Speaker 1: Hello, and welcome to the Credit Edge, a weekly markets podcast.
Speaker 1: My name is James Crumby. I'm a senior editor at Bloomberg.
Speaker 1: This week, we're very pleased to welcome Fraser Lundy, head
Speaker 1: of fixed income at Federated Hermes, based in London. How
Speaker 1: are you, Fraser, Yeah, very well, thanks thanks for having me.
Speaker 1: Thank you so much for joining us today. I'm very
Speaker 1: keen to get your thoughts on the markets. We're also
Speaker 1: delighted to welcome back Lisa Lee, who covers credit markets
Speaker 1: from London. Great to see you again, Lisa.
Speaker 2: Great to see you too, thanks for having me.
Speaker 1: Also a bit later on the show, we're going to
Speaker 1: be talking to FRIEDA Silver, who covers the eighty one
Speaker 1: bond market for Bloomberg Intelligence based in Hong Kong. So
Speaker 1: do stay with us. But first, Fraser Lundy Federated Hermes.
Speaker 1: Great to have you on Credit Edge. Let's start with
Speaker 1: an easy one. Do you think that the US Federal
Speaker 1: Reserve has finished hiking? And how fast and deep do
Speaker 1: you expect them to start easning. I know it's a
Speaker 1: big one, but that's what everyone is talking about right now.
Speaker 1: Everyone has a view and I wanted to start with that.
Speaker 3: Yeah, I could see you smiling when you were asking
Speaker 3: that question there, So yeah, an easy one. Indeed, I
Speaker 3: think it's perhaps been slightly easier to answer that question
Speaker 3: than it would have been forty eight hours ago because
Speaker 3: of the data that we've been getting in most notably
Speaker 3: the CPI print, And you know, I think it is
Speaker 3: starting to mount up the evidence to give people conviction
Speaker 3: to say that we are now at a peak. So
Speaker 3: I think the harder part of the question is more
Speaker 3: related to the second part, which is the timing and
Speaker 3: extent of cuts to come. We do think actually there
Speaker 3: is scope for disappointment here in the sense that whilst
Speaker 3: it looks like we're traveling the right direction, now, you know,
Speaker 3: it's pretty likely to be bumpy. And I say that
Speaker 3: because this has to This has not been a normal
Speaker 3: cycle by any stretch. You know, when you think about
Speaker 3: the implications of COVID and wars and so on, making
Speaker 3: like for like comparisons that bit difficult, which means the
Speaker 3: data is going to continue to be pretty jumpy and
Speaker 3: hard to read from a trend perspective. So to the
Speaker 3: extent that people are becoming a little bit too you know,
Speaker 3: over a confident in that cut progression into next year,
Speaker 3: and we're maybe getting there that there is some scope
Speaker 3: for disappointment, but you know, bigger picture in longer term
Speaker 3: that that is where we're headed.
Speaker 1: Yeah, we've seen some big calls this week. UBS expects
Speaker 1: the FED cut rates by two hundred and seventy five
Speaker 1: basis points next year. That's almost four times what the
Speaker 1: you know, more than what the market's pricing right now.
Speaker 1: Morgan Sandy expects easing to start next June. Goldman maybe
Speaker 1: later in the year, but everyone is kind of getting
Speaker 1: more excited about easing starting next year. As you say,
Speaker 1: it's kind of the pace of it, and when it
Speaker 1: happens could be some big disappointment. But then from there,
Speaker 1: you know, because this is a credit show phrase, it
Speaker 1: where do we go from here in terms of credit?
Speaker 1: How does that inform your credit view?
Speaker 3: Yes, so, I mean, I think what we're thinking about
Speaker 3: at the moment from a more credit specific perspective is
Speaker 3: that the volatility markets, as so called fear gauges, I
Speaker 3: think is one of the most interesting things in the
Speaker 3: sense that equity and credit volatility are are pretty low here.
Speaker 3: If you look at the vics, for example, in equity space,
Speaker 3: I think we're sub fourteen right now, which is well
Speaker 3: below long term averages. The one outlier remains interest rate volatility, which,
Speaker 3: as we've just been talking about, is elevated because there
Speaker 3: is still some uncertainty around timing of peak and cuts
Speaker 3: to me in credit. There's quite a lot of sub
Speaker 3: sectors that have been disproportionately hurt by that inflated interest
Speaker 3: rate volatility regime over the last year eighteen months, and
Speaker 3: it's there that we think you're likely to see most
Speaker 3: of the benefit from what we think is going to
Speaker 3: be a movement of that pendulum from essentially inflation concerns
Speaker 3: towards growth concerns. You know, obviously, the longer we are
Speaker 3: at this higher for longer state of play, the more
Speaker 3: punishing it is going to be, inevitably for both consumers
Speaker 3: and for corporates in terms of earnings and balance sheet degradation.
