The Financial Stability Board (FSB) has urged Europe’s too-big-to-fail banks to issue up to €1trn in subordinated debt to decrease the likelihood they would again have to be saved by the taxpayer if they get into trouble. These bonds would be converted into equity or bondholders would incur a loss in case a bank’s capital ratios fall below a certain level.
With 44% of delegates at Expert Investor Switzerland saying they will probably buy this new debt, it is set to become the most popular fixed income instrument among the Alpine country’s fund buyers. The popularity of the asset class is not that surprising, considering high yield bonds are also in demand among the yield-hungry Swiss. Close to four in 10 Swiss investors plan to increase their allocation to this asset class, the second-highest reading in Europe.
Peter Jeggli, a global high yield fund manager at Fisch Asset Management in Zurich who spoke at the event, will consider including the subordinated debt in his investment portfolio. “But only as an opportunistic investment. They would not play a major role in our fixed income portfolios,” he said.
Overall, subordinated bonds are good news for senior bondholders, since they decrease the likelihood of a default, and bad news for shareholders, Jeggli believes. “The latter could get diluted via new equity issuance, and banks will have to pay a very high coupon on these coco’s, between 8 and 10% I expect.”
Equity managers, attention please!
This high yield makes subordinated debt attractive to equity managers, according to Jeggli. “They really should start looking at these instruments. The yields will be comparable to the returns on the stock market.”
Urs Beck, manager of the New Capital Swiss Select Equity Fund, agreed with his compatriot Jeggli. “It’s interesting to look for example at the contingent convertible bonds (coco’s) outstanding at Credit Suisse. The management had to participate in the issue by having part of it in their bonus, so they have a very strong intention not to have to trigger [the clause in] these bonds,” he said.
Beck believes the issuance of contingent convertibles is particularly bad for shareholders, since the board’s stake in the coco-issue would almost certainly issue shares to raise equity, before calling the trigger on the convertible bonds. “This doesn’t help my appetite for banks in Europe,” Beck, who is underweight financials with an allocation of less than 15%, concluded.
Click here for a full overview of the voting results from Expert Investor Finland.
And click here to see a slideshow of photos taken at the event.
