September was a challenging month as the macro backdrop continues to be difficult, with notably concerns regarding inflation, the potential for a hard landing, the energy crisis and events in the UK following the appointment of the new prime minister. However, valuations have become attractive, in our view, as spreads have widened significantly year-to-date. This is despite the fact that credit fundamentals of financials remain strong, as asset quality is currently the strongest we have seen over the last 15 years and capital ratios remain high with common equity tier 1 (CET1) ratios of European banks still well above 15%, which is close to the all-time highs. For the insurance companies, especially life insurers, we have seen their capital ratios increase with the higher interest rates. Most
European insurances have more than two times the capital required. We believe financials will benefit within a context of higher interest rates. Moreover, as stated above, valuations are getting close to the wides of Covid, despite the strong credit fundamentals. On top of that, we are capturing significantly high income. As an example, BBVA 6.5% currently has a yield to next call in 2025 of 12.5%. The yield to worst is close to 10%. As we can see most of the subordinated debt is pricing extension risk (around 90%). As an example, additional tier 1 (AT1), restricted tier 1 (RT1) and corporate hybrids are perpetual bonds which have call dates and a strong track-record to be called at first call date. During positive market periods, we believe they should benefit going forward as valuations tighten and these sequentially will reprice to the next call date. During risk-off environments such as this year, callable perpetual bonds tend to reprice to maturity, creating a double-negative effect on prices. However, the opposite is true too, ie when markets begin to normalise, spreads of those bonds start to tighten, leading to a re-pricing to next-call date and sequentially creating a double-positive effect on prices. As the large majority of our bonds are pricing the extension risk, we believe they should benefit going forward as valuations tighten. In the meantime, we are getting considerably high income.