As the European banking sector completes its regulatory transformation, investors find themselves at a crossroads. Between the end of the accounting optimization imposed by Basel IV and the emergence of record structural profitability, the subordinated credit landscape is being radically reshaped.
Roberto Facchini, an expert at Valori Asset Management, explains why we are entering an era of "truth in pricing". Far from being a constraint, this new paradigm is transforming banks into veritable fortresses of yield. From alpha opportunities in Southern Europe to the highly strategic "Grandfathering Trade" of 2026, plunge into an uncompromising analysis of a market that has become, in his view, the new "sweet spot" for diversified allocations.
To begin with, could you briefly outline what Basel IV is, what it seeks to correct in relation to previous agreements, and why its entry into force today represents a major turning point for the European banking sector?
If we had to sum up Basel IV in one sentence, it's the regulator's attempt to restore "truth in pricing" to bank balance sheets. For years, we had to live with an anomaly: two banks presenting the same risks could post totally different solvency ratios, thanks to the "accounting gymnastics" permitted by their internal models. Basel IV puts an end to this recreation. Its linchpin, the famous 72.5%Output Floor, now imposes a limit: banks can keep their sophisticated models, but their risk-weighted assets (RWA) can no longer fall below a standardized threshold.
But the real turning point today goes beyond simple mathematical calculations. As the ECB's December 2025 report points out, we are witnessing a questioning of the very soul of capital structure. Regulators, spurred on by the BIS (FSI), are finally questioning the very nature of Additional Tier 1 (AT1) bonds . Are they there to save a bank in full operation (going-concern) or are they merely a means of financing an orderly resolution (gone-concern)?
This debate is historic, because it signals the end of the post-crisis emergency era. We are entering a mature phase where the rules of the game are becoming simpler and more harmonized. For investors, this means an end to the "regulatory fog". The hierarchy has finally been clarified: the shareholder takes the first hit, followed by a layer of transparent subordinated debt. Basel IV thus transforms a complex niche market into a clear, institutional asset class.
We often hear that European banks are entering this new phase with particularly strong balance sheets. What is your macro analysis of the situation in the European banking sector after several years of regulatory tightening?
The metamorphosis of the European banking sector is spectacular. We have gone from an industry that was once on life support to one that is now undoubtedly one of the safest and most profitableutilities in the bond world. The average CET1 ratio of 16.1% is not just a figure on paper; it is a massive bulwark that enables banks to absorb Basel IV-induced RWA inflation without even batting an eyelid.
What really changes the macroeconomic picture today is the return of structural profitability. With a return on equity (ROTE) now in excess of 10%, these banks are no longer simply storing capital: they are generating it. This organic generation capacity is the ultimate safety net for holders of subordinated debt. It means that banks can pay their dividends, buy back their shares and honor every AT1 coupon without ever having to tap the market for a dilutive capital increase.
The ECB's recent pivot towards "simplification" is the final proof of this strength. By proposing to cut through the "mille-feuille" of capital reserves to keep just two clear categories, regulators are implicitly admitting that the days of putting out fires are over. For an investor, we are no longer betting on a "turnaround". We are investing in a stable income machine, so heavily regulated that systemic risk has, by construction, been evacuated from the system.
Basel IV does not apply uniformly to all banks. What do you see as the main differences in impact between institutions or regions, and why is this "multi-speed" reading essential for investors?
The mistake not to make would be to treat banks as a uniform block. Basel IV draws a very distinct multi-speed map. On the one hand, you have the banks of Northern Europe and Germany, which find themselves "punished" for their own past sophistication; their reliance on optimized internal models could lead to a significant increase in their capital requirements. On the other hand, the champions of the South (Italy, Spain), who are already playing by the standardized rules, feel no pain, and some even benefit from a capital surplus.
But complexity doesn't stop at Europe's borders. We are witnessing a fascinating global divergence. Australia is moving away from the AT1 product, while the UK and Switzerland are tightening conditions with rigorous profitability tests. Meanwhile, in Asia (Japan, India), the AT1 market is just beginning to take off.
For an informed investor, this divergence is a goldmine for generatingalpha. It's no longer enough to analyze a balance sheet; you have to understand the local regulatory regime. Do you buy a bank facing a 300 basis point capital shortfall, or one sitting on a massive surplus?
By selecting the "winners" of this regulatory shift, particularly where the ECB has promised not to apply retroactive rules, we can capture significant yield premiums while reducing our real regulatory risk. In 2026, geography and regulatory nuance matter as much as pure credit analysis.
In an environment marked by rate volatility and the search for carry, how can European bank subordinated debt find its place in a diversified allocation, alongside other credit segments?
Today, subordinated debt (AT1 and Tier 2) is the " sweet spot " of the credit world. It's one of the few segments where we can still capture yields of 5% to 6% on fortress-type balance sheets. Compared to industrial high-yield, which is exposed to economic cycles and margin compression, the banking story is much more solid. You get paid a "complexity premium" to own an ultra-regulatedutility.
But the real driver for investors in 2026 is what I call the " Grandfathering Trade ".
The ECB has been very clear: the new rules will not be retroactive. This means that if it ever introduces a "new version" of AT1s (perhaps with higher triggers or profit-linked coupons), the securities you hold today will become " legacy" assets . Historically, these vintages are extremely valuable. Their clauses are often more favorable to investors, and as they eventually become "non-conforming" for the bank, the latter has a huge incentive to buy them back at the earliest opportunity.
This dynamic largely erases extension risk (the fear that the bond will never be repaid).
As the supply of these "old-fashioned" bonds dwindles, they become collectors' items offering a high carry. In a diversified allocation, these instruments act as an income driver that, paradoxically, becomes increasingly secure as the regulatory framework becomes clearer. Put simply, it's a way of getting paid handsomely to wait, while the safest banking system in decades continues to deliver.
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