Credit Opportunities – Gregoire Mivelaz

What were the major recent events and impacts on your asset class?

The main three events for the third quarter were clearly about earnings, bonds getting calls and the primary markets that reopened. So going into order I mean we saw a very, very strong earnings season for the companies we're exposed to. It shouldn't really be a surprise as such because as you know in a rising interest rate environment, I mean the sector that benefits the most from that is clearly the financials. And this is what we've heard pretty much across the board. But at the same time, asset quality remained very resilient during the quarter.

So pretty much a perfect market environment for financials. So the sentiment toward the sector kept on improving. And this is somewhat reflected by equity price of European banks, that is currently up 15% year-to-date. So that was clearly one catalyst we were looking forward for the asset class. The second one, banks have been calling their callable perpetuals as expected, or we thought as expected on first call date. Now why that matters? Even a few months ago, the bulk of the market had repriced those bonds to maturity pretty much, saying they will not get called. And now we have the indication that 93% of those callable bonds will be called at first call dates. So that matters for bond holders, because whether you price those bonds at maturity or next call date has quite some impact in terms of the price. The third component, in terms of the primary market that reopened, that was very important. Just to put things into context, January, February, we saw some of the strongest demand on the primary market. Then, you know, the market completely stopped end of the first quarter, and we had to wait until the third quarter for banks being able to issue AT1 CoCos. And what we saw, BBVA coming back to the market in euro with very strong demand from European investors and sequentially BNP issuing AT1 CoCo in dollar targeting Asian and US accounts. And just to put some indication of the demand we saw, the bank issued 1.5 billion AT1 CoCos and demand was more than 8 billion. So just to sum up, those were three events or positive catalysts we mentioned end of second quarter that we would welcome to see. And once again, as we start the fourth quarter, I think something bondholders should be, you know, looking forward to.

What can your asset class offer in the current environment?

I mean as you know subordinated debt is issued by very strong issuers. So clearly an asset class that brings credit quality to investors. The average rating of the issuers we own is single A rated. And we're in a late credit cycle, so credit quality should really matter for bond holders. Secondly this is an asset class that generates a very high income. So credit quality is great but high income you know even greater. We currently have a yield to call of more than 10%. So this is unique. We have an income which is higher than high yield currently. And thirdly you know subordinated debt is very attractive; as we are talking spreads still remain too wide. Plus if you add the extension risk which I'll be talking later on, this is an asset class that should not just deliver in terms of high income, but has great optionality in terms of providing price appreciation too.

What is your outlook in the near and medium term?

Well, I mean, clearly, you know, because of the rising rate we've seen credit is very attractive again; it's a yielding asset class, but we're in a late credit cycle. There's still a lot of uncertainty on the macro front. All things equal, we think that IG investment grade should outperform high yield. We think financials should outperform corporates. And subordinated debt has scope to outperform senior.

Is there one chart you’re currently monitoring closely?

We actually used this chart last quarter already but you know, currently it might be the chart of the year so we thought let's use that for the third quarter again. It's just too attractive not to show it again. And it really highlights the sort of mispricing we're seeing in the market. And mispricing can also mean great opportunities, which we think is exactly the case as we're talking. And just to put things into context, you know, callable perpetual bonds can either be called at first call date or not. And whether you price them to next call date or maturity matters. If we look since inception of the asset class, 90% of those bonds have been called at first call date. And why that matters, I mean, right now only 35% of the bonds are priced to next call date. And we think that the market is gradually going to reprice that to historical levels. And along the way that means potentially some very interesting price appreciation. And just if we look at this year, for example, just a few months ago, all those bonds were priced to maturity. And actually 93% of those bonds will actually be called at first call date, the bonds callable this year. So once again a great chart to look at because we think that's going to create quite some interesting opportunities for investors.