Liontrust sees buys in bank sub bonds

By Jane Baird and Laurence Fletcher

LONDON (Reuters) - Liontrust Credit Fund is finding buys among thousands of European subordinated bank bonds by combing the market, name by name and instrument by instrument, chief investment officer Simon Thorp said.

The long/short hedge fund sees an opportunity, for example, in a Commerzbank Tier 1 bond. "There's one or two things the market may have missed," he told Reuters in a recent interview, adding the bond may be cheap.

The fund began snapping up subordinated bonds of British banks in late February after Britain's Treasury changed the terms of the Bradford & Bingley (BB_p.L) bailout to enable the failed mortgage lender to skip coupon payments on its subordinated bonds without triggering a default.

The move upset investors, and bond prices plummeted.

The fund, while buying these bonds at around 40-50 pence on the pound, could see the major banks were becoming more profitable, starting with a March 10 statement by Citigroup (C.N).

At the same time, regulators were making clear that Tier 2 bonds would not count toward banks' capital ratios.

"We could see the conditions were beneficial for banks to buy back Lower and Upper Tier 2 bonds," Thorp said.

By late March, Lloyds Banking Group (LLOY.L), Royal Bank of Scotland (RBS.L) had started offering to buy back Tier 2 bonds at a stiff premium over the rock-bottom prices of the time.

"With the benefit of hindsight, these trades were no-brainers," Thorp said. "But in the dark days of February, people had apocalyptic views."

While bank paper has come a long way since then, "we still like the sector", he said, adding the fund has focused on British and Swiss banks. "Banks will be a good performing sector for the rest of the year, but we have to be very, very selective."

RAISING THE GATE

It was also in the dark days of February that the Credit Fund limited investors' access to its cash after receiving redemption demands for more than 20 percent of the portfolio.

Thorp said the fund was currently negotiating with investors when to lift the gate, and he expected to see investment inflows exceed outflows at that point.

"We certainly haven't had any redemption requests in the last three months. We know of ... quite a number of investors who want to give us money," he said.

The fund's euro share class is up 7.5 percent in the first five months of the year, after a marginally positive 2008 and small gains in 2007.