Posted inSOUTHERN EUROPEFixed Income

Subordinated debt: the inverse of a convertible bond

More than six in 10 delegates said they are likely or very likely to buy the subordinated debt Europe’s too-big-to-fail banks have been urged to issue by the Financial Stability Board (FSB). The FSB deems this necessary to decrease the likelihood banks would again have to be saved by the taxpayer if they get into trouble.

David Bennett, manager of the Standard Life Investments Total Return Credit Fund, which is mainly invested in high yield bonds, conceded the high coupon on these bonds looks attractive. “If you do your credit selection very carefully and pick banks that are deleveraging, then you can clip that extra yield for a while. Making sure you watch for earnings writedowns is crucial,” he told the audience.

However, Bennett believes these securities are too risky for most fixed income funds, since they do not provide any downside. “It’s actually the inverse of a convertible bond.”

Or is it an equity look-a-like?

The dissimilarity with convertible bonds is exactly the reason that Renaud Martin, head of convertible bonds at Mirabaud asset management, is not enthusiastic at all about subordinated bank debt. “With convertible bonds, you convert at a good time. With coco’s, you are asked to convert when capital ratios are going down, which is bad because the stock will obviously also have come down at that moment,” he explained.

The main problem he has with contingent convertibles is that there is no convexity on the higher end of the yield curve. “I wouldn’t invest in these bonds because I want to be protected on the downside.”  

François Rimeu, head of cross-asset and total return at La Française, acknowledged the objections of his compatriot. “Issuing these bonds is practically the same thing as issuing stocks. Subordinated debt is correlated to stocks on the downside. It’s basically an equity look-a-like for bond investors.”  

Click here for a full overview of the voting results from Expert Investor Italy.

And click here to see a slideshow of photos taken at the event.

Part of the Bonhill Group.