Macro Backdrop
EUR investment grade (IG) spreads ended the month 2 basis points (bps) tighter at 77 bps, after an initial widening, with spreads now only 4 bps away from the post-global financial crisis (GFC) lows seen in 2018. Spreads widened by circa 6 bps in the first half of the month, as renewed trade tensions between the US and China, the US government shutdown and worries around the US regional banking sectors weighed on risk assets. As trade headlines turned positive, markets quickly turned stronger, also supported by strong Q3 earnings (alleviating concerns around US regional banks). French risk remained volatile, as budget discussions remain fragile and the sovereign rating was downgraded by S&P and put on negative outlook by Moody’s. However, OATs (French government bonds) rapidly stabilised at around circa 80 bps (10-year OAT spread to Bunds), after peaking at around 86 bps earlier in the month. On the rates side, we saw a material decline in rates, US 10-year Treasury and German 10-year Bund yields down 7 and 8 bps respectively on weaker macro, albeit the rates rally lost steam towards the end of the month after the Federal Reserve (Fed) delivered a hawkish message after cutting rates by 25 bps. EUR IG corporates total returns were up (0.70%) in October (as measured by the Bloomberg Euro Aggregate Corporate Total Returns Index in EUR), mainly driven by lower rates and slightly tighter spreads.pact of higher rates.
Performance
The fund’s NAV during the month (Institutional class, EUR) was up 0.67% during the month. In October, financials slightly underperformed nonfinancials (1 bp tighter versus 2 bps tighter). Across the capital structure, bank senior bonds (2 bps tighter) outperformed Bank Tier 2 capital bonds (Tier 2s) (1 bp tighter) and insurance Tier 2s (2 bps wider). EUR Additional Tier 1 (AT1) contingent convertible bonds (CoCos) were 4 bps wider on the month.
Top performers were mainly longer-dated bonds (senior and Tier 2s) that benefitted more from the decline in rates. Bottom detractors were mainly shorter-dated bank seniors and Tier 2s that benefitted less from lower rates.
Positionning
Issuance of green bonds from the European financial sector was strong in October, with USD 5.5 billion printed – +19% year-over-year (YoY), well above the USD 2.8 billion average for the same month across 2022 to 2024. Year-to-date (YTD) issuance is up 30% YoY to USD 48 billion, on track for a record year of supply. The key focus in October was Q3 earnings. The majority of European banks have reported Q3 earnings – another very strong quarter where the majority came above consensus estimates, while capital and asset quality remained rock-solid. As an example, NatWest reported a net profit of GBP 1.6 billion in Q3, a circa 25% beat to consensus. The bank delivered a very strong 22.3% RoTE (return on tangible equity) in Q3, while raising its guidance for the full-year 2025 to a >18% RoTE (versus >16.5% previously). The bank’s CET1 (Common Equity Tier 1) ratio was up 60 bps on the quarter to 14.2%, with excess capital of >7 billion above requirements. Asset quality remains very strong, 1.3% NPL (nonperforming loans) ratio and low levels of loan loss provisions in Q3 at just 0.15% of loans (annualised). Overall, another very supportive set of earnings from the sector. French political risk remained in focus, as France’s sovereign rating was downgraded by S&P (no impact on bank ratings) and put on negative outlook by Moody’s, reflecting the high budget deficit. Moreover, the government is working on two news taxes on banks (on super-dividends and share buybacks) that weighed on French bank shares. The reaction on the credit side was fairly muted, no material underperformance. The only notable underperformed was BNP Paribus, as a US jury delivered a relatively high award to plaintiffs in a legacy litigation case related to Sudan.
The market quickly extrapolated the amount to a potential large class action lawsuit, and this led to a sharp decline in the share price as estimates of a potential settlement were as high as circa USD 10 billion. BNP has issued several statements on this case, where they think there is a strong case for an appeal and that they will win the case. From credit perspective, even a circa USD 10 billion settlement would be manageable in an absolute worst case, representing only half of annual pre-tax profits. The fund’s exposure is limited to senior bonds, the majority of which are short-dated. The US regional banking sector was under pressure over the past few days as two US banks announced provisions against specific loans backed by commercial real estate. Similar to recent issues with banks exposed to First Brands and Tricolor – the losses were related to collateral issues (either pledged twice or fraudulent). We see zero readacross for the European banking sector, and at this stage there does not seem to be a widespread wave of corporate defaults, but rather several cases that reflect weak risk management at certain institutions. European banks are highly profitable, very well capitalised, and focused on low-risk lending (such as prime mortgages). Hence even in a more stressed scenario, fundamentals would remain robust. The fund has no exposure to US banks.
Outlook
We remain positive going forward – with attractive spreads against a backdrop of very strong credit quality. We continue to see financials as the most attractive part of the market, with rock-solid fundamentals and earnings that have benefitted from the normalisation of interest rates. With a yield (to next call) of around 3.2% and an average spread (G-spread) of circa 90 bps on the fund (compared to 3.0% and 75 bps for the broader EUR IG corporate market), we believe the fund offers an opportunity to capture high income. This comes further upside potential from spreads tightening, despite the fund’s high-quality bias (average bond rating of A- / average issuer rating of A+).