Speaker 3: But actually the areas that we think are perhaps most
Speaker 3: interesting are ones that should be more shielded from that
Speaker 3: direct sensitivity, sensitivity to the underlying economy, because they tend
Speaker 3: to be areas of the market that have been hurt
Speaker 3: more by that interest rate volatility. So, you know, we
Speaker 3: don't think things are going to be getting easier from
Speaker 3: here for corporates. Actually far from it. We think there
Speaker 3: is going to be an inevitable increased headwind as companies
Speaker 3: start to think about refinancing to the new normal of
Speaker 3: much higher coupons. But there is a sufficient amount of
Speaker 3: the credit spectrum out there that I still think is
Speaker 3: priced quite interestingly that as long as you are not
Speaker 3: falling into the trap of thinking that there's going to
Speaker 3: be a rising tide floating all boats and you are
Speaker 3: quite discriminate when it comes to credit quality and security selection,
Speaker 3: I think it is still a pretty constructive environment.
Speaker 1: Is that a global view or do you have particular
Speaker 1: regional biases?
Speaker 3: Well, for the most part, it is a global view.
Speaker 3: I would say though that in the US, where the
Speaker 3: economy is and is likely to remain more resilient certainly
Speaker 3: than it is here in Europe, there is something of
Speaker 3: an offset to that from a credit perspective, which is
Speaker 3: that a lot of those gains or benefit I think
Speaker 3: go to shareholders first through more equity friendly behavior from
Speaker 3: those corporates, and we have seen and will see I
Speaker 3: think a lot of share buy back activity, hiking of
Speaker 3: dividends as well as you know to some extent debt
Speaker 3: funded M and A, and I think those things are
Speaker 3: more prevalent in the US, and I think just you know, again,
Speaker 3: sometimes taking a step back, people forget that in credit
Speaker 3: we don't like things to be too good because when
Speaker 3: times are too good, you know, that's when you need
Speaker 3: to be in equities frankly, and actually we love a
Speaker 3: muddle through. So you know that to me essentially cancels
Speaker 3: out the gains that you might have thought would be
Speaker 3: there for the US versus Europe or or the rest
Speaker 3: of the world. So to me, it's more about sector
Speaker 3: specific and credit quality specific that I think is the differentiation.
Speaker 2: So you say credit quality, would you go lower under
Speaker 2: a skill would you so high your bards, leverage loans
Speaker 2: or would you prefer stay more higher graded investment grade
Speaker 2: given the macro environment and then the fact that we
Speaker 2: might be a peak.
Speaker 3: Yeah, I mean, this has been an incredibly interesting year
Speaker 3: because despite what everyone might have thought at the begin
Speaker 3: the year, you've seen some pretty outstanding returns from the
Speaker 3: very lowest quality of credit, particularly triple C rated credit,
Speaker 3: which I believe is still double digit returns here today
Speaker 3: as of today. Know that is something that I think
Speaker 3: most people would be very surprised to have heard at
Speaker 3: the start of this year, and it's been a combination
Speaker 3: of the fact that recessionary fears have been delayed and
Speaker 3: or canceled, depending on your view. But also there's a
Speaker 3: technical element to this, which is, you know, perhaps less appreciated,
Speaker 3: the market itself is shrinking. You know, high yield as
Speaker 3: an asset class is shrunk roughly ten percent in the
Speaker 3: last year. Most estimates have it shrinking again by another
Speaker 3: five next year, and essentially that means there's less stuff
Speaker 3: to buy in a market where things have proved more
Speaker 3: resilient than what most people thought. Now. I don't think
Speaker 3: that's going to continue forever, and I certainly wouldn't want
Speaker 3: to base a constructive view on triple C credit on
Speaker 3: the fact that there's less of it to buy. And
Speaker 3: actually there is an element of that market that I
Speaker 3: think will also end up being paper gains, only in
Speaker 3: terms of what that has been achieved this year, you know,
Speaker 3: private credits emergence has been an interesting element of that
Speaker 3: as well. Generally speaking, there has been less M and
Speaker 3: A and LB activity this year, but what activity there
Speaker 3: has been has seen a competing source of funding for that,
Speaker 3: and again that's fueling this shrinking of the market. So
Speaker 3: there are always going to be exceptions. But I would
Speaker 3: say at this point that you know, being higher quality
Speaker 3: in your allocations from a multi asset credit perspective is
Speaker 3: likely to pay off well going to next year. And
Speaker 3: actually you don't really need to stretch in order to
Speaker 3: achieve some pretty meaningful yields here, which is another, you know,
Speaker 3: comforting thing to think about. When we think about relative
Speaker 3: value and credit, we try as much as possible to
Speaker 3: extend the discussion beyond just simple spread. And obviously a
Speaker 3: lot of people will will will focus on spread. You know,
Speaker 3: what's the spread, what's the default rate? Are we compensated?
Speaker 3: I think for many end investors the yield number is
Speaker 3: just as important, arguably more important, and because of what's
Speaker 3: happened to underlying government bond yields and cash rates, the
Speaker 3: yields on offer today are very attractive versus history, and moreover,
Speaker 3: the actual cash price of the bond you're buying is
Speaker 3: very low compared to history. I think the average cash
Speaker 3: price in hw you, for example, right now is about
Speaker 3: eighty eight cents in the dollar. Investment grade not dissimilar,
Speaker 3: maybe nineteen ninety one cents in the dollar. And this,
Speaker 3: you know, this makes the capital appreciation potential of the
Speaker 3: acid class that bit greater. There's nothing in the way
Speaker 3: of ceilings to hit, whether it be call option related
Speaker 3: or otherwise. And you know, I do think that, you know,
Speaker 3: still being pretty foot on the gas, but foot on
Speaker 3: the gas in the higher quality segment of the market
Speaker 3: is the right way to play this.
