Each week, a professional investor tells MoneyWeek where she’d put her money now. This week: Rebecca Seabrook, director of UK credit at F&C.
The first quarter of 2009 has been a difficult time for the credit markets, with growing uncertainty and volatility around subordinated debt (which has lower priority than other debt), financials in particular. This was driven mainly by Bradford & Bingley’s announcement that the terms of its nationalisation had been changed, enabling it potentially to avoid paying coupons on its lower tier-two bonds. This is a significant departure from previous precedents, and it caused all subordinated financials to underperform and fall substantially in price.
Since this low point, some of the larger banks have made use of low bond prices to offer tenders and exchanges for subordinated debt. For example, Lloyds and Royal Bank of Scotland offered to swap some of their upper tier twos for new senior bonds.
This has helped to alleviate some stress in the market, as many investors were left holding off-benchmark positions that they couldn’t sell. Although it crystallises losses, the ability to change some of these troublesome positions into more liquid assets is well received.
This has provided some support for bond prices during March, improving the market tone and offering a small amount of stability, particularly for subordinated financials. All this is welcome news for insurers, who generally hold most of the subordinated financial debt. Elsewhere, corporates have outperformed, benefiting from the Bank of England credit purchase scheme.
New issue markets have remained busy, generally in defensive sectors. These issues are seeing good demand, notably from the retail sector, which is receiving cash inflows. As a result new issue premiums are starting to slim.
Although the tone in the credit markets has improved, there is still a long way to go. Further new issuance will help. However, resolution of the most troublesome situations in the credit market is essential to ensure better quality issues and liquidity. Overall, despite the recent G20 announcement on extra funding and positive actions taken by global authorities so far to aid recovery, economic data are disappointing and we remain in very deep recession.
The first bond I like at the moment is transport company First Group 8.125% 2018. The integration of American bus operator Laidlaw’s business has progressed very smoothly and First Group is earning a decent proportion of revenue from school bus runs, which have proved to be highly recession-proof. The main benefit is that the company has aligned its interest with bondholders by retaining cash and strengthening its balance sheets. In my opinion, this is a defensive name in a difficult environment.
The second is Imperial Tobacco 9% 2022, a tobacco company that is weathering the economic storm with relative ease. Growth momentum has been steady so far in 2009 and its premium cigarette brands, such as Davidoff, are growing well in emerging markets. Crucial for bondholders is the fact that Imperial has quickly paid down its debt. Fears over its ability to refinance acquisition debt from last year have also proved pessimistic. In addition, the bonds trade relatively cheaply compared with others in the sector.
Lastly, I like Telecom Italia 6.375% 2019, who this year announced aggressive de-leveraging targets. Following a phase of acquisitions in recent years, the company is now consolidating its position and paying down debt that will underpin its rating, and which separates it from the rest of the sector.