The chart below shows the MSCI Europe Banks index is down 36 per cent year-to-date, while the sector’s contingent convertible bonds (CoCos) have recovered to only a 2 per cent loss so far this year. Since the end of 2015, bank CoCos are up more than 30 per cent cumulatively while their stocks are down by a similar amount. But despite their strong outperformance, CoCos still appear to be the best way to invest in Europe’s banks during these tough times.

A confluence of factors still support bank bonds. First, the major challenge for European banks is one of profitability, not solvency or liquidity. Their average common equity tier 1 ratio hovers around 15 per cent, a much higher capital buffer than the high single digit ratios during the 2008 financial crisis. Non-performing loan ratios have also contracted recently. Liquidity remains healthy too, supported by the regulator’s ban on dividends and European Central Bank’s (ECB) recent Targeted Longer-Term Repo Operation. As a result, default risk is relatively low for CoCos, especially for those issued by high quality banks. 

Valuations too could be appealing to income-focused investors with the average yield on CoCos at around 5 per cent (though it’s worth noting yields are at their lowest levels since CoCos were introduced). 

Lastly, the technical picture also looks constructive. While CoCos do not benefit directly from the ECB’s asset purchase program, they will be supported by investors’ on-going search for yield. Meanwhile, in terms of new supply, CoCo issuance for the remainder of the year is expected to be only €25 billion, which is manageable compared to previous years when banks’ efforts to raise capital buffers generated a much higher supply of new issues.

Stuart Rumble

Stuart Rumble

Investment Director

Becky Qin

Becky Qin

Bob Chen

Bob Chen

Investment Writer

Mark J Hamilton

Mark J Hamilton

Senior Graphic Designer