Lehman favours bank cap bonds and high-yield debt

The bank advises bond investors to consider opportunities in Asian bank cap securities and high-yield credit.
Lehman BrothersÆ credit research team is recommending investors find opportunities in Asian bank capitalisation bonds and high-yield corporate debt, given an economic outlook for a æsoftÆ landing of the United States economy, with stable US interest rates, tight corporate spreads and the threat of leveraged buyouts in the corporate sphere.

This also reflects a view that Asian high-yield credit is relatively more attractive than high yield in America, says Pradeep Mohinani, senior vice president for Asia credit research at Lehman in Hong Kong. And similarly, bank cap securities are priced wider than corporates.

He believes the current inversion in the US Treasury yield curve is due to structural factors (ie, huge demand from Asian central banks, oil producers and pension funds) and is not predicting a recession. He expects the Treasury yield curve to eventually normalise, and swap spreads could widen back out.

Nonetheless, high-grade sovereign and corporate spreads against US Treasuries will remain tight, so investors must seek gains in credit through increasing exposure to financial institutions. The global corporate sector offers little value because spreads there are also very tight, and it is even less attractive in Asia, where many companies are on the acquisition trail and more likely to leverage their balance sheets û to the detriment of bondholders.

ôWe recommend investors either put on relative-value trades versus sovereigns, or negative basis trades,ö Mohinani says on the high-grade corporate front.

Relative value involves putting on trades using credit default swaps: buying protection on corporates and selling it on sovereigns û for example, buying five-year protection on Posco and selling five-year protection on Republic of Korea. Negative basis trades involve taking advantage of low premiums for credit default swaps that are actually below the price of the underlying corporate bond. In both cases, anomalies can be found in which investors are paid a carry to hedge away credit risk.

Tight spreads worldwide mean investors seeking enhanced returns must either use leverage against reliable businesses, or take many smaller positions in more volatile sectors. But, suggests Annisa Lee, vice president under Mohinani, Asian high-yield names trade wider than peers in the US, particularly after last yearÆs default by Ocean Grande and a slew of new, lower-quality issues. ôAsian high yield offers a cushion if thereÆs a sell off,ö she says.

LBOs are a growing risk to high-grade corporate investors, so Lehman believes the bank sector offers better value, particularly in markets set for a re-rating, such as Korea and India, says Hong Yang-myung, vice president for Asia credit research. Overall bank fundamentals are solid; growth may be modest (with the exception of India) but asset quality has improved.

ôThe cap securities side of banks looks positive,ö Hong says. ôSpread levels offer better yield than similarly rated corporates.ö

Hong believes that extension risk on bank cap securities is limited. Nonetheless, this risk should be factored into the credit ratings with investors still better compensated than in the corporate sector. By comparison, senior bank debt tends to trade very tightly. Lehman suggests selective picks from hybrid Tier-1 cap bonds, such as issues by Shinhan Bank or ICICI Bank, as well as Upper Tier-2 from Chinatrust Commercial Bank.
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