Speaker 2: You notice that the levi's loan market has been shrinking
Speaker 2: this year, and a lot of that has to do
Speaker 2: with the rise of private credit, which which many people
Speaker 2: are saying, so the goal an age of private credit
Speaker 2: investors are very bullish on the asset class. Given peak race,
Speaker 2: do you think is still going to be the golden era?
Speaker 2: And tell me what do you how you think through
Speaker 2: the interplay of private credit and leverage loans.
Speaker 3: Yeah, I mean, the leverage market is an interesting one
Speaker 3: because it gives you an insight into the immediate effect
Speaker 3: of that coupon change that we are experiencing because of
Speaker 3: underlying rates. Because it's a floating rate instrument, the interest
Speaker 3: coverage ratios that you see today have already taken the
Speaker 3: full brunt of that pain. Whereas asset classes like high
Speaker 3: yield and investment grade being more fixed in nature, haven't
Speaker 3: yet to any meaningful degree. So there has already been
Speaker 3: a decent amount of pain in there, and I would
Speaker 3: say similarly, some of that has been not fully absorbed
Speaker 3: in terms of market prices because the market has been shrinking,
Speaker 3: there's less of it to buy, and it's been artificially
Speaker 3: propped up to some extent. The Again, I would say
Speaker 3: that the differentiation there is not as pronounced as I
Speaker 3: would have liked like it to be in order to
Speaker 3: be more constructive. In the leverage loan space generally speaking,
Speaker 3: is dominated by you know, private companies and financially levered companies,
Speaker 3: and the other thing that concerns me is we're coming
Speaker 3: in off the back of a decade or more of
Speaker 3: continuously declining covenant quality, and you're already starting to see
Speaker 3: that take effect in terms of the low recovery rates
Speaker 3: that are being realized on restructuring and default scenarios in
Speaker 3: the levers loan market. Now, it's not moving the needle
Speaker 3: yet because the default rate is only you know, one
Speaker 3: two percent, but we are going to go to three
Speaker 3: and four and possibly five and above, and you know,
Speaker 3: if you are experiencing recovery rates in the event of
Speaker 3: default that are say, half what they might have been
Speaker 3: long term history wise, then that becomes quite painful from
Speaker 3: a loss given default perspective, and suddenly, you know, that
Speaker 3: extra premium that you thought you were receiving in terms
Speaker 3: of spread quite quickly gets eaten away at. You know,
Speaker 3: private credits emergence is another very interesting one, and I
Speaker 3: do think that you can argue that in normal market
Speaker 3: conditions it's probably a positive for the public market space
Speaker 3: in the sense that it's an additional potential source of
Speaker 3: funding and therefore another area that more stress corporates can
Speaker 3: can look to to pull at. And it's also shrinking
Speaker 3: our market, so it's adding that technical positive as well.
Speaker 3: There is obviously some potential concerns and red flags about
Speaker 3: it as well, though, which I think would be more
Speaker 3: relevant in a more dysfunctional market. You know, people estimate
Speaker 3: that private credit has now reached something like a trillion
Speaker 3: dollars in size, which puts it roughly the same size
Speaker 3: as the US high you market. Now. It took fifty
Speaker 3: years and more for US hih yield to get to
Speaker 3: the size it is today. Private credit barely existed ten
Speaker 3: years ago. That on its own to me is something
Speaker 3: of you know, a concern or something to be monitored,
Speaker 3: as is obviously the opacity of the returns and frankly
Speaker 3: the opacity of the fundamentals because it's not a rated
Speaker 3: asset class, but where it rated, I would imagine that
Speaker 3: the likes of SMP in modies would probably rate its
Speaker 3: single BEE or thereabouts. And you know, as we know
Speaker 3: from the public market side, anything in single B space
Speaker 3: is currently undergoing a coupon shift from three four, five
Speaker 3: six percent to nine ten, eleven, twelve percent, and that
Speaker 3: is not going to be absorbed cleanly and easily. And
Speaker 3: the lack of lookthrough is something that I find it
Speaker 3: quite difficult to have conviction on.
Speaker 1: So do you expect a lot of defaults there? I mean,
Speaker 1: we might not even see them because the lenders just
Speaker 1: keep extending, right well.
Speaker 3: That is part of the problem related to loose covenants
Speaker 3: in general, is that the ability to as they say,
Speaker 3: extend and pretend because covenants are loose enough to do so,
Speaker 3: means that eventually, if there is a restructuring, that the
Speaker 3: recovery rates that are that bit lower. And actually I
Speaker 3: think if you look at the high YO market, which
Speaker 3: has better data, there's a very large percentage of the
Speaker 3: defaults that happen are companies that have previously defaulted. So
Speaker 3: if you're not very good to start with, then you know,
Speaker 3: it's difficult to reinvent a bad business essentially. So you know,
Speaker 3: all these things, combined with the performance that that low
Speaker 3: quality has had year to date, give us quite a
Speaker 3: high degree of confidence that it's an area that you
Speaker 3: can confidently not invest in materially here and focus on
Speaker 3: higher quality.
