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PREFERRED SECURITIES

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Clients asking if we can provide them with a commentary or updated information about preferred securities;
as they are seeing more issuance on the space than before and don’t understand the reason behind it.

Context: LatAM clients are used to preferred securities which are bonds equivalent to AT1 Cocos but
issued from US banks.

Fund: USD fund.

Impact of the fund: Pref Shares are more expensive then European AT1 cocos which is supportive
for our strategy.

First of all, the preferred securities we hold in the fund are mostly legacy capital securities issued by banks
and insurers under previous regulatory regimes, and hence these are not issued any more as they would not
be eligible as capital.

US banks do issue “preferred securities”, which are the equivalent of AT1 CoCos for US banks with very similar
features to AT1 CoCos (fully discretionary coupons, perpetual, etc.). These instruments are fairly different from
old-style prefs that we hold in the fund, that are usually fully perpetual (no call dates), can have cumulative
coupons, etc.

European banks and insurers currently only issue new-style fully eligible instruments, namely AT1 CoCos for
banks and Restricted Tier 1s for insurers. We have seen c€26bn of European banks AT1 and c€2bn of
European insurance RT1 being issued YTD. While the AT1 CoCo issuance figure is slightly ahead of the €20–
25 bn expectation we had for the year, supply has not been a headwind for the sector given very strong
appetite for higher yielding paper in a negative rates environment. We have seen for example Nationwide
bring a new £ AT1 CoCo this week, oversubscribed more than five times despite the overhanging Brexit
uncertainty. Moreover, as issuers have front-loaded some of 2020’s issuance, technical will remain very
favorable for the sector.

Our reasoning behind the lack of involvement in US prefs is driven by valuations, where European banks offer
significantly wider spreads. For example, HSBC 6,375% AT1 CoCos callable in 2024 currently offers a spread
of c350bps over treasuries, compared to c220bps spread for JP Morgan 6,125 US Pref callable in 2024. This
is despite similar ratings (both BBB— Bloomberg Composite) and similar bond structures

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