GAM Star Credit Opportunities (EUR)

The month of July was relatively strong, and this culminated with the news of an agreement of a European Recovery Fund between EU members. The continuation of the strong fiscal support combined with central bank easing should be very supportive for the valuation of our securities. Q2 earnings season has begun and for the moment results have been strong from a credit perspective. Despite loan loss provisions linked to Covid increasing significantly, most of the banks have reported higher capital ratios, as profits before provisions remain elevated. Combined with regulatory relief measures, it means that banks’ capital cushions have increased in Q2, which is a positive for bondholders. This is in line with our position that banks should be able to withstand the shock through pre-provisioned income, as banks should generate enough income and have built up enough excess capital to cover future expected credit losses. Reflecting our view, the European Central Bank (ECB) published the results of a stress test, titled COVID-19 Vulnerability Analysis, on 28 July, stating that the European banking sector is sufficiently well capitalised to withstand the current shock and its consequences. We do expect prices to continue to recover in the next six to nine months as the uncertainty raised by the Covid-19 outbreak slowly fades away.Despite the partial recovery, we feel current valuations remain positive as we are able to capture spreads of more than 550 bps. On top of that, a large number of the subordinated debt issues of financials are 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.

GAM Star Credit Opportunities (GBP)

The month of July was relatively strong, and this culminated with the news of an agreement of a European Recovery Fund between EU members. The continuation of the strong fiscal support combined with central bank easing should be very supportive for the valuation of our securities. Q2 earnings season has begun and for the moment results have been strong from a credit perspective. Despite loan loss provisions linked to Covid increasing significantly, most of the banks have reported higher capital ratios, as profits before provisions remain elevated. Combined with regulatory relief measures, it means that banks’ capital cushions have increased in Q2, which is a positive for bondholders. This is in line with our position that banks should be able to withstand the shock through pre-provisioned income, as banks should generate enough income and have built up enough excess capital to cover future expected credit losses. Reflecting our view, the European Central Bank (ECB) published the results of a stress test, titled COVID-19 Vulnerability Analysis, on 28 July, stating that the European banking sector is sufficiently well capitalised to withstand the current shock and its consequences. We do expect prices to continue to recover in the next six to nine months as the uncertainty raised by the Covid-19 outbreak slowly fades away.Despite the partial recovery, we feel current valuations remain positive as we are able to capture spreads of more than 600 bps. On top of that, a large number of the subordinated debt issues of financials are 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.

GAM Star Credit Opportunities (USD)

The month of July was relatively strong, and this culminated with the news of an agreement of a European Recovery Fund between EU members. The continuation of the strong fiscal support combined with central bank easing should be very supportive for the valuation of our securities. Q2 earnings season has begun and for the moment results have been strong from a credit perspective. Despite loan loss provisions linked to Covid increasing significantly, most of the banks have reported higher capital ratios, as profits before provisions remain elevated. Combined with regulatory relief measures, it means that banks’ capital cushions have increased in Q2, which is a positive for bondholders. This is in line with our position that banks should be able to withstand the shock through pre-provisioned income, as banks should generate enough income and have built up enough excess capital to cover future expected credit losses. Reflecting our view, the European Central Bank (ECB) published the results of a stress test, titled COVID-19 Vulnerability Analysis, on 28 July, stating that the European banking sector is sufficiently well capitalised to withstand the current shock and its consequences. We do expect prices to continue to recover in the next six to nine months as the uncertainty raised by the Covid-19 outbreak slowly fades away.Despite the partial recovery, we feel current valuations remain positive as we are able to capture spreads of more than 450 bps. On top of that, a large number of the subordinated debt issues of financials are 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: ECB announces dividend suspension until January 2021; banks have the capacity to absorb Covid-19 shock

The ECB announced an extension of its recommendation for European banks to suspend any shareholder pay-outs (dividends, share buy-backs) until January 2021 at the earliest. This is in line with our expectations and follows similar comments and recommendations from Christine Lagarde, chair of the European Systemic Risk Board (ESRB) and president of the ECB. The ECB aims to ensure that banks conserve capital to safeguard the resilience of the financial system, as well as ensuring that banks continue to lend and support the real economy.In parallel, the ECB conducted a vulnerability analysis of the banking sector in light of Covid-19 related uncertainty. The conclusion is that under the ECB’s base case economic scenario (the one they see most likely to materialise), banks’ CET1 ratios would decline by 190 bps to 12.6% and remain well above regulatory requirements. This assumes an 8.7% decline in eurozone GDP in 2020, with only a modest recovery in 2021 and 2022 (+5.2 and 3.3% GDP growth respectively). We see this as a very bullish signal by the ECB, and it reflects the banks’ ability to absorb the Covid-19 shock while maintaining solid capital buffers.

High Income Credit: European Bank At1s – A Relative Safe Haven

Valuations are attractive on both AT1 CoCos and global high yield (HY), with spreads of 550 bps and 600 bps, respectively. Nevertheless, we view AT1s as very well positioned to outperform in the coming years, underpinned by resilient credit quality in an uncertain environment and remote default risk in a context of rising defaults. There is an opportunity to capture attractive spreads of around 550 bps, around 400 bps of pick-up compared to global investment grade corporate bonds. Meanwhile, extension risk is a positive tailwind, and we believe investors would strongly benefit from a re-pricing to call of the market. AT1 CoCos and global HY have performed broadly in-line YTD, with total returns still slightly negative (-3.1 and -2.6% respectively).

Despite significant drawdowns due to Covid-19 related uncertainty, both asset classes have recovered around 80% of the drawdown. Prices have significantly recovered as a result of unprecedented global coordinated fiscal and monetary easing, as well as positive economic momentum driven by gradual easing of lockdown measures in most developed economies.While performance is broadly in-line on a YTD basis, AT1 CoCos have significantly outperformed global HY over the past five years (total returns of 44% versus 29% respectively). While we see value for high income investors in both asset classes, we continue to see European bank AT1 CoCos as extremely well positioned to continue outperforming over the next five years. Our view is driven by resilient fundamentals in the face of Covid-19 uncertainty, supportive technicals and attractive valuations.

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