Speaker 2: Oh, you mentioned recoveries, and they've been shockingly low in
Speaker 2: the US for the leverage low market, loan recoveries are
Speaker 2: down at ten to twenty cents, and many people attribute
Speaker 2: that to some most called lender and lender violence, where
Speaker 2: sponsors and some lenders push down other lenders. We haven't
Speaker 2: seen that yet in Europe. Do you think that that
Speaker 2: will never come to the shores or do you exp
Speaker 2: that are you braced for it?
Speaker 3: I don't think there's any significant reason why it wouldn't
Speaker 3: come here. I think this is really to do with
Speaker 3: data set and size of sample, which so far has
Speaker 3: been quite small. As I mentioned, you know, default rates
Speaker 3: so far have been relatively small. Now there's more of
Speaker 3: them in the US generally because the US is in
Speaker 3: aggregate a lower rated asset class and it has more
Speaker 3: percentage of triple c's to start with. Now, triple C
Speaker 3: credit I think fifty percent of the time doesn't make
Speaker 3: it to maturity, you know, from issuance, which means that
Speaker 3: you're never to be going to find more of them
Speaker 3: in that part of the market. Now, through a recessionary
Speaker 3: period where default rates increase, you're going to get a
Speaker 3: bigger sample pool. And I don't think there's a significant
Speaker 3: difference when it comes to covenant language to suggest that
Speaker 3: Europe would be in some way immune to some of
Speaker 3: that type of behavior.
Speaker 1: So you do sound quite cautious phraser a role. I mean,
Speaker 1: obviously wea credit people, so we ah cautious naturally, But
Speaker 1: do you feel that we are that we have just
Speaker 1: delayed the big blow up that we were somewhat fearing
Speaker 1: at the beginning of this year.
Speaker 3: No, I mean, and actually thanks for pointing out that,
Speaker 3: because I don't want to appear too cautious. I think
Speaker 3: it's important to remember that most of what we look
Speaker 3: at is perfectly fine in terms of its ability to
Speaker 3: weather through somewhat harder times, and in fact, you know,
Speaker 3: if you're talking about investment grade and the vast majority
Speaker 3: of the double B space, let's say, declines of five
Speaker 3: ten percent of EBITD something like that, you know, as
Speaker 3: a mild recessionary. If that type environment, which is probably
Speaker 3: most people's case for going to next year for most
Speaker 3: of those companies, if not the vast majority of those companies,
Speaker 3: all that means is dialing down their dividend payments, dialing
Speaker 3: down share buybacks, you know, maybe holding off on debt
Speaker 3: funded m and A. It's you know, it doesn't need
Speaker 3: to be more than that. Having said that, you know,
Speaker 3: I think when you're going into that type of mark environment,
Speaker 3: it's important to think about the premiums that you're being
Speaker 3: paid for different types of company. So, you know, real
Speaker 3: sort of laser eye attention on cyclicality, premium, country premium,
Speaker 3: the premium for owning a private company versus a public company. Obviously,
Speaker 3: you know, from that perspective, I think that's a really
Speaker 3: important one in the credit space because going into harder
Speaker 3: times public companies, I think people sometimes forget it's that
Speaker 3: bit easier for them to raise other forms of capital
Speaker 3: you know, they can do a rights issue, they're more
Speaker 3: readily available to do non core asset sales and so on.
Speaker 3: And I think, you know, these are all ultimately not
Speaker 3: great if we were sitting here having an equity podcast, frankly,
Speaker 3: And I do think that some of these grafts that
Speaker 3: will show you right now that yields and credit are
Speaker 3: significantly above yields of dividend yields, they to me, from
Speaker 3: a more multi asset perspective, would suggest that people need
Speaker 3: to remember that you know, you can pay a dividend,
Speaker 3: but you must pay a coupon. And that feels like
Speaker 3: that's the type of environment we're going to be going
Speaker 3: to next year.
Speaker 1: So to use your phrase the laser like focus, I mean,
Speaker 1: where are the best opportunities right now? You have a
Speaker 1: really big broad remit, you look at everything. What is
Speaker 1: the best thing to invest in, you know, by product,
Speaker 1: by geography, by sector?
Speaker 3: Yes, I think I think probably the two things that
Speaker 3: we're trying to hone in on are what has been
Speaker 3: hurt by interest rate volatility and what's been hurt by
Speaker 3: just generally this rise in yields that has already taken
Speaker 3: that pain. So that brings me to areas like, you know,
Speaker 3: the long end of the investment grade market where cash
Speaker 3: prices are phenomenally low and you're not talking about having
Speaker 3: to buy bad companies to access that. You're you're buying
Speaker 3: real blue chips at fifty and sixty cents on the dollar. Here,
Speaker 3: That to me is an underappreciated advantage when it comes
Speaker 3: to convexity, when it comes to jump to default risk,
Speaker 3: when it comes to access to upside event risk. And again,
Speaker 3: you know, CFOs of companies are not stupid, and they
Speaker 3: are knowing that that they're going to be in harder times.
