As in January, February was a risk-off month. Initially, we saw some volatility linked to inflation, as well as central bank rhetoric regarding quantitative tightening and rising interest rates. On top of that, volatility continued to increase due to the Russia-Ukraine conflict which started at the end of the month. Credit markets and subordinated debt also saw spreads widening. For instance, spreads on additional tier 1 (AT1) contingent convertible bonds (CoCos) widened by more than 100 bps. It is important to note that the fund has no exposure to Russian, Belarussian or Ukrainian companies. Moreover, the indirect exposures of European financials to those countries is very low and does not constitute a credit issue. Most European banks had reduced their exposure to Russia following the 2014 sanctions. Most of their exposure is through equity participations. An example of indirect exposure is Société Générale’s exposure to Russia through their stake in Rosbank. A full write-down of its stake in Rosbank (Russian entity) would be worth only 50 bps of capital. Put in perspective, Société Générale has 470 bps of excess capital (approximately EUR 17 billion). Therefore, this is not having an impact from a credit perspective.
It is important to note that from a credit quality standpoint, financials remain in a very strong position. Asset quality is also at its strongest level. As such we believe the spread widening creates opportunities and seems to be overdone. With spreads of subordinated debt of financials above 400 bps, we believe valuations are at very attractive levels. On top of that, we are receiving very high income. Moreover, our strategy has low sensitivity to interest rates, as demonstrated in 2021, as well as during previous periods of rising interest rates.
We have been in earnings season and results have been very strong from a credit perspective, with credit quality and capital ratios remaining at very strong levels. A good demonstration of the strong capital ratios is Credit Agricole, which has more than EUR 50 billion of excess capital.
In conclusion, the recent market weakness creates attractive opportunities, as spreads have widened significantly despite credit fundamentals remaining at very strong levels.
