The most conservative investor who has not yet decided to invest in the stock market has a fixed income formula that will allow him to join the bank, one of the most popular sectors for this year thanks to the improvement in business that the increases with will bring . The current economic slowdown and the uncertainty of how far interest rate hikes will reach do not yet encourage positions in the stock market, where many banks have made substantial gains over the past year.
The sector will be more exposed to the effects of the economic downturn in 2023, which will be reflected in higher defaults. But it has the best of all in its favor: smashing interest rate hikes in the eurozone and business margin expansion that promises to more than offset the rise in arrears. The results released this week by Sabadell, which are close to record profits and set to increase the profits they return to their shareholders, are a clear example of the good times the sector is enjoying.
Banking is starting 2023 with a positive wind and investors can take advantage of the good moment in the industry beyond the stock market. The year began with a flurry of financial debt issuance with strong returns, perhaps not comparable to what can be achieved in the stock market, but undoubtedly superior to any savings product. Fixed income securities, traditionally considered safe haven assets, showed their darkest version in 2022, posting historic losses as interest rates soared. But looking ahead to 2023, it will be managers’ favorite asset, when bonds will already largely have rate hikes priced into their prices and also provide significantly higher rewards. In this context, debt issued by banks is the bet of choice for fixed income managers this year Many companies enter 2023 with an overweight position in financial bonds.
As explained by María Portillo and Rafael Seves, Fixed Income Managers at Mutuactivos, “The rate hike scenario is very favorable for banks and the consequent increase in margins and good capital position will be more than enough to cushion the consequent increase in arrears economic slowdown”.
Managers overweight banks in their fixed income portfolio
Mutua Madrileña’s manager has a special financial debt fund, Mutuafondo Bonos Financieros, which is down 7% last year but is up 2.4% this year. One of its positions is the issuance of contingent convertible bonds — coconuts in financial lingo — which it launched this month Ibercaja, with an annual coupon of 9.125%. That placement received a wave of applications that exceeded the amount granted by more than nine times, and highlights the appeal of bank debt at a time when, despite the slowdown, a worrying rise in defaults, let alone bankruptcies, is not expected in the industry. In fact, the issue has appreciated nearly 3% in value in just over a week of trading in the secondary market. “It is unlikely that companies like Cajamar or Ibercaja could go bankrupt,” said Rafael Valera, partner, CEO and manager of Buy & Hold.
Cajamar and Ibercaja bonds
This manager has in his portfolio Ibercaja coconuts at 9.125% and Cajamar subordinated debt at 11%. They are the flagship holdings of the Buy & Hold Bonds fund, which is 100% fixed income and, with almost 25% in subordinated debt, exceeds the maximum risk limit it accepts in its portfolio. This vehicle, which lost 8.6% last year, starts 2023 with a gain of 3.2%. And the Buy & Hold Flexible, a mixed fund in which the Cajamar issue has a 9% weighting, is leasing 8% so far this year. “This show is like shooting set pieces. The bank is in a good moment, it will have more advantages due to the rate hike,” he defends.
Valera clarifies that it would be wrong to propose bank bonds as an alternative to the equity market as they are different investment profiles. Not even as an alternative to receiving a dividend. “The sensible thing is to compare the coupon with the return on equity and invest through funds,” he adds. Thus, the purchase of the above issues, usually reserved for institutional investors, requires a minimum investment of 100,000 euros. “The most practical and cheapest way to invest in bank debt is through mutual funds”adds Cristina Gavín, debt manager at Ibercaja Gestión.
The slowdown does not endanger the solvency of banks, nor does it raise fears of a wave of defaults
Like Valera, Gavín is overweight financial debt in his fixed income portfolio. “Banking has suffered a lot, but now it’s a very interesting sector with interest rates rising. We are very positive towards large and solid banks that will hardly be affected by late payments,” he adds. Ibercaja Gestión has just launched a new private pension fund, Ibercaja Renta Fija Horizonte 2025, with an unguaranteed return target of 3% APR and in which financial debt will feature prominently.
Senior Debt
For Roberto Ruiz Scholtes, head of investment strategy at Singular Bank, bank debt is one of the clear bets on fixed income this year and a powerful alternative to deposits. “Senior Debt Offers a Much Greater Return than Bank Deposits”, To explain. This type of debt, with the lowest credit risk, within which banks issue to complete the regulatory buffers of bonds with the ability to absorb losses, offers a reward of almost 4%, according to the index compiled by Bloomberg for European banks.
“The senior debt of European banks does not pose a solvency problem. We expect an upward revision of financial institutions’ profits thanks to interest rate hikes. Analysts have yet to factor in all of the positive impacts in their estimates, and fears of a spike in non-performing loans are overdone. Because of the pandemic, there is a large volume of private savings and many publicly guaranteed loans,” says Ruiz Scholtes.
The Singular Bank is declaring “more bondholders than shareholders” for the year, although this maximum does not include the highest-risk bank debt, the junior and convertible quotas, despite their higher remuneration. “In this case, we prefer the shares of financial institutions where we see the greatest potential,” adds Ruiz Scholtes. Coconuts are the bank debt offering the highest yield, more than 9% per year in the January placements of Ibercaja and Sabadell, but also the riskiest. Their profile is the most similar to that of a stock within the fixed income universe, as they are the first asset to deal with losses in the event of bankruptcy.
Coconuts are also perpetual bonds, so theoretically there is no time to recoup the investment at maturity. Until last year, investors took for granted the early redemption of these issues and their replacement with a new issue, but rate hikes are challenging that mantra. Sabadell had to refrain from this early write-down in the first window in which it had the opportunity to do so, but the good market timing at the beginning of the year and the company’s favorable situation have allowed it to carry out this write-down and start a new placement of coconuts. Bank issuance of this type of debt is even becoming more expensive in the secondary market earlier this year.
Ignacio Victoriano, Fixed Income Manager at Renta 4, expects a busy year for bank issuance, mainly due to the drag that the rate hike in 2022 put on some issuance. Compared to other sectors, banks need to go public at the request of regulators to meet the targets they have set in order to have a cushion to absorb losses. Victoriano is also overweight banking in its fixed income portfolios. “The improvement in margins will continue and the banks already have good capital ratios. We like national champions,” he explains. Barring the brilliance of dividends or stock market gains — of which Sabadell set a fine example with this week’s stock market rally — bank debt points to gains again this year.