Speaker 3: I think they will be more incentivized to look at
Speaker 3: their cap structures and think about being more preemptive and opportunistic.
Speaker 3: So I think you're going to see more in the
Speaker 3: way of tender activity, can sense solicitations, early addressing of
Speaker 3: front end bonds. All that leads me to believe that
Speaker 3: focusing on cash price of securities is going to be
Speaker 3: really important. Away from that, I think areas like the
Speaker 3: corporate hybrid space in Europe are particularly interesting. They have
Speaker 3: suffered somewhat in sympathy with the pain that eighty one
Speaker 3: financials have had in Europe this year. Even though they
Speaker 3: have nothing really to do with financials or indeed that
Speaker 3: security type, other than they are another form of subordinated
Speaker 3: perpetual debt. That part of the market, to me, is
Speaker 3: quite dislocated from straight debt, and I think will ultimately
Speaker 3: be one of the major beneficiaries of normalized of that
Speaker 3: interest rate volatility regime. Another one actually will be the
Speaker 3: eighty one market itself. And you know, you've seen some
Speaker 3: recent primary market deals, probably most notably the UBS deal,
Speaker 3: which underlines just how big the pent up demand is
Speaker 3: for yielded paper in that space. In fact, from what
Speaker 3: I read, the order book on that deal equated to
Speaker 3: nearly twenty percent of the size of the entire market
Speaker 3: for eighty one's never mind UBS. So you know, those
Speaker 3: are two areas that I think it's worth leaning on here.
Speaker 3: I think the structured credit space is also pretty interesting. Again,
Speaker 3: the floating rate nature of it means that it's now
Speaker 3: at some very attractive yields, and being able to access
Speaker 3: that complexity and illiquidity premium in lieu of more sensitivity
Speaker 3: to the underlying economy is something that I think will
Speaker 3: continue to be an interesting thing to be done. And
Speaker 3: you are going to see more broad participation from a
Speaker 3: whole host of different types of investor base in that
Speaker 3: structure credit area continue and I think that will continue
Speaker 3: to add to the quality of that as an allocation.
Speaker 1: Type, massive area multitude of sins. So what do you
Speaker 1: mean by structure credit here? Is it clos? Is it nbs,
Speaker 1: is it CMBs? What are you talking about here?
Speaker 3: Yeah, I'm predominantly talking here. You know, if I was
Speaker 3: to choose within that spectrum, we would probably be focused
Speaker 3: mostly on the European CLO space in the investment grade
Speaker 3: parts of that cap structure. And from a risk reward perspective,
Speaker 3: if you look at where triple B CLO tranches are
Speaker 3: currently pricing, to me, there's a very significant premium to
Speaker 3: for example, I Track's crossover or CDX hig yield in
Speaker 3: terms of looking at some of the comparable spread in
Speaker 3: public markets. And you know that won't always be the case,
Speaker 3: and I think it's important to be sizing those types
Speaker 3: of allocations appropriately. But the fact that they do not
Speaker 3: correlate that highly on a day to day, week to
Speaker 3: week basis with a lot of other things that we
Speaker 3: look at mean that they are official to an overall
Speaker 3: multi asset credit allocation. I would also say there are
Speaker 3: ears that we don't like at all right now, emerging
Speaker 3: market debt being one of them, just purely on a
Speaker 3: valuation basis. But it's still worthy of its place, albeit
Speaker 3: in a small way, within a multi asset credit context,
Speaker 3: because of that decorrelation argument and being able to push
Speaker 3: your portfolio out that efficient frontier to get to a
Speaker 3: bitter return basis. I would say the same about leverage loans,
Speaker 3: albeit I think that you know, again it's now not
Speaker 3: the time to be leaning too heavily on that space.
Speaker 1: So last question praise before we talked to pre de
Speaker 1: silver Ritt Bloomberg Intelligence about the at one market, what
Speaker 1: in a big global context, what is your biggest contrarian trade?
Speaker 3: Well, I mean, I think where we are possibly most
Speaker 3: out of kilter with the market right now is from
Speaker 3: a sector perspective, and this is perhaps more appropriate from
Speaker 3: a US audience US investor base, but I've heard more
Speaker 3: recently people referring to the energy sector as a safe haven,
Speaker 3: and that to me is a big red flag. It
Speaker 3: has obviously performed very well essentially ever since the Russia
Speaker 3: Ukraine crisis kicked off and the fundamentals in that space
Speaker 3: continue to be very robust. There's a lot of M
Speaker 3: and A. There's not a lot to dislike, frankly, but
Speaker 3: in credit space again, I feel like we're at the
Speaker 3: point now where it's a little bit like pre the
Speaker 3: energy crisis of twenty fourteen fifteen in the US space,
Speaker 3: where it became very shareholder friendly very quickly, and from
Speaker 3: a valuation perspective, it's never really been this expensive relative
Speaker 3: to the rest of the market. And you to me,
Speaker 3: I think if you look longer term, stretched this back
Speaker 3: over twenty thirty fifty years, energy essentially is a global
Speaker 3: GDP play. I mean that has a beta of one
Speaker 3: to that and if we're going to go into tougher
Speaker 3: times or maybe we stretch into recessories fact times, who knows.
