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Tiers for fears

Hannah Stodell analyses the prospects for a rebound in banks and financials, with some commentators saying the various levels of debtholdings could offer outstanding opportunities

Fidelity fund guru Anthony Bolton’s bullish view on banking stocks has divided the industry as some pundits fail to see green shoots in the battered financials sector.

Despite being underweight in banks for many years, Fidelity International president of investment Bolton is bullish on their recovery. “Although they are very difficult to analyse, I think if you buy a basket of banks today you will do well over the next few years,” he said recently at the National Association of Pension Funds investment conference.

But Invesco Perpetual income and higher income fund manager Neil Woodford says recovery in the sector is unlikely in the next three years. He says: “It is clear that now is not a good time to be in bank equities as we are not sure of the quantum of bad assets. But they do have plaudits and should make a return as the economic environment improves.”

New Star global financials fund manager Guy de Blonay considers that financials should not be viewed homogenously and it is more of a question of separating the wheat from the chaff as banks may have suffered but other sub-sectors, such as reinsurance, have not been so badly hit.

He says: “In contrast to the majority of their counterparts in the banking industry, many companies in the reinsurance sector have strong, well capitalised balance sheets. Hannover Re indicated recently that its excess capital was about £470m above the levels required for a Standard & Poor’s AA rating.”

Within the fixed-income sphere, Truestone technical consultant Ben Stevens says there is a feeling that tier-one top-quality debt of financials has been sold off “completely irrationally” and that it could, in fact, present a good investment opportunity.

He says: “Under European law, tier-one debt is treated as equal to a depositor and every major Western government has waded into banks with money, saying they will not leave depositors out in the cold.

So they are also saying they will not leave tier-one debtors in the cold. You would think that their response would make tier one quite an attractive prospect as it is almost bec oming a gilt paying a higher rate but it has been sold off even more strongly by the market since the bailouts. It does not make sense.”

Rathbones fixed-income fund manager Bryn Jones says tier one could offer a good investment opportunity but warns there is a huge risk that the coupons might get withheld.

He says: “All the time that a bank is paying its equity dividend, a preference shareholder or tierone debtholder is going to continue to receive their coupons.

“But as soon as the bank stops paying the equity dividend, they are well within their rights to stop paying the coupon on preference and on tier one. However, they are not considered to be in default and the coupons are non-cumulative so they do not need to be backpaid later on.”

Jones has 4.55 per cent exposure to tier-one debt within the Rathbones ethical bond fund through “structurally important” names such as Lloyds Banking Group and Nationwide. But he favours the upper tier two space where he believes clients are more protected and yields are still quite attractive.

He says: “I prefer upper tier two rather than messing around with things that, if they do go wrong, could leave you with noncumulative coupons as I do not want my clients’ income to be hit too hard. “We are not through this yet, a lot of the banks gave their toxic assets to the Treasury and, as they clean their balance sheets, they are going to be quite profitable.

It is going to take some time to work its way out of the system and these are potentially good opportunities but they do not come without risk.”

Hargreaves Lansdown head of research Mark Dampier says some bond managers may be forced to sell tier ones even if they think they are a good bet, as the banks are being downgraded to junk status and shifting into the highyield index, so no longer qualify for investmentgrade ratings.

He says: “If you are a corporate bond manager running investment grades you are going to have to sell this, creating forced sellers. The problem has become political and regulatory.

“Unfortunately, tier one debt is not a one-way bet. It could be a fantastic buying opportunity but it could also suddenly go the other way. It is like tossing a coin.”


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