Managers cautious on bank debt despite sharp declines

Financials still under pressure from unfinished business in the eurozone and the threat of downgrade for banks

Fixed interest managers have warned against investing in bank debt despite sharp falls in values caused by Moody’s threat to downgrade 14 UK banks last week.

Credit default swaps on European senior financials widened substantially on Monday 23, from 145 basis points to 155 basis points, while yield on sterling denominated financial debt widened about 20 basis point. The moves followed Moody’s warning UK banks are at risk because the government may not bail them out in the event of a new crisis.

Ongoing fears over the European sovereign debt crisis have also contributed to the movement in spreads.

Although bank debt has become cheaper, managers warned there are still significant headwinds for the European market.

Chris Bowie, manager of the £277m Corporate Bond fund at Ignis, said: “The potential downgrade by Moody’s has added more fuel to the fire, so there was even more weakness in banks last week.”

Corporate debt issued by financials is highly correlated to CDS markets, and Bowie said it has therefore become much cheaper in the last week. However, he said he is steering clear of the asset class until problems across Europe are resolved.

“Although it has become cheaper, it is not a buying opportunity yet. We are still underweight in financials as there is a lot of unfinished business with regards to Greece and the rest of the European Union, as well as with government deficits generally,” he said.

Peter Harvey, manager of the £714m Cazenove Strategic Bond fund, said Moody’s warning has exacerbated issues already impacting banks.

“The Moody’s rating review is one of several factors taking European bank spreads off their tightest levels this year. Since mid-May, most bank CDS are 3% to 4% wider,” he said. “Right up until early May, EU bank spreads were contracting, but since then they have widened modestly because of Greece, the Spanish elections and the Moody’s report.”

Christine Johnson, manager of the £38m Old Mutual Dynamic Bond fund, said the effect of the Moody’s note has been on senior paper, where some expectation of government support is still included in the rating.

Johnson said: “There remain considerable macro issues – not least the unfolding problems in Europe – and while such uncertainty persists bank paper could be volatile.”

However, Nick Gartside, international CIO of fixed income at J.P. Morgan, believes there are opportunities in the UK banking sector, despite the Moody’s report,” he said.

“I think the impact on CDS is greater because of what is going on in Europe, rather than what Moody’s put out. Moody’s note was expected and what they are really doing is reviewing the amount of systemic support factored into ratings.”

“Bank debt in our strategic bond fund is about 14%, which has come down from 17% over the last few weeks. But this is just because of valuation - some paper had done well, so we took profits.”

Jenna Barnard, manager of the £1.1bn Strategic Bond fund at Henderson, agreed with Gartside there are opportunities in bank debt, but she warned investors need to be picky.

“Over the past nine months, we have been much more selective in the names we hold, which are primarily UK ones.”