reflects the group’s very limited lending risk, mostly focused on low-LTV domestic mortgages and secured lending to wealth management customers, and therefore the group should bear limited impact from the Covid-19 situation compared to international peers. Due to market volatility and increased activity, the group’s CET1 ratio was down 90 bps on the quarter to 12.8% despite a USD 1.1 billion increase in CET1 capital to USD 36.7 billion. Excess capital remains strong at 3.1% or USD 8.9 billion, albeit slightly down compared to the fourth quarter 2019. Overall, UBS’s business model shields the group’s P&L from large loan loss provisions, and UBS delivered a strong performance in Q1 20. Capital ratios declined modestly due to higher RWAs as with other banks, but excess capital remains strong to protect bondholders.

Focus: Banco Santander 

Banco Santander reported sound results despite an 82% drop in net income to EUR 0.3 billion as the bank recognised an incremental EUR 1.6 billion in loan loss provisions for future credit losses due to the Covid-19 situation. Excluding these provisions, underlying performance of the bank was very strong, with underlying profits rising by 1% and return on tangible equity of 11.1%. Total loan loss provisions were EUR 3.9 billion for the quarter, of which EUR 1.6 billion is earmarked for the Covid-19 situation. Nevertheless, asset quality indicators remain solid, with NPLs on a continued downtrend to 3.25% and underlying cost of risk unchanged at 100 bps. Capital metrics remain strong, with the group’s CET1 ratio broadly unchanged at 11.6%. As regulatory requirements (MDA) declined by around 80 bps, the group’s MDA buffer increased from 190 bps to 270 bps or EUR 16 billion. Therefore, from a bondholder’s perspective, while earnings were impacted by provisions, the group’s balance sheet remains strong and excess capital to protect bondholders has improved, therefore reducing coupon risk. For further details on the Q1 20 results, please see our latest article on the current credit fundamentals of the financial sector.

GAM Star Credit Opportunities (GBP)

During the month of April, financial markets showed some positive momentum, as reflected by the beginning of a recovery in prices for the securities within our fund. This has been a positive reaction to the support showed by central banks, governments and regulators, all of which took extraordinary measures to support the economy throughout this period of uncertainty. It is also a reflection of the Q1 results published by some of the major banks which were overall positive from a credit perspective and shed some light on the uncertainty related to the economic ramifications of the Covid-19 outbreak. The credit quality of our issuers continues to be strong, as reflected by the average rating of BBB at the issuer level. Financials remains one of the strongest sectors within credit markets, and, in our view, they are able to pursue their role of lending to the real economy and being part of the solution (compared to being part of the problem during the global financial crisis). As we progress through banks’ first quarter earnings, we are starting to see the impact of Covid-19 on results. As expected, Covid-19 had a significant impact, reflected by a surge in loan loss provisions as banks brace for a sharp deterioration in the macro environment. Nevertheless, we maintain the view that this remains an equity story and not a balance sheet story – demonstrated by lower profitability and suspended dividends while banks’ excess capital positions remain very strong. Pre-provision profits, we believe the first line of defense against credit losses, are currently sufficient to absorb the Covid-19 effects. Excess capital positions remain very strong, bondholders are very well protected, and in particular we see coupon risk as broadly unchanged given very large buffers. For further details on the Q1 20 results from some of the major issuers we hold in the funds please refer to the following Spotlight.Despite the partial recovery, we feel current valuations remain attractive, as we are able to capture spreads of more than 700 bps. On top of that, 90% of the subordinated debt of financials is still trading to perpetuity – with a large upside for bondholders on a re-pricing to call. Moreover, the fund is capturing high and predictable income.

Spotlight: Q1 2020 banks earnings, good for our banks so far.

