Update on the subordinated debt market: overview of events since Santander episode
We maintain our positive view of the asset class, despite tighter valuations, and we pay particular attention to the surge in geopolitical risks – i.e. US-China, US/UK-Iran, Brexit – which have been the main volatility drivers over the past several months.
The main central banks’ stance has eased over recent months, with the Fed cutting its key rate – or Fed Funds – in early August 2019, while the European Central Bank seems to be ready to do anything it takes to shore up economic activity in the event of a slowdown, particularly with the latest round of measures announced.
However, the current low interest rate environment carries its fair share of risks for the banking sector, and the main question in the sector for the years ahead is set to be banks’ profitability. Against this backdrop, the portfolio management team will focus on issuers that can find ways to tackle this situation by developing diversifying businesses for example, or taking consolidation measures or even adopting digital transformation and/or cost-cutting policies.
In our view, the asset class still offers an attractive risk premium i.e. subordination, liquidity, extension – and this is particularly true of Coco AT1 bonds – if we take positions on financial and non-financial issuers with solid fundamentals and an investment grade credit rating.
In light of yields on the euro fixed-income market, subordinated debt can help investors in their search for yield, while enabling them to continue targeting investment grade issuers.