Speaker 3: I find it very hard to believe that energy as
Speaker 3: a sector will continue to be as expensive as it
Speaker 3: currently is. So that is an area that we are
Speaker 3: holding essentially nothing in or close to nothing right now
Speaker 3: and expect it to underperform next year. I don't think
Speaker 3: you'll find many people who agree with me.
Speaker 1: Is that ESG related at all?
Speaker 3: Red Well, I think there's an element of ESG thinking
Speaker 3: comes into it. But really this is more than that.
Speaker 3: This is about I think, I guess to some extent
Speaker 3: connected from a governance perspective, but I do feel that
Speaker 3: in that space the incentives to be more short term
Speaker 3: shareholder friendly are a little bit too high. But really
Speaker 3: it's I think, to do with short term memories as
Speaker 3: well as much as anything. The fact is it's done
Speaker 3: well for two three, four years, and therefore people are
Speaker 3: starting to lean on it so heavily that they're actually
Speaker 3: changing their opinion of it. As I said, become a
Speaker 3: safe haven asset class, which I think is it's not likely.
Speaker 2: To be so. Talking about safe haven, what asset classes
Speaker 2: would you consider safe haven? And you mentioned eighty ones
Speaker 2: which are sort of more yieldy product in the financial seeking, Yes,
Speaker 2: return seeking perhaps not a safe but you take on
Speaker 2: bank financials and financial credit and whether given the way
Speaker 2: the economy is going it is it is a lever
Speaker 2: play on the economy, and whether you would go into
Speaker 2: that space maybe in the I grade section.
Speaker 3: Yes, I think the eighty one space is going to
Speaker 3: continue to be very volatile. It is a gog asset class.
Speaker 3: As you said, it's deeply subordinated, but banks more generally
Speaker 3: are trading pretty cheap by most historic standards, and you
Speaker 3: can triangulate this in various different ways, but I think
Speaker 3: you know, versus corporates, they are here, you know, attractive levels.
Speaker 3: I don't think you can say there's much in the
Speaker 3: way of the equity friendliness risk that we are been
Speaker 3: referring to elsewhere. There is a lot of I think
Speaker 3: implicit backing from politicians and regulators to ensure that banks
Speaker 3: continue to function and lend at a point when lending
Speaker 3: surveys would suggest that that's not looking great. And you know,
Speaker 3: if we are going to avoid harder times next year,
Speaker 3: we do need the banks to continue to be as
Speaker 3: facilitating as possible, and so we do remain pretty constructive
Speaker 3: on that space, but again not expecting it by any
Speaker 3: stretch to be a safe haven and needs to be
Speaker 3: sized appropriately.
Speaker 1: Great stuff. Raiser Lundy, head of fixed Income at Federated
Speaker 1: Hermes in London, thank you so much for joining us.
Speaker 3: Thank you very much.
Speaker 1: And Lisa Lee with Bloomberg News in London, thanks to
Speaker 1: you again. Brilliant to see you and thanks for all
Speaker 1: your questions.
Speaker 2: Thank you so much for having me again.
Speaker 1: Read all of Lisa's great scoops on the Bloomberg terminal
Speaker 1: and of course at Bloomberg dot com. So, as I
Speaker 1: mentioned earlier, were joined again by pre Da Silver with
Speaker 1: Bloomberg Intelligence in Hong Kong.
Speaker 4: How's it going, pre James, My pleasure, glad to be back.
Speaker 2: Great.
Speaker 1: Last time we were on the show, we were in
Speaker 1: the midst of a banking crisis which claimed Credit Swiss
Speaker 1: as one of its victims. Very volatile times. Amazing to
Speaker 1: think it was only just earlier this year, but at
Speaker 1: that time, I mean this was an April I think
Speaker 1: we taught you made a very bold call at that time,
Speaker 1: predicting that eighty one's would make a swift comeback, and
Speaker 1: you were right. So this is your victory, lap Prix.
Speaker 4: Thank you so glad to glad to get that call right.
Speaker 1: So right now, let's look at the market and see,
Speaker 1: you know what's ahead. The dollar eighty one market is
Speaker 1: very active. We've seen quite a lot of deals. But
Speaker 1: I wanted to just gently break everyone into this market
Speaker 1: because there are some people still that don't really know
Speaker 1: what this is. So if you can just kind of describe,
Speaker 1: you know, what it is and why has it been
Speaker 1: so hot in the news this year.
Speaker 4: So in eighty one stands for additional TiO one securities
Speaker 4: and banks issue these securities for regulatory capital purposes, and
Speaker 4: banks in regulated entities they need to meet certain capital requirements,
Speaker 4: so this helps them get there, and it's a cheaper
Speaker 4: alternative for instead issuing common equity, So that's the incentive
Speaker 4: for banks. For investors, the attraction here is a higher yield.
Speaker 4: The eighty ones that are currently in the market are
Speaker 4: offering close to ten percent, which is quite high compared
Speaker 4: to where the US treasuries are and compared to our
Speaker 4: regular investment grade corporate bonds are trading. So from an
Speaker 4: investor standpoint, it's an opportunity or an avenue so to speak,
Speaker 4: to generate a higher return.
