The sell-off in Deutsche Bank and Credit Suisse bonds and shares caused by the banks’ end of year reports is not a death knell for fixed income investors in the sector.
In an investor update, Smouha said both banks used significant capital in their investment banking activities in early 2000s which is now having a negative effect. However, Smouha thinks recent management changes had not had chance to take effect.
‘They also both have new hard-headed managers in charge, who aim to reshape their businesses so that the important cash generative franchises they own come to the fore and the value for equity holders can be rebuilt. This will take time and the litigation issues must be resolved.’
‘Sometimes goodwill will be written off as in the 16-year-old goodwill for the Donaldson, Lufkin & Jenrette acquisition by Credit Suisse. But goodwill is a non-cash item so that investors should look through some of the published losses and focus on real cash generating ability,’ he said.
Where to buy
Smouha currently has a 4.3% holding in Lloyds Banks, which is the largest allocation in the fund. Other banking names include HSBC (3.1%) and BNP Paribas (2.7%).
‘We will avoid buying debt of banks that are in troubled zones or that have questionable business models. We prefer older legacy securities as banks reshape their balance sheets for debt that is losing its regulatory capital advantages.’
‘For example, Deutsche Bank repaid some old floating rate notes this month at 100% after they were trading at 60% the day before the announcement,’ Smouha said.
Smouha added there could be short-term losses as credit spreads had widened and stock markets had performed poorly. He thinks there are opportunities in subordinated debt.
‘Time for adjustment will be needed but there should be no major systemic shock. We will hear more about rising default levels, particularly in the energy sector, but it would be wrong to exaggerate those issues,’ Smouha said.
‘Losses may be taken by banks on idiosyncratic loans and weaker credits that were able to raise money in better markets. However we would expect this to be manageable for the major banks and not to derail their capital strengthening.’
‘In some cases, banks may need to go back to their shareholders through discounted rights issues as they have done in the past years. But strengthening of the banks’ equity is making subordinated debt and particularly senior subordinated debt more attractive.’
The GAM Star Credit Opportunities fund 20.19% in US dollar terms over the three years to the end of January 2016. This compares to a rise of 4.4% by its Citywire-assigned benchmark, the BofA Merrill Lynch US High Yield BB-B Rated TR, over the same period.