Page 42 - DIY Investor Magazine - Issue 27

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 Antionia 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. 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.
‘EUROPEAN BANKS, ARE VERY ATTRACTIVE IN THE CURRENT MARKET CONTEXT FROM A BOND INVESTOR STANDPOINT’
DIY Investor Magazine | Mar 2021 42