Speaker 1: But for that higher return, you're obviously gonna have to
Speaker 1: take on bigger risk, and the big risk as you
Speaker 1: get wiped out as you did in the case of
Speaker 1: Credit Swiss earlier this year. How has that affected the sentiment?
Speaker 4: So after the credit Sweeze debacle, so to speak, the
Speaker 4: market crosse effect actively shot and no issue could come
Speaker 4: to the market, as we discussed at that point, and
Speaker 4: right now banks are able to come and issue eighty
Speaker 4: ones without any major challenge. What's different, so to speak,
Speaker 4: is the rates that they're paying. So prior to the
Speaker 4: events around Credit Suis and the collapse of SBB, eighty
Speaker 4: one as an asset class was yielding about call it
Speaker 4: two and a quarter percent more than US treasuries. And
Speaker 4: right now things have improved. The spreads are narrowed, but
Speaker 4: eighty ones just as a whole are still yielding about
Speaker 4: two point six five maybe close to two point seven
Speaker 4: percent over the treasuries. So the market conditions have improved,
Speaker 4: but they haven't made the full round trip back.
Speaker 1: But why do you think the market came back so quickly?
Speaker 1: Was it just demand?
Speaker 4: So? I think a couple of things. One the key
Speaker 4: thing here is the opportunity to custer sitting on the sidelines.
Speaker 4: If you're an investor, you have somebody issuing at ten
Speaker 4: percent with the ten percent coupon. If you don't participate, yeah,
Speaker 4: it's going to create performance issues down the road. And
Speaker 4: I think that's a that's one key driver. The second
Speaker 4: is a whole full court press so to speak that
Speaker 4: the the bank especially made to kind of get the
Speaker 4: message across that credit speez might be an isolated kind
Speaker 4: of an event and that kind of behavior may not
Speaker 4: be then arm.
Speaker 1: So after that wipeout by credits Waze and I think
Speaker 1: there are still some lawsuits, right but but are there
Speaker 1: any kind of other implications on the eighty one market?
Speaker 1: Have structures changed of you know, is there anything new
Speaker 1: and in the guarantees all the paperwork that gives you
Speaker 1: more safety in the event of a credit swis type event.
Speaker 4: With Credit swiez, what happened was when Finnma decided basically
Speaker 4: said the as a class needs to be wiped out.
Speaker 4: It was. It was a complete write down, so investors
Speaker 4: lost everything. And now what the issuers are trying to
Speaker 4: do and kind of come up with an alternative, is
Speaker 4: to do the other more popular avenue, which is to
Speaker 4: convert to equity, and that helps recapitalize the bank the issuer,
Speaker 4: but they're doing it in a more investor friendly manner
Speaker 4: because at least this way you get common equity instead
Speaker 4: of you're eighty one, but you're not getting completely written
Speaker 4: down and stuck with nothing. So that's a the whole.
Speaker 1: Bit that would been in the event of some kind
Speaker 1: of issue, some kind of problem with the issue.
Speaker 4: Right, Yes, in the event of a RTE down or
Speaker 4: in the event of a non viability event.
Speaker 1: Okay, but you'd be getting equity in an entity that
Speaker 1: you would hope has some value.
Speaker 4: Yes, that's these af are were the instruments. So ideally
Speaker 4: this all goes to show that you can't be shoveling money.
Speaker 4: People need to roll up the sleeves, do the credit work,
Speaker 4: and spend some time understanding what you're buying and paying
Speaker 4: attention to your holdings.
Speaker 1: So, as we discussed earlier this year, you know bold
Speaker 1: calls from pre to silver, you talked about a comeback
Speaker 1: for the Japanese banks in the eighty one market. That happened,
Speaker 1: is happening even more now what's going on there?
Speaker 4: Yeah, So back then I think the Japanese banks were
Speaker 4: the most likely to issue because they could issue into
Speaker 4: the end market and that was almost as somewhat island
Speaker 4: in its own way. Now what's happening is back in September,
Speaker 4: we kind of went out and made another ball call
Speaker 4: saying Japanese banks will need to issue up may issue
Speaker 4: dollar denominated eighty ones and two months later Behold MUFG
Speaker 4: issued the first ever dollar denominated additional T one by
Speaker 4: a Japanese bank, and so that's a big development. And
Speaker 4: the reason I think it's a big development is because
Speaker 4: the investor base for eighty one s tends to be
Speaker 4: a lot of private wealth, private banks. And so if
Speaker 4: you're a non US investor, and if you're buying US
Speaker 4: eighty one equivalent the US preferred stock, you're subject to
Speaker 4: federal tax withholdings. That makes it a lot more likely
Speaker 4: that the private welve private banking crowd is overexposed to
Speaker 4: European banks and European bank eighty ones. And so when
Speaker 4: the Japanese banks are able to now going to issue
Speaker 4: dollar denominated eighty once, that opens a whole new avenue,
Speaker 4: a whole new almost a sector that investors can now
Speaker 4: invest in.
Speaker 1: And is there relative value against Europe in Japan.