Focus: HSBC

HSBC’s results were sound for the first quarter of 2020, despite a surge in loan loss provisions. From an earnings perspective, pre-tax profits were down 48% year-on-year to USD 3.2 billion, equivalent to approximately 4% RoTE, which was mainly driven by loan loss provisions rising by USD 2.5 billion to USD 3 billion, or a 5x increase. Nevertheless, the group remained profitable in a challenging environment, and more positively showed its ability to absorb significantly higher loan loss provisions of USD 6 billion, or twice those of Q1 20. Management has commented that loan loss provisions are expected to be USD 7-11 billion for 2020, therefore Q1 20 provisions are 30-45% of the total expected for the year, reflecting conservative provisioning assumptions. Moreover, USD 7-11 billion compares to USD 22-23 billion of annual pre-provision profits, a very strong buffer to absorb losses. From a bondholders’ perspective, total CET1 capital was up USD 1 billion to USD 125 billion on the quarter, although the group’s CET1 ratio was down 10 bps at 14.6% due to higher risk-weighted assets (RWAs) as corporates drew on their credit lines and the group continues to support its customers during this time of uncertainty. Given the reduced capital requirements, the group’s MDA buffer increased to USD 32 billion from USD 29 billion in Q4 19 – therefore, bondholders benefit from higher excess capital. Overall, the group’s results have shown the ability to absorb losses from pre-provision profits while capital remains rock solid and excess capital is increased on Q1 20.

Focus: Barclays

Barclays reported strong results for Q1 20, benefiting from very strong tailwinds in its corporate & investment bank (CIB) that partly offset higher provisions due to deteriorating macro conditions. While the group’s headline RoTE of 5% and net income decline of 42% year-on-year is weak on the face on it, this includes a whopping GBP 2.1 billion in loan loss provisions (equivalent to 2.2% of outstanding loans). Interestingly, the group discloses its assumptions underlying the GBP 2.1 billion loan loss provisions that reflect a deep recession followed by a recovery in 2021. For example, the group assumes a decline in UK GDP growth of 51.5% at the worst point with a rise in UK unemployment from 1.1% to 8%. Similarly, the group expects US GDP to fall by 45% at the worst point and unemployment to rise from 3.8% to 17%. This reflects the very conservative stance towards loan loss provisions, and positives from a bondholders’ perspective are likely to cover more than future actual credit losses. The group’s capital metrics remain strong, although CET1 ratio is down 70 bps to 13.1% as RWAs grew by 10% on the quarter (due to higher loans as corporate clients drew on credit lines and the group supported its customers through this period of uncertainty), offsetting CET1 capital growth of GBP 1.7 billion to GBP 42.5 billion. The group’s buffer to maximum distributable amount (MDA) grew by 30bps QoQ to 160 bps as requirements fell by 100 bps, equivalent to GBP 5 billion of excess capital. Overall, the group’s underlying performance has been very strong due to tailwinds in CIB operations, and frontloading of loan loss provisions is credit positive. Capital positions remain strong with a sound MDA buffer, credit positive.

Focus: UBS

UBS reported strong results, delivering a 13% return on tangible equity and 30% rise in pre-tax profits. The group benefitted from strong performance in its investment banking division (mainly sales & trading), while wealth and asset management continued to perform strongly. While the group’s loan loss provisions were up 13 times compared to the first quarter of 2019, at USD 268 million these remain modest compared to the group’s approximate USD 2.3 billion of pre-provision profits. This reflects the group’s very limited lending risk, mostly focused on low-LTV domestic mortgages and secured lending to wealth management customers, and therefore the group should bear limited impact from the Covid-19 situation compared to international peers. Due to market volatility and increased activity, the group’s CET1 ratio was down 90 bps on the quarter to 12.8% despite a USD 1.1 billion increase in CET1 capital to USD 36.7 billion. Excess capital remains strong at 3.1% or USD 8.9 billion, albeit slightly down compared to the fourth quarter 2019. Overall, UBS’s business model shields the group’s P&L from large loan loss provisions, and UBS delivered a strong performance in Q1 20. Capital ratios declined modestly due to higher RWAs as with other banks, but excess capital remains strong to protect bondholders.

