Hedge funds are zeroing in on European banks’ bonds, betting that the region’s long-troubled lenders are now in good enough shape to withstand the ongoing US financial turmoil.
(Bloomberg) — Hedge funds are zeroing in on European banks’ bonds, betting that the region’s long-troubled lenders are now in good enough shape to withstand the ongoing US financial turmoil.
A source of pain for investors for over a decade, European banks’ recent relative calm compared with some US peers has been noted by money managers, including those from Man Group Plc and Brook Asset Management, an affiliate of Crispin Odey’s hedge fund firm.
“We favor European banks because we believe they are well regulated,” said Sriram Reddy, managing director for credit at Man GLG. “We don’t see this as a systemic issue in Europe, whereas the picture is more complex in the US.” Man GLG is one of the investment divisions of Man Group Plc, the world’s largest publicly traded hedge fund.
European banks are generally cushioned by high-quality capital buffers, a result of tighter regulations following the 2008 financial crisis. In the US on the other hand, a 2018 bipartisan move under the Trump administration rolled back some stress-testing rules for smaller institutions.
The average CET1 ratio — a key measure of banks’ ability to withstand crises — was 15.3% in Europe at the end of 2022, data from the European Central Bank shows. The median among large US regional banks was 9.6%, according to a Federal Reserve stress test conducted last year.
Credit Suisse
Europe’s financial sector did endure a selloff in March, when Credit Suisse Group AG collapsed. An index of European bank debt carries an average 190 basis-point yield premium over benchmark government bonds, rising from about 150 basis points in early-2023. Spreads also remain wider than on broader European credit.
Still, Reddy sees this as a buying opportunity. Many agree — Europe’s largest bond investor, Amundi Asset Management, earlier this month said it was taking advantage of the selloff to pick up newly cheap bank bonds.
Both Man GLG and Brook described the Credit Suisse rescue as “idiosyncratic,” and indeed there is little sign of spillover following its government-brokered takeover by UBS Group AG. However, one legacy is Swiss authorities’ decision to wipe out $17 billion in Credit Suisse’s AT1 bonds, a risky debt category that is often treated in a similar way to equity.
Write-off
The write-off on AT1s, also known as contingent convertibles or CoCos, hammered such bonds across Europe. It’s left Bloomberg’s total return gauge of European CoCo debt down 9.5% for the year, contrasting with a 2.7% gain for a broader bank bonds index. However, buyers have been returning, with the CoCo index rebounding more than 7% after its 9.8% plunge immediately after the Credit Suisse decision.
Louis Gargour, chief investment officer at Lng Capital Plc, said there was “enormous value” in AT1s, and does not expect other European governments to follow Switzerland’s example. He particularly likes AT1s from Deutsche Bank AG, noting: “Deutsche Bank is systemically too important to fail, there’s implicit state support and its CoCos basically offer very good value.”
Banking Exposure
Brook too has bought AT1s, portfolio managers James Hanbury and Jamie Grimston told clients in a letter seen by Bloomberg, adding they had increased overall banking exposure.
Hanbury and Grimston contrasted Europe’s brightening growth outlook with the picture in the US, where ongoing financial stress is expected to pressure credit conditions and the economy.
“This different macro set up is not consistent with the valuation differences in the two relative markets, and could well facilitate a reversal in the relative negative flows that European funds have had versus the US over the past few years,” they wrote.
–With assistance from Nishant Kumar.
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