As the European banking sector completes its regulatory transformation, investors find themselves at a crossroads. Between the end of accounting optimization mandated by Basel IV and the emergence of record structural profitability, the landscape of subordinated debt is being radically reshaped.
Roberto Facchini, an expert at Valori Asset Management, explains why we are entering an era of “price truth.” Far from being a constraint, this new paradigm is transforming banks into true fortresses of returns. From alpha opportunities in Southern Europe to the highly strategic “Grandfathering Trade” of 2026, dive into an uncompromising analysis of a market that, in his view, has become the new “sweet spot” for diversified allocations.
To begin with, could you briefly explain what Basel IV is, what it aims to correct compared to previous agreements, and why its entry into force today marks a major turning point for the European banking sector?
If we had to sum up Basel IV in one sentence, it is the regulator’s attempt to restore “price truth” to bank balance sheets. For years, we lived with an anomaly: two banks with the same risks could post completely different capital ratios due to the “accounting acrobatics” allowed by their internal models. Basel IV signals the end of this game. Its cornerstone, the famous 72.5% Output Floor, now imposes a limit: banks can keep their sophisticated models, but their risk-weighted assets (RWAs) 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 highlights, we are witnessing a fundamental reevaluation of the very essence of capital structure. Regulators, prompted by the BIS’s (FSIO) deliberations, are finally questioning the fundamental nature of Additional Tier 1 (AT1) bonds. Are they intended to save a bank in operation (going concern) or are they merely a means of financing an orderly resolution (gone concern)?
This debate is historic, as it signals that the era of post-crisis urgency is over. We are entering a phase of maturity where the rules of the game are being simplified and harmonized. For investors, this means the lifting of the “regulatory fog.” The hierarchy is finally being clarified: shareholders take the first hit, followed by a layer of transparent subordinated debt. Basel IV thus transforms a complex niche market into a transparent, institutional asset class.
We often hear that European banks are entering this new phase with particularly strong balance sheets. How do you assess, from a macro perspective, the current state of the European banking sector after several years of regulatory tightening?
The transformation of the European banking sector has been spectacular. We have moved from an industry that was once on life support to a sector that is undoubtedly one of the safest and most profitable utilities in the bond market today. The average CET1 ratio of 16.1% is not just a number on paper; it is a massive bulwark that allows banks to absorb the RWA inflation driven by Basel IV without even batting an eye.
What is truly changing the macroeconomic landscape today is the return of structural profitability. With a return on equity (ROE) now exceeding 10%, these banks are no longer content to simply hoard 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 toward “simplification” is the final proof of this strength. By proposing to trim the “layered” capital reserves to retain only two clear categories, regulators are implicitly admitting that the era of firefighting is over. For an investor, we are no longer betting on a “turnaround.” We are investing in a stable revenue machine, so heavily regulated that systemic risk has, by design, been eliminated from the system.
Basel IV does not apply uniformly to all banks. In your view, what are the main differences in impact between institutions or regions, and why is this “multi-speed” interpretation essential for investors?
The mistake to avoid would be treating banks as a uniform bloc. Basel IV paints a very distinct multi-speed picture. On one hand, you have the banks of Northern Europe and Germany that 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, the Southern European leaders (Italy, Spain), which, having already been playing by standardized rules, feel no pain—some even benefit from excess capital.
But the complexity doesn’t stop at Europe’s borders. We’re seeing a fascinating global divergence. Australia is moving away from the AT1 product, while the United Kingdom and Switzerland are tightening conditions with rigorous profitability tests. Meanwhile, in Asia (Japan, India), the AT1 market is just beginning to take off.
For a savvy investor, this divergence is a goldmine for generating alpha. It is no longer enough to analyze a balance sheet; one must understand the local regulatory framework. Do you buy a bank facing a 300-basis-point capital shortfall, or an institution sitting on a massive surplus?
By selecting the “winners” of this regulatory shift—particularly where the ECB has promised not to apply retroactive rules—one can capture significant yield premiums while reducing actual regulatory risk. In 2026, geography and regulatory nuances matter just 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 is one of the few segments where one can still capture yields of 5% to 6% on “fortress-like” balance sheets. When compared to industrial high yield, which is exposed to economic cycles and margin compression, the banking story is far more solid. We are paid a “complexity premium” for holding an ultra-regulated “utility.”
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 trigger thresholds or profit-linked coupons), the securities you hold today will become “legacy” assets. Historically, these vintages are extremely valuable. Their terms are often more favorable to investors, and since they eventually become “non-compliant” for the bank, the bank has a huge incentive to buy them back at the first opportunity.
This dynamic largely eliminates the extension risk (the fear that the bond will never be repaid).
As the supply of these “old-style” bonds shrinks, they become collectibles offering high carry. In a diversified portfolio, these instruments act as an income engine that, paradoxically, becomes increasingly secure as the regulatory framework becomes clearer. Put simply, it is a way to be generously compensated for waiting, while the safest banking system in decades continues to deliver its performance.
