European Bank bonds – the last oasis of income in the credit market

 

 

 

2021 started in an unprecedented context of low rates across the globe making it difficult to find bonds offering a reasonable risk reward – by Antonio Roman and David Benamou

 
 
As central banks have increased their corporate bond buying programs during the pandemic, bonds have seen their valuations inflate and their dividends reduce towards or below 0%.

As bonds issued by financial institutions are in general excluded from Central bank bond buying programs, their valuations and yields have remained attractive in relative terms.

Corporate bonds with a BB+ rating currently offer c.2% income whereas a BB+ bank bond offers a far more attractive c.4%.

Bank bonds are in a way the last oasis of yield in the European credit market. Axiom European Financial Debt Fund (AXI LN), a specialist investment trust operating in this area offering 8% yield in GBP, is a sensible way to diversify an investment portfolio in the current market.

 

Bank bonds: what are the risks?

 

 

Post 2008, investing in banks is for many investors like walking on eggshells. The industry, heavily regulated, laden with mind-blowing acronyms and jargon remains difficult to access for many investors.

Companies like Axiom Alternative investments, operating in this area since 2009, have a whole product range dedicated to financials. The company has developed a rigorous investment process that covers everything from fundamentals down to the small print within the bond documentation.

Financial bonds bear three main risks that can be summarized in three simple questions: will the income be paid, will the financial institution be helped by the regulator in case of financial difficulty, will the bond be repaid on its maturity date?

Addressing these issues when investing in financial bonds is of utmost importance and requires a detailed analysis of the bond legal documentation, the issuer’s balance sheet and regulatory detail.               

Over the last 12 years Axiom has proven ability in navigating these risks.

 

Bank bonds: Are financial institutions safer than before?

 

 

Financial regulators have gone the extra mile in the last decade to ensure that banks, building societies and insurers have much larger capital reserves and can withstand any major losses that might emerge.

A perfect example of this is the current global pandemic. European banks entered this crisis with an average capital reserve ratio above 15%, more than twice the level than at the start of the 2008 financial crisis.

Tougher regulation makes financial institutions less profitable but more solvent and thus better able to pay back the capital and income on the bonds they have issued.

 

‘European banks, are very attractive in the current market context from a bond investor standpoint’

 

Hence, regulatory changes have made European banks look more attractive from a bond investor standpoint than from an equity investment standpoint.

Separately, the pandemic has created a supportive backdrop for bonds issued by financial institutions as central banks provided significant support via measures such as funding mortgage holidays and supplying cheap capital.

On top of these regulatory relief measures, fiscal and monetary support in the form of government guaranteed loans and direct transfers helped keep unemployment at reasonable levels while lowering the stress on corporates and smaller businesses.

Despite the continuing low interest rate environment, European banks, are very attractive in the current market context from a bond investor standpoint.

 

Bank bonds: what are the major opportunities Axiom sees in 2021?

 

 

Strong fundamentals, a supportive backdrop and a good risk adjusted yield are not the only reasons for Axiom to believe the European financial debt market is currently one of the most attractive sectors in the fixed income market.

We see attractive investment opportunities within the financial sector due to tailwinds caused by M&A, restructuring and digitization.

 

‘We see attractive investment opportunities within the financial sector due to tailwinds caused by M&A, restructuring and digitization’

 

We believe that continued consolidation and cost efficiency improvements in 2021 should boost the sector and provide further upside potential.

During lockdown, bank customers, and banks themselves, were able to see the advantages of online banking. We believe the crisis will expedite the digitisation of banks, thus leading to cost and efficiency advantages.

Some banks have announced they won’t reopen branches that were closed during lockdown. This should help improve the sector’s cost/income ratio, which remains high in some countries. For example, there are 60 branches per 100,000 inhabitants in France, compared with 15 in the United Kingdom.

To give few examples: (i) In Germany, Commerzbank announced an aggressive restructuring plan that aims at a 30% reduction in headcount, coupled with a reduction in the number of branches, half of which are to be closed. (ii) the planned exit of Natwest from Ireland continues to attract interest from local competitors and private equity firms (iii) In Spain, Unicaja and Liberbank finalized the terms for their merger, creating the 5th largest bank in Spain with c.€110bn in assets.

We believe that further cost reductions, whether organic or through M&A, will strengthen banks’ operating profitability, particularly in the most segmented markets.

 

Axiom European Financial Debt (AXI LN):  a diversified portfolio targeting 6p dividend

 

 

AXI is an investment trust listed on the London Stock Exchange offering investors exposure to a diversified portfolio covering the entire European financial sector.

AXI has a current yield of 8% and pays 6 pence dividend per annum, distributed quarterly.

The fund enables investors to take advantage of the best opportunities within the sector and provides attractive income over and above traditional income investments, while maintaining a prudent level of diversification and limiting downside risk.

 

More information about Axiom European Financial Debt Fund here >     

 

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Select Axiom European Financial Debt Fund (AXI LN) – GG00BTC2K735