Focus: Banco Santander

Banco Santander reported sound results despite an 82% drop in net income to EUR 0.3 billion as the bank recognised an incremental EUR 1.6 billion in loan loss provisions for future credit losses due to the Covid-19 situation. Excluding these provisions, underlying performance of the bank was strong, with underlying profits rising by 1% and return on tangible equity of 11.1%. Total loan loss provisions were EUR 3.9 billion for the quarter, of which EUR 1.6 billion is earmarked for the Covid-19 situation. Nevertheless, asset quality indicators remain solid, with NPLs on a continued downtrend to 3.25% and underlying cost of risk unchanged at 100 bps. Capital metrics remain strong, with the group’s CET1 ratio broadly unchanged at 11.6%. As regulatory requirements (MDA) declined by around 80 bps, the group’s MDA buffer increased from 190 bps to 270 bps or EUR 16 billion. Therefore, from a bondholder’s perspective, while earnings were impacted by provisions, the group’s balance sheet remains strong and excess capital to protect bondholders has improved, therefore reducing coupon risk.

For further details on the Q1 20 results, please see our latest article on the current credit fundamentals of the financial sector.

GAM Star Credit Opportunities (USD)

During the month of April, financial markets showed some positive momentum, as reflected by the beginning of a recovery in prices for the securities within our fund. This has been a positive reaction to the support showed by central banks, governments and regulators, all of which took extraordinary measures to support the economy throughout this period of uncertainty. It is also a reflection of the Q1 results published by some of the major banks, which were overall positive from a credit perspective and shed some light on the uncertainty related to the economic ramifications of the Covid-19 outbreak. The credit quality of our issuers continues to be strong, as reflected by the average rating of BBB+ at the issuer level. Financials remain one of the strongest sectors within credit markets, and, in our view, are able to pursue their role of lending to the real economy and being part of the solution (compared to being part of the problem during the global financial crisis). As we progress through banks’ first quarter earnings, we are starting to see the impact of Covid-19 on results. As expected, Covid-19 had a significant impact, reflected by a surge in loan loss provisions as banks brace for a sharp deterioration in the macro environment. Nevertheless, we maintain the view that this remains an equity story and not a balance sheet story – demonstrated by lower profitability and suspended dividends, while banks’ excess capital positions remain very strong. Pre-provision profits, we believe the first line of defense against credit losses are currently sufficient to absorb the Covid-19 effects. Excess capital positions remain strong, bondholders are very well protected, and in particular we see coupon risk as broadly unchanged given very large buffers. For further details on the Q1 20 results from some of the major issuers we hold in the funds, please refer to the following SpotlightDespite the partial recovery, we feel current valuations remain attractive as we are able to capture spreads of more than 550 bps. On top of that, 90% of the subordinated debt of financials is still trading to perpetuity – with a large upside for bondholders on a re-pricing to call. Moreover, the fund is capturing high and predictable income.

Spotlight: Q1 2020 banks earnings, good for our banks so far.

Focus: HSBC

HSBC’s results were sound for the first quarter of 2020, despite a surge in loan loss provisions. From an earnings perspective, pre-tax profits were down 48% year-on-year to USD 3.2 billion, equivalent to approximately 4% RoTE, which was mainly driven by loan loss provisions rising by USD 2.5 billion to USD 3 billion, or a 5x increase. Nevertheless, the group remained profitable in a challenging environment, and more positively showed its ability to absorb significantly higher loan loss provisions of USD 6 billion, or twice those of Q1 20. Management has commented that loan loss provisions are expected to be USD 7-11 billion for 2020, therefore Q1 20 provisions are 30-45% of the total expected for the year, reflecting conservative provisioning assumptions. Moreover, USD 7-11 billion compares to USD 22-23 billion of annual pre-provision profits, a very strong buffer to absorb losses. From a bondholders’ perspective, total CET1 capital was up USD 1 billion to USD 125 billion on the quarter, although the group’s CET1 ratio was down 10 bps at 14.6% due to higher risk-weighted assets (RWAs) as corporates drew on their credit lines and the group continues to support its customers during this time of uncertainty. Given the reduced capital requirements, the group’s MDA buffer increased to USD 32 billion from USD 29 billion in Q4 19 – therefore, bondholders benefit from higher excess capital. Overall, the group’s results have shown the ability to absorb losses from pre-provision profits while capital remains rock solid and excess capital is increased on Q1 20.

