Monthly Commentary February

by | Mar 9, 2021 | Commentaries

GAM Star Credit Opportunities (EUR)

The end of February was all about rising interest rates and the impact on financial markets. This has not been a significant concern for our fund, as it is positioned to have low sensitivity to interest rates, notably through the exposure to fixed-to-floater and floater securities. Moreover, subordinated debt, especially subordinated debt issued by the financial sector, tends to benefit from a rising rate environment. This is because the profitability of financials increases with interest rates, and therefore this should lead to tighter spreads for our securities. We also believe, that despite the moves we have witnessed, central banks will remain accommodative. Furthermore we have seen slightly more positive news surrounding Covid-19 and the reopening of European countries. At the same time, we are capturing spreads of circa 400 bps within the subordinated debt of financials. Valuations on these securities are still 140 bps wider than pre-Covid-19. Following the release of the bulk of Q4 earnings, financials overall have been resilient and exceeded expectations in this regard. We have seen a gradual path to normalisation, with less provisioning for expected credit losses. Additionally, capital remains a bright spot, with the average common equity tier one (CET1) ratio increasing to 14.2% from 13.4% pre-Covid-19. We believe the financial sector should be able to remain resilient even in a prolonged Covid-19 scenario. Moreover, due to our exposure to fixed-to-floater and floater securities, we believe the fund is well positioned for a period of rising rates. Finally, subordinated debt of financials remains one of the rare areas where valuations are significantly wider than pre-Covid-19.

GAM Star Credit Opportunities (GBP)

The end of February was all about rising interest rates and the impact on financial markets. This has not been a significant concern for our fund, as it is positioned to have low sensitivity to interest rates, notably through the exposure to fixed-to-floater and floater securities. Moreover, subordinated debt, especially subordinated debt issued by the financial sector, tends to benefit from a rising rate environment. This is because the profitability of financials increases with interest rates, and therefore this should lead to tighter spreads for our securities. We also believe, that despite the moves we have witnessed, central banks will remain accommodative. Furthermore we have seen slightly more positive news surrounding Covid-19 and the reopening of European countries. At the same time, we are capturing spreads of circa 400 bps within the subordinated debt of financials. Valuations on these securities are still significantly wider than pre-Covid-19. Following the release of the bulk of Q4 earnings, financials overall have been resilient and exceeded expectations in this regard. We have seen a gradual path to normalisation, with less provisioning for expected credit losses. Additionally, capital remains a bright spot, with the average common equity tier one (CET1) ratio increasing to 14.2% from 13.4% pre-Covid-19. We believe the financial sector should be able to remain resilient even in a prolonged Covid-19 scenario. Moreover, due to our exposure to fixed-to-floater and floater securities, we believe the fund is well positioned for a period of rising rates. Finally, subordinated debt of financials remains one of the rare areas where valuations are significantly wider than pre-Covid-19.

GAM Star Credit Opportunities (USD)

The end of February was all about rising interest rates and the impact on financial markets. This has not been a significant concern for our fund, as it is positioned to have low sensitivity to interest rates, notably through the exposure to fixed-to-floater and floater securities. Moreover, subordinated debt, especially subordinated debt issued by the financial sector, tends to benefit from a rising rate environment. This is because the profitability of financials increases with interest rates, and therefore this should lead to tighter spreads for our securities. We also believe, that despite the moves we have witnessed, central banks will remain accommodative. Furthermore we have seen slightly more positive news surrounding Covid-19 and the reopening of European countries. At the same time, we are capturing spreads of circa 330 bps within the subordinated debt of financials. Valuations on these securities are still significantly wider than pre-Covid-19. Following the release of the bulk of Q4 earnings, financials overall have been resilient and exceeded expectations in this regard. We have seen a gradual path to normalisation, with less provisioning for expected credit losses. Additionally, capital remains a bright spot, with the average common equity tier one (CET1) ratio increasing to 14.2% from 13.4% pre-Covid-19. We believe the financial sector should be able to remain resilient even in a prolonged Covid-19 scenario. Moreover, due to our exposure to fixed-to-floater and floater securities, we believe the fund is well positioned for a period of rising rates. Finally, subordinated debt of financials remains one of the rare areas where valuations are significantly wider than pre-Covid-19.

Spotlight: European bank earnings Q4 2020 – The slow path to normalisation

While earnings have been under pressure, as expected, bank solvency has exceeded estimates and European Central Bank (ECB) projections, with capital ratios ending the year higher. This is supportive for bondholders. Moreover, while 2020 proved to be a real-life stress test, the banking sector has been resilient beyond expectations. As such, February’s full year 2020 earnings season has confirmed that from a credit standpoint, everything is on-track. Finally, we note that Q4 2020 marked a gradual path back to normalisation with lower credit losses and shareholder pay-outs being put back on the table.

Key takeaways:

  1. Solvency continues to be the bright spot of bank earnings with capital positions having consistently improved from Q1 2020 showing that bank resilience has clearly been above expectations. The average CET1 ratio increased to 14.2% from 13.4% pre-Covid-19. 
  2. Asset quality remained robust in Q4 2020 with credit losses now trending back to pre-Covid-19 levels with a cost of risk of just under 60 bps, which is less than half of peak levels in Q1 / Q2 of around 120 bps of loans.
  3. Outlook for profitability remains challenging in the short term, which is mostly an equity story. However, the key takeaway from a bondholder’s perspective is that banks have demonstrated their ability to remain profitable despite a real-life stress test scenario in 2020.

Implications for the fund: We maintain our positive stance on the banking sector underpinned by robust solvency and the ability to absorb Covid-19 related uncertainty. We believe investors will continue to focus on asset quality this year, closely monitoring non-performing loan formations as well as confirmations of a normalisation of loan loss provisions. Stress tests will also be a key element of the calendar, with the European Banking Authority (EBA) expected to provide granularity on the resilience of individual banks in July. Given residual uncertainty, we believe it is appropriate to focus on banks with capacity to absorb a prolonged Covid-19 scenario without jeopardising credit fundamentals. For this reason, we remain focused on the top European banks, either global systemically important banks (G-SIBs) or national champions.

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