High-yield investors lured by FIG

Thu Feb 14, 2013 10:52am EST

* Financials play bigger role in high-yield portfolios

* Higher coupons, returns, brighter outlook drive demand

* Ignoring banks seen as a huge bet for global funds

By Natalie Harrison

LONDON, Feb 14 (IFR) - High-yield investors are increasingly turning to financials, lured by the better returns available compared to those on offer in the industrials sector.

The high-yield buyside has traditionally shied away from FIG, but financials outperformed in 2012. Factor in the superior returns available, and that has changed many investors' minds.

Bank subordinated debt, including both Contingent Capital (CoCo) instruments and Tier 1 perpetual hybrids, is now at or near the top of the wanted list for many accounts.

"The interesting development is the higher quality buy-and-hold high-yield investors that are now looking at these instruments," said Chris Cote, a syndicate banker at Bank of America Merrill Lynch.

"It's a healthy sign for the market in general, with incremental sources of demand helping to provide more stability to secondary trading."

While supply has been somewhat limited, banks need to issue these kinds of instruments in order to meet new capital regulatory requirements.

And the burst of interest will surely only fuel demand, as investors come to terms with the fact that high-yield looks set to dwindle to high single-digit returns - at best - in 2013.

Including financials, high-yield returned 27% last year compared to 23.25% excluding financials. Year-to-date they have returned 0.041% and -0.125% respectively, according to Bank of America Merrill Lynch data.

"Ignoring financials is a huge bet that can offset all the benefits of smart security selection elsewhere," said David Newman, head of global high-yield at Rogge Global Partners.

RELATIVE VALUE

The pick-up in demand goes right back to the Barclays CoCo in November, which was sold mainly to European and U.S. institutional investors rather than high net worth investors in Asia that have driven previous subordinated deals denominated in dollars.

"Despite the large size of the Barclays CoCo, the institutional investor demand for that deal has helped the bonds remain stable in the secondary market," said BAML's Cote.

High-yield investors also accounted for a significant portion of the EUR5bn order book for Bank of Ireland's (BoI) EUR1bn three-year convertible CoCo, and the USD8.5bn book for Belgian bank KBC's USD1bn 10-year CoCo, which went a step further in testing risk appetite because of its permanent writedown structure.

The BoI and KBC CoCos, both rated Ba2/BB+, pay coupons of 10% and 8% respectively - substantially higher than those offered by similarly rated corporate issuers.

Irish-listed packaging firm Smurfit Kappa, rated Ba2/BB+, offered a 4.125% coupon on a EUR400m seven-year bond issued last month, while British cable company Virgin Media's Ba3/BB- senior secured dollar and sterling tranches, which priced earlier in February, offer 5.75% and 6% coupons respectively.

Meanwhile the improved stability in the financial sector has also helped to make banks more attractive, and there is a general feeling that a lot of banks in troubled regions have turned the corner.

"Investors are now more willing to spend time assessing relative value of specific credits," said Cote.

A NATURAL FIT?

To some extent, high-yield investors who track indices have already gone heavily into financials due to a spate of bank downgrades. Financials now account for about 18% of BAML's global high-yield index.

In any case, high-yield investors are arguably more natural buyers of CoCos than traditional FIG investors, who are less comfortable with the instrument's loss features.

"High-yield investors are used to riskier instruments and are more familiar with distressed situations and scenarios where debt is swappped into equity," said Gerald Podobnik, head of capital solutions at Deutsche Bank.

Unlike in corporate restructurings - when losses for creditors vary case by case - CoCo investors know from the outset that they will be either converted into equity or written off completely if capital ratios fall below a certain level.

Of course, that means CoCos are definitely a riskier investment - but that shouldn't necessarily deter investors, said Rogge's Newman.

"As with any credit investment, it is key that you only buy what you fundamentally like and understand," he said.

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