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ING

ING 3.875% May-27/Perp

Whilst we have seen volatility pickup over the last few weeks, we have seen opportunities present themselves in capital securities issued by high quality European banks where we see call risk as limited because of the characteristics of the bond.

With interest rates rising, the capital value of fixed rate bonds will generally fall. However, the prices (and yield) on a lot of these securities (especially the financial perps) have already readjusted to the market’s expectations of higher interest rate expectations. For evidence, see the change in price over three- and six-month periods below.

The ING 3.875% May-27/Perp is one such security which now offers close to a 7% yield to call (YTC). This security was trading around the USD95 mark at the start of the year and has now fallen to around USD86. This bond is rated Ba1 by Moody’s and BBB by Fitch.
Firstly, on call risk. This is a function of three aspects:

  1. The Implied Reset Coupon at the first call date
  2. The Distance to the Common Equity Tier 1 (CET1) ratio trigger
  3. The Maximum Distributable Amount (MDA) cushion – bank capital ratios falling into the MDA buffer zone raise red flags for investors

On these three aspects, ING scores very well.

  • The implied reset coupon of 5.25% at the first call date sits well above the current low coupon of 3.875%. Thus, there is limited economic incentive for ING to keep these securities outstanding.
  • ING’s CET1 is a very heathy 15.8%, which is c.8.8% above the 7% CET1 threshold. Quantifying this – CET1 capital would need to fall by over EUR30bn before this 7% CET1 threshold is reached. A highly unlikely proposition, even in a Doomsday Scenario.
  • ING currently maintains a healthy Maximum Distributable Amount (MDA) cushion of over 5%. This is a measure of the ability for European banks (under CRD IV regulation) to continue paying Additional Tier 1 (AT1) coupons. Quantifying this – CET1 capital would need to fall by around EUR15bn before the 10.5% MDA cushion is breached.

In our view, ING is also a better credit than SocGen, UBS, and BNP. This is evidenced by the higher CET1 ratio, MDA cushion, as well as the comparable higher ratings (aside from BNP respectively).

Table 1. Credit Ratings

S&P Moody’s Fitch Composition
ING 3.875% May-27/Perp NA Ba1 BBB BBB-
SOCGEN 4 7/8 Perp NA Ba2 NA NA
UBS 4 7/8 Perp BB NA BBB BB+
BNP 4 1/2 Perp BBB- Ba1 BBB BBB-

Source: Bloomberg

Chart 1. MDA Cushions

Source: CreditSights

Turning to the credit quality, ING became the latest European bank to detail its exposure to Russia and Ukraine following disclosures by other European banks last week. In summary, it has Russian-related credit exposure of c.EUR7bn (or 1% of total loans), and exposure to Ukraine of c.EUR1m (or 0.1% of total loans). Any losses should be comfortably absorbed – its FY21 pre-tax profit was EUR6.8bn and its CET1 capital at end-2021 was EUR49.8bn.

ING displays robust and consistent asset quality, good earnings, solid capital ratios, and a well-balanced funding profile. These attributes are supported by its strong franchise in retail and wholesale banking in the Benelux region, its good geographic diversification, and its focus on low-risk residential mortgage lending. At the same time, it has sizeable exposures to cyclical industry sectors in its Wholesale Banking division, although these have been reduced in recent years.

Chart 2. Financial Metrics

Source: CreditSights

Relative Value

The rating of Ba1 (Moody’s) and BBB (Fitch) translates into a Composite Rating of BBB-, which is used by global investors and funds with CoCo mandates. This compares favourably to the Major Bank Listed Hybrids, which only have a private rating of BBB- (not provided to retail investors under S761G of the Corps Act).

We assess the relative value of the ING 3.875% May-27/Perp versus over-the-counter (OTC) issues as well as the ASX-listed AT1 (hybrids) issued from domestic major and regional banks. The ING 3.875% Perp sits well wide of both listed and unlisted comparable issues of similar credit strength.

In our view, ING is also a better credit than SocGen, UBS, and BNP. This is evidenced by the higher CET1 ratio, MDA cushion, as well as the comparable higher ratings (aside from BNP respectively).

Chart 3. Relative Value

Source: BondAdviser

Chart 4. European Bank Perp Comparison Metrics

* using BVAL PCS
Source: Bloomberg

We also assess the relative value of the ING 3.875% May-27/Perp versus the European bank perps outstanding. Because of its higher duration, the prices (and yield) on a lot of these securities (especially the financial perps) have already readjusted to the market’s expectations of higher interest rate expectations.

The ING 3.875% May-27/Perp is one such security which now offers close to a 7% yield to call (YTC). This security was trading around the USD95 mark at the start of the year and has now fallen to around USD86. This bond is rated Ba1 by Moody’s and BBB by Fitch.

Chart 5. European Bank Perp Relative Value

* using BVAL PCS
Source: Bloomberg

Please speak to an IAM Sales Representative to discuss the trade.

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