Focus: Barclays

Barclays reported strong results for Q1 20, benefiting from very strong tailwinds in its corporate & investment bank (CIB) that partly offset higher provisions due to deteriorating macro conditions. While the group’s headline RoTE of 5% and net income decline of 42% year-on-year is weak on the face on it, this includes a whopping GBP 2.1 billion in loan loss provisions (equivalent to 2.2% of outstanding loans). Interestingly, the group discloses its assumptions underlying the GBP 2.1 billion loan loss provisions that reflect a deep recession followed by a recovery in 2021. For example, the group assumes a decline in UK GDP growth of 51.5% at the worst point with a rise in UK unemployment from 1.1% to 8%. Similarly, the group expects US GDP to fall by 45% at the worst point and unemployment to rise from 3.8% to 17%. This reflects the very conservative stance towards loan loss provisions, and positives from a bondholders’ perspective are likely to cover more than future actual credit losses. The group’s capital metrics remain strong, although CET1 ratio is down 70 bps to 13.1% as RWAs grew by 10% on the quarter (due to higher loans as corporate clients drew on credit lines and the group supported its customers through this period of uncertainty), offsetting CET1 capital growth of GBP 1.7 billion to GBP 42.5 billion. The group’s buffer to MDA grew by 30bps QoQ to 160 bps as requirements fell by 100 bps, equivalent to GBP 5 billion of excess capital. Overall, the group’s underlying performance has been very strong due to tailwinds in CIB operations, and frontloading of loan loss provisions is credit positive. Capital positions remain strong with a sound maximum distributable amount (MDA) buffer, credit positive.

Focus: UBS

UBS reported strong results, delivering a 13% return on tangible equity and 30% rise in pre-tax profits. The group benefitted from strong performance in its investment banking division (mainly sales & trading), while wealth and asset management continued to perform strongly. While the group’s loan loss provisions were up 13 times compared to the first quarter of 2019, at USD 268 million these remain modest compared to the group’s approximate USD 2.3 billion of pre-provision profits. This reflects the group’s very limited lending risk, mostly focused on low-LTV domestic mortgages and secured lending to wealth management customers, and therefore the group should bear limited impact from the Covid-19 situation compared to international peers. Due to market volatility and increased activity, the group’s CET1 ratio was down 90 bps on the quarter to 12.8% despite a USD 1.1 billion increase in CET1 capital to USD 36.7 billion. Excess capital remains strong at 3.1% or USD 8.9 billion, albeit slightly down compared to the fourth quarter 2019. Overall, UBS’s business model shields the group’s P&L from large loan loss provisions, and UBS delivered a strong performance in Q1 20. Capital ratios declined modestly due to higher RWAs as with other banks, but excess capital remains strong to protect bondholders.

Focus: Banco Santander

Banco Santander reported sound results despite an 82% drop in net income to EUR 0.3 billion as the bank recognised an incremental EUR 1.6 billion in loan loss provisions for future credit losses due to the Covid-19 situation. Excluding these provisions, underlying performance of the bank was strong, with underlying profits rising by 1% and return on tangible equity of 11.1%. Total loan loss provisions were EUR 3.9 billion for the quarter, of which EUR 1.6 billion is earmarked for the Covid-19 situation. Nevertheless, asset quality indicators remain solid, with NPLs on a continued downtrend to 3.25% and underlying cost of risk unchanged at 100 bps. Capital metrics remain strong, with the group’s CET1 ratio broadly unchanged at 11.6%. As regulatory requirements (MDA) declined by around 80 bps, the group’s MDA buffer increased from 190 bps to 270 bps or EUR 16 billion. Therefore, from a bondholder’s perspective, while earnings were impacted by provisions, the group’s balance sheet remains strong and excess capital to protect bondholders has improved, therefore reducing coupon risk.For further details on the Q1 20 results, please see our latest article on the current credit fundamentals of the financial sector.

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