The beginning of the year has not been entirely equivalent between equity markets, which experienced significant performance in January, and bond markets, which have been more moderate, driven rather by anticipation, uncertainty, and significant interest rate volatility. The actions and statements of both the European and American central banks this week were an important step, confirming three trends for interest rates in 2025:

• A wait-and-see Federal Reserve attitude, balancing economic statistics and tensions with the White House current tenant
• A more accommodative ECB posture due to the slowdown in European growth
• A persistent widening of the interest rate differential between the Eurozone and the United States

This third point deserves clarification as it partly determines bond allocation choices, which differ from what can be observed in the equity market. In this period of increasing differential between the USA and Europe, an investor might be tempted to favour the American market at the expense of Europe; this reasoning holds for equities, of course, but does not hold for bonds:

• From an interest rate perspective: while the decline in the Eurozone’s key rates creates upward pressure on euro-denominated bond prices—and thus better bond performance—the maintenance of higher key rates in the USA offers higher carry but also potential widening of long-term rates, leading to volatility and potential capital losses on long-term bonds, particularly in the event of a normalization of the U.S. yield curve through long-term rates.
• From a credit perspective: companies in a highly dynamic economic zone are generally inclined to pursue a more aggressive financial policy to expand, invest, or acquire competitors and new businesses, whereas companies in a struggling zone will be more cautious in managing their cash flow and developments. Thus, the first zone may be beneficial for a shareholder but presents an additional risk for creditors, which is currently not compensated, as average credit spreads in the USA are roughly identical to European credit spreads. European corporate bonds therefore seem, on average, more attractive at present than U.S. corporate bonds.

Finding them remains a challenge, and we have often discussed in this weekly report all the issuers, sectors, countries, and types of companies we avoid in our portfolios, as bond management is, first and foremost, about avoiding default risk and therefore managing through exclusion. However, the value-oriented bond management we have been practicing for nearly fifteen years at Octo AM also involves seeking issuers offering yield premiums because they are underrecognized or suffer from an unjustified credit discount. In the second part of this weekly report, we will discuss an investment case we have integrated into our portfolios this week: Nova Ljubljanska Bank. This Slovenian bank, another diversification in  the Southern European banks allocation we have strongly favoured in recent months as replacements for French banks, appears to offer a yield premium of 50 to 100 basis points on its bonds compared to institutions with similar credit ratios and exposures. Additionally, country risk is a major factor in banking risk, and Slovenia, despite its small size, is an integral part of the Eurozone and thus under the ECB's "umbrella," while benefiting from a stronger economy and public finance management than the European average, with France at the forefront.

NLB Group is an atypical banking group (due to its country exposures) but solid, ambitious yet well-managed, with a reassuring trajectory in every respect. Owned 25% (+1 share) by its reference sovereign, NLB Group holds a 31.1% market share, making it the leading banking group in Slovenia and one of the major banking players in Southeastern Europe. It holds market shares exceeding 10% in five countries of the former Yugoslavia (excluding Croatia, where it recently re-entered through the acquisition of Summit Leasing Slovenija, finalized on September 11, 2024). Its assets in these different countries represented 37.7% of its total assets as of September 30, 2024. Furthermore, it operates under a multiple point-of-entry resolution framework, which allows for a slightly different risk assessment given its geographical positioning.

Beyond these structural elements, it is essential to highlight that NLB Group compares favourably to its European peers across all key dimensions of credit quality assessment for a financial intermediary: it is particularly diversified, built around conservative and well-supervised credit granting practices, and its asset portfolio has shown remarkable resilience in recent years. Its profitability (naturally benefiting from the increase in its net interest margin) surpasses that of its peers, especially those exposed to countries with similar risk profiles. Regarding its funding and liquidity profile, built on commercial franchises and a stable deposit base (although largely on-demand), without any concentration risk, it appears stronger than that of many of its European counterparts (see, in addition to the traditional liquidity ratios, the liquid assets/short-term deposits ratio of 42% it posted as of September 30, 2024), which also enables NLB Group to limit its reliance on financial markets solely to meet its MREL requirements.

However, it is worth noting that on April 30, 2024, NLB Group unveiled an ambitious 2030 strategy aimed at doubling recurring revenues through the consolidation of its position as the leading universal bank in all the countries where it operates (notably through the establishment of a fully digital offering) and the development of its corporate and investment banking activities to an equivalent level. This strategy is expected to absorb a significant portion of its excess capital and naturally carries specific execution risks. This cautious note should not be misinterpreted. As aggressive as it may seem, this strategy does not call into question our positive assessment of this issuer’s credit risk, given the risk control objectives and target capital ratios that underpin it (target cost of risk between 30-50bps, CET1 ratio >13%, with a target Tier 1 ratio around 15%). Moreover, according to Moody’s conclusions, it could even lead to an improvement in its ratings in the short to medium term.

This week, we initiated three bond positions in this banking institution, selecting our investments according to the fund’s profile:

• In the Octo Crédit Value fund: NLB subordinated 2034 (call in 2029), rated BB, with a 4.85% yield
• In the Octo Crédit Court Terme and Octo Crédit Investment Grade funds, where credit risk and volatility must be more contained: NLB senior 2029 (call 2028), rated BBB+, with a 3.5% yield

Želimo vam lep vikend! (We wish you a great weekend in Slovenian!)