Performance of European financials’ green bonds was negatively impacted by rising rates over the month, with German 10-year bund yields rising by circa 10 bps, bringing the total rise to 40 bps since August. While the price move was mainly driven by rates, credit spreads also widened, albeit at more muted levels of around 3 bps for investment grade credit. The strong fundamentals of the financials sector, limited supply of new issuance and real yields in credit markets becoming more negative than ever helped keep a lid on spread widening despite interest rate volatility.
Across the capital structure, the theme was decompression, with high quality outperforming. Senior bonds outperformed subordinated debt (Tier 2 and AT1) given the slightly risk-off environment. Nevertheless, market moves remained limited with spreads widening by circa 10 bps or less across subordinated debt.
Issuance was muted over the month, with most issuers in a blackout period ahead of earnings, with only a handful of deals in the European financials space. Earnings were in focus during October as most European banks reported Q3 earnings. We saw continued strong earnings – with most banks beating expectations. Credit conditions continue to be benign, with continued reversals of loan loss provisions made for Covid-19 and non-performing loans remaining low. Capital positions remained strong at or near all-time highs, providing extremely large buffers to protect bondholders. Quarterly results were also a chance for issuers to update their sustainability strategies, for example NatWest pledging GBP 100 billion of climate and sustainable funding and financing by the end of 2025.
In October, we added one new position from La Banque Postale (LBP), a government-owned French retail bank, a green non-preferred senior issued in May, maturing in 2029. LBP became the first European bank with a 2040 Net Zero pathway recognised by the Science Based Targets initiative. This includes ambitious policies to restrict financing to coal and other fossil fuels. We did not participate in new issues during October due to either sustainability reasons (issuers and / or bonds not passing our internal assessment) or valuations not being attractive, or both.
At current spread levels we remain positive on markets and continue to see value in green bonds of banks and insurers. Beyond a supportive macro picture, we expect third quarter earnings to continue to showcase the strength of the banking and insurance sectors. Through green bonds (and other impact bonds) of financials we can achieve yields of around 1.2%, around three times above that of EUR-denominated corporate green bonds. We continue to favour high quality issuers (BBB+ average bond rating).