Sentiment was somewhat weaker in August, with spreads on EUR investment grade (IG) corporates 8 bps wider on the month to 155 bps. Rates volatility weighed on IG spreads, as the 10-year German bund yield peaked at 2.71% in mid-August and then ended the month lower at 2.47%. Inflation and central banks remain in focus – as inflation continues to slow but remains too high for central banks.
EUR IG corporate total returns were positive on the month (0.16%) mainly driven by income, while the decline in rates was more than offset by the move higher in spreads.
The fund’s NAV(Z class, EUR) was up 0.2% during the month. Performance has mainly been driven by income, while the decline in rates offset some of the negative impact from wider spreads. Top performers over the month were mainly shorter dated bonds that outperformed and subordinated insurance bonds, while bottom performers were mainly Additional Tier 1 (AT1) contingent convertibles (CoCos) and longer dated senior bonds.
Issuance was very light in August, with EUR 1 billion of green bonds issued from the European financial sector, a large decline year-on-year (circa EUR 7 billion issued in August 2022).
Earnings remained in focus in August, with the vast majority of banks and insurers now having reported second quarter earnings. As expected these have been strong, reflecting the tailwind from higher rates in terms of earnings and the fortress balance sheets of the banking sector. As an example, ING reported a 17.5% return on equity in Q2 2023, supported by strong growth in net interest income as the bank continues to benefit from higher rates. Capital remained strong as the bank’s Common Equity Tier 1 (CET1) ratio increased by 50 bps quarter-on-quarter to 14.9%, comfortably above the 10.7% requirement (circa EUR 14 billion excess capital), and there were no signs of a deterioration in asset quality as non-performing loans (NPLs) remained low at 1.4% and provisions for loan losses were very low at just 6 bps (annualised) of total loans. On the insurance side, earnings remain strong as well, with Munich Re reporting a 16.9% return on equity in the first half of the year, and a solvency II ratio up 13 percentage points half-on-half to 273%.
We remain positive going forward – given attractive spreads and catalysts on the horizon. We continue to see financials as the most attractive part of the market, with solid fundamentals and positive earnings momentum from higher rates. Beyond the catalyst from strong earnings, which we expect to continue, most issuers behave in a bondholder friendly way by calling bonds at their first call date. Even in the AT1 market, more than 90% of AT1s up for call this year have been called. This is a positive catalyst with upside as bonds re-price to call. With a yield (to next call) of around 5.6% and an average spread (G-spread) of circa 290 bps on the fund (compared to 4.3% / circa 155 bps for the EUR IG corporate market), we see this as an opportunity to capture high income with upside potential from tightening spreads. This is despite the high-quality bias of the fund (average bond rating of BBB+ / average issuer rating of A) and similar duration compared to EUR IG corporates (4.3 versus 4.4).
Green Project in focus
BNP Paribas SA
- Project type: renewable energy – interconnector
- Location: UK and Denmark
- Project owner: Viking Link (joint venture between National Grid and Energinet)
- Total financing amount: USD 743 million (BNP’s share not disclosed)
- The loan is structured as a green loan following the Green Loan Principles
- BNP acted as the structurer of the deal and took a part of the debt financing
- The interconnector (subsea electricity cable) will be close to 800km long and will allow electricity to be exchanged between the UK and Denmark, supplying renewable energy to 1.4 million households
- The project has been included on the EU’s list of projects of common interest, given the material contribution of the project to the transition to green energy
BNP’S sustainability strategy highlights
- It has a net zero commitment by 2050 including the group’s lending portfolio
- It takes a granular approach to the group’s net zero pathway, focusing on sectors with the most impact: BNP targets a better mix in its energy book compared to the International Energy Agency’s Sustainable Development Scenario (SDS) scenario (well below 2˚C pathway)
- BNP was part of the “Katowice banks” (BBVA, BNP, ING, Société Générale, Standard Chartered) that pledged to develop an opensource methodology to steer their portfolios to the Paris Agreement targets