Speaker 4: In terms of relative value? Some of the European banks
Speaker 4: are offering much higher coupons. So sub geners in the
Speaker 4: market they issued at ten ten percent ubs which bought
Speaker 4: Grady Sweez came to the market with a jumbo size
Speaker 4: three and a half billion deal that is paying in
Speaker 4: nine o'clock out of percent coupon our dividend, and Barclays
Speaker 4: is also in the market that looks like that. My
Speaker 4: price in the high nine, So quite a bit of
Speaker 4: the European eighty ones are coming up with higher coupons.
Speaker 4: I think where the value in Japanese eighty ones is
Speaker 4: as a diversification option for investors. You may not get
Speaker 4: close to ten percent, but there's a benefit to having
Speaker 4: a diverse portfolio. And the other thing that if I
Speaker 4: may add is Japan has a different regulatory set up,
Speaker 4: our structure, and that may create that makes the eighty
Speaker 4: ones less risky. So, without getting too much into the
Speaker 4: weeds here, Japan's Insurance Deposit Insurance Act allows banks to
Speaker 4: get capital from the public sector without causing a ride
Speaker 4: down of capital securities like eighty ones, So that is
Speaker 4: a key differentiating factor and that needs to get recognized.
Speaker 4: So in other words, Japanese eighty ones are less risky
Speaker 4: than a similar security issued by a European bank.
Speaker 1: And back to the issue perspective here, you're saying that
Speaker 1: it's it's attractive for an issue right now to issue.
Speaker 1: I mean, is it cheap for them to on a
Speaker 1: relative basis for them to raise that through the eighty
Speaker 1: one market.
Speaker 4: Form a Japanese bang. The alternative is to issue common equity.
Speaker 4: So when you think about what's cheaper costa common equity
Speaker 4: or cost of an eighty one. And if a Japanese
Speaker 4: bank were to come to the based on where MFG
Speaker 4: is trading almost seven and a half percent, European banks
Speaker 4: close to ten. Still it's cheaper than common equity. So
Speaker 4: I think from an issue standpoint, it's still attractive to
Speaker 4: optimize the capital structure and have eighty ones to the
Speaker 4: optimal level.
Speaker 1: So we expect issuans to continue at this pace through
Speaker 1: next year, do we?
Speaker 4: Yes? Right now, what you're seeing is a little bit
Speaker 4: of catching up because the market was frozen for a
Speaker 4: while and nothing got done. But once the catching up
Speaker 4: is done, I think you'll still start to see and
Speaker 4: one of the drivers a this is the Barcil three
Speaker 4: reforms that are taking place globally that causes leading to
Speaker 4: an increase in respected assets. Many more need for securities
Speaker 4: such as eighty ones and subordinated debt, which are t
Speaker 4: your two notes So.
Speaker 1: Okay, great, So to wrap it up, pre what else
Speaker 1: are we looking at right now? And what were your
Speaker 1: bold calls for twenty twenty four? You've been proven right
Speaker 1: in the past. We trust your view. What if you
Speaker 1: should we be looking at here.
Speaker 4: Thank you James. Thanks for the kind words. In terms
Speaker 4: of we expect, we expect more eighty one from Japanese banks.
Speaker 4: That I think is we are on track for that
Speaker 4: the basil free reforms and are probably going to lead
Speaker 4: to an increase in issuance for most banks globally. And
Speaker 4: the other kind of lingering thing is Chinese banks. They
Speaker 4: need to start issuing bail in debt at some point
Speaker 4: and the deadline is basically in the next year, so
Speaker 4: we should see a lot of teap of bailing debt
Speaker 4: been issued by Chinese banks.
Speaker 5: Although it's hard to see a lot of investors out
Speaker 5: in Europe and US clamoring to buy Chinese bank bail
Speaker 5: in debt, but I think that's going to be a
Speaker 5: story out in Asia.
Speaker 1: Who would buy it.
Speaker 4: A lot of it is going to be issued on
Speaker 4: shore to the domestic Chinese market, and even the dollar
Speaker 4: de nominated that if you go by the track CREC card,
Speaker 4: it's going to be probably bought by the national team,
Speaker 4: so I think they'll follow suit.
Speaker 1: He you two great stuff. We'll definitely be watching your
Speaker 1: research with great interests pre to Silver with Bloomberg Intelligence
Speaker 1: in Hong Kong. Thank you. So much for joining us.
Speaker 4: James, thank you very much for having me.
Speaker 1: We look forward to having you back on the show
Speaker 1: very soon. And thanks again to Fraser Lundi, head of
Speaker 1: fixed Income at Federated Hermes in London, as well as
Speaker 1: to Lisa Lee from Bloomberg News. Read all of Lisa's
Speaker 1: great scoops on the terminal and at Bloomberg dot com,
Speaker 1: and please do subscribe wherever you get your podcasts. We're
Speaker 1: on Apple, Google and Spotify. Please give us a review,
Speaker 1: tell your friends, or email me directly at jcrumb eight
Speaker 1: at Bloomberg dot net.
Speaker 4: That's J.
Speaker 1: C ro O, M B I E as in my
Speaker 1: surname and the number eight at Bloomberg dot net. We
Speaker 1: do want to hear from you. I'm James Cromby. It's
Speaker 1: been a pleasure having you join us again next week
Speaker 1: on the Credit Edge.