By ADRIAN LOWCOCK 31/07/2009
Bank’s own debt was previously an uninspiring asset class. Blue chip banks would borrow money from investors at relatively low rates because the likelihood of a major bank defaulting on the interest payments of its debt, let alone collapsing, was unthinkable. Investors could be confident about the security of the debt, the only risk was inflation and the impact of interest rates on the price.
Following the collapse of several major banks and financial infrastructure everything changed, suddenly it not only mattered which bank you had invested in but also the seniority of the loan ( i.e. The ranking of debt in bankruptcy). The less secure it is the less it was worth. Investors couldn’t sell what they had and the little that was being traded was going for distressed prices. Bank debt was almost worthless as the risks of the banks being nationalised and the debt being written off was just too high.
Since March we have seen a marked improvement in sentiment towards the banks and their debt is looking less risky and more attractive. Prices have recovered significantly, but because there is still some uncertainty over the banks, some debt continues to trade below its redemption price (usually of £1 per £1 of stock) which means that not only will the interest being earned be higher because of the low price, but there is the possibility of further capital gains if the recovery gains traction.
The return of confidence is one factor providing impetus to the asset class. The banks are also contributing to this as they look to buy up their own debt on the cheap: they can buy their own debt at 70p now instead of £1 later, and they can cancel the interest they are paying on it. The outcome for the bank is even better as the banks can book a profit on the buying the investment and by reducing the amount of debt they have to service the banks can increase their creditworthiness at the same time.
Bestinvest’s opinion
While the recent rally in bonds has taken some of the shine off, corporate debt remains our favoured asset class and there is still significant opportunity out there. Investors can access bank debt exposure through managed funds where the manager’s expertise and market knowledge will be beneficial in getting the right exposure.
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