DO YOUR HOMEWORK
Despite the different opinions, fund managers all agree institutions need to go through these deals with a fine tooth comb and carefully crunch the numbers.
“Investors have to do their credit work and look at the underlying structure of the bond,” says Murfin. “They are not a homogenous group in that they have different trigger rates and mechanisms. I would like to see more consistency in structures.”
According to a report from Henderson Global Investors, each issue can be unique in its structure. They vary in terms of the loss absorption mechanism – permanent write-down, temporary write-down, equity conversion – as well as minimum capital trigger levels. They also differ in regards to the capital levels at which coupons can be switched off. For example, a CoCo with a higher trigger level but with an equity conversion could be preferable to a low trigger level with permanent write-down, depending on the issuer.
Satish Pulle, lead portfolio manager for financials at ECM Asset Management also notes that credit analysis on well-known banks is as important as it is for smaller institutions.
“For example, to analyse a bank like HSBC which is a large global diversified institution, a connection between the bank’s AT1 bond and macro events such as China slow-down or US Treasury sell-off needs to be drawn although there would be many moving parts,” he says. “It is more difficult to assess banks such as the UK’s Nationwide. At first glance many would not have realised that it had an important loan base in Scotland and a vote for independence would have had a significant impact.”
Investors are also advised to be realistic about the yields these instruments will generate. They have already dropped from their lofty levels of 10-11% in 2012 to today’s approximate 6% due to healthier bank fortunes and investor popularity. “There is room for spread compression because the subordinated premia is wide,” says Philippe Bodereau, managing director at Pimco. “We will not see the repeat of the performance of two to three years ago, but they are still more attractive than senior or government bonds.”
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