Monthly Commentary June

The month of June started strongly as there was positive news on the macroeconomic front, combined with central bank easing and the continued reopening of economies. This led to a large amount of new issues within the fixed income universe, as well as within subordinated debt of financials. Most of the new issues came at attractive levels. However, the amount of new supply combined with less positive news on Covid-19 meant our securities ended the month mixed. Given the blackout period, in terms of new issues, prior to Q2 results, as well as attractive spreads, we believe this should be supportive for valuations. Supervisors still believe banks should be able to withstand the Covid-19 shock through pre-provisioned income, as banks should generate enough income to cover future expected credit losses, as well as the excess capital they have built up. This is in line with our view that the Covid-19 crisis remains an equity story for European financials, and not a balance sheet story.We 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 extremely attractive 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.

Spotlight: Legacy bonds – recovery dispersions and price dislocations provide opportunities.

Since mid / end March, price recovery in the subordinated financials debt market has been strong, with AT1 CoCos recovering around 75-80% of the drawdown. With significant extension risk currently priced in (circa 65% of the market is priced to maturity) and attractive spreads of around 500 bps we remain positive on the asset class.

Despite the strong recovery seen in AT1 CoCos, for example, dispersion within subordinated financial remains elevated. One area in particular that has lagged is legacy bonds (old-style capital securities issued by banks and insurance companies pre-Basel III and pre-Solvency II), where for example discounted perpetual floating rate notes (FRNs) have only recovered around 40% of the drawdown. This has been due to a significant re-pricing to maturity as well as focus of the investor base on new-style AT1 CoCos, an asset class that is now very well understood.We see significant value in the legacy bond space, as these old bonds need to be taken out by issuers by December 2021 (banks) and December 2025 (insurers) given the loss of regulatory value at the end of the grandfathering period. In particular, we see value in legacy bonds trading at a discount with upside to a par call or tender, or instruments trading above par with special redemption features or tender potential (and without the downside risk of par calls). For example:

• Commerzbank 8.151% 2031 (callable in 2029) in USD currently trade at 136% or 3.4% yield to maturity (260 bps spread). The issuer has the option to redeem the bonds from December 2021 at a special price called the “make whole” price, currently equivalent to circa 150% and therefore the yield to call in January 2022 is attractive at 13.7%.

• RBS legacy perpetual FRNs (floating coupon of Libor +232 bps) in USD currently trade well below par at 92%. RBS can redeem those at par from December 2021 at which point the bonds will no longer count as capital. This is equivalent to an 8% yield to call (or circa 800 bps of spread).

The key catalysts for repricing are time and continued re-pricing of AT1 CoCos. Time is a positive tailwind for the asset class, as issuers will need to optimise their capital structures until the end of the grandfathering period. For banks this is broadly only 18 months away and therefore we expect continued takeouts in the near term, while we would also expect to see some opportunistic action from insurers despite more time until the end of the grandfathering period in December 2025. Secondly, as AT1 CoCos spreads continue to tighten, we expect interest in legacy bonds to increase given very attractive valuations and dislocations.Overall, we see legacy bonds as one of the most attractive segments of the subordinated financials asset class, where price recovery has lagged AT1 CoCos. The investment case remains very strong with attractive valuations and free optionality upon a takeout.For further details on legacy bonds, please contact your client relationship manager at GAM to read our note published in June.

GAM Star Credit Opportunities (GBP)

The month of June started strongly as there was positive news on the macroeconomic front, combined with central bank easing and the continued reopening of economies. This led to a large amount of new issues within the fixed income universe, as well as within subordinated of financials. Most of the new issues came at attractive levels. However, the amount of new supply combined with less positive news on Covid-19 meant our securities ended the month mixed. Given the blackout period, in terms of new issues, prior to Q2 results, as well as attractive spreads, we believe this should be supportive for valuations. Supervisors still believe banks should be able to withstand the shock through pre-provisioned income, as banks should generate enough income to cover future expected credit losses, as well as the excess capital they have built up. This is in line with our view that the Covid-19 crisis remains an equity story for European financials, and not a balance sheet story.We 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 extremely attractive as we are able to capture spreads of more than 600 bps. On top of that, a large number of the subordinated debt 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.

The month of June started strongly as there was positive news on the macroeconomic front, combined with central bank easing and the continued reopening of economies. This led to a large amount of new issues within the fixed income universe, as well as within subordinated of financials. Most of the new issues came at attractive levels. However, the amount of new supply combined with less positive news on Covid-19 meant our securities ended the month mixed. Given the blackout period, in terms of new issues, prior to Q2 results, as well as attractive spreads, , we believe this should be supportive for valuations. Supervisors still believe banks should be able to withstand the shock through pre-provisioned income, as banks should generate enough income to cover future expected credit losses, as well as the excess capital they have built up. This is in line with our view that the Covid-19 crisis remains an equity story for European financials, and not a balance sheet story.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 extremely attractive as we are able to capture spreads of more than 500 bps. On top of that, a large number of the subordinated debt 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.