It’s been more than three weeks since Mark Lieb, an investor who specializes in junior bank debt, returned to the US from a marketing trip to Europe but he only recently found the time to unpack his bags.
(Bloomberg) — It’s been more than three weeks since Mark Lieb, an investor who specializes in junior bank debt, returned to the US from a marketing trip to Europe but he only recently found the time to unpack his bags.
The founder and CEO of Spectrum Asset Management flew home the day before Silicon Valley Bank collapsed, setting off a market slide that culminated in Credit Suisse Group AG’s forced merger with UBS Group AG and the writedown of $17.3 billion of its most junior debt. Although Lieb didn’t hold any of Credit Suisse’s additional tier 1 bonds, the broader selloff caused by that move has sent his biggest fund tumbling 4.8% in the past month, according to data compiled by Bloomberg.
But that’s not what’s been keeping Lieb so busy. He’s spent much of the past few weeks buying up AT1s of Europe’s highest-quality banks, wagering that the Credit Suisse drawdown will have depressed prices far below what the notes are worth. On the day the markets opened following the Swiss merger his firm bought more than $100 million of the debt, he said.
“When you see these types of markets, you’ve got to take advantage of them,” said Lieb, who has been involved in subordinated securities since the 1970s and founded Spectrum in 1987. “This is why I’ve been in the business longer than anybody else.”
Lieb is one of a handful of outspoken investors who are convinced, even after the Credit Suisse writedown, that buying the riskiest bank bonds is the best way to make money in the current environment of soaring inflation and rising interest rates. Whether because of conviction or lack of an alternative, several of the money managers who were most exposed to the debt are now more bullish than ever.
Sebastiano Pirro, an investor who runs a €9 billion ($9.8 billion) fund for Algebris Investments, which is heavily exposed to AT1s and has lost more than 4% in the past month, says much of the selloff was related to margin calls and “panicky” investors.
“There were some weak hands, shaky hands, and the market is now mispriced,” Pirro said in an interview. “The market is a spectacular buy.”
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The strategy was paying off before the recent banking sector turmoil, with a multicurrency index of AT1s issued by European banks returning 3.6% in the first two months of the year. Junior debt isn’t backed by collateral and in the event of a crisis it usually only gets repaid after other bonds. But it offers some of the highest coupons in the credit market and gets paid back through optional calls after a few years, making it more attractive than longer-term debt when rates are going up.
But those high yields come at price. Although AT1s are specifically designed to absorb losses when banks collapse, few predicted the total wipeout of Credit Suisse’s notes. The bank had adequate capital metrics until shortly before its demise, as did Banco Popular Espanol SA when its junior debt was dissolved in 2017. The debt is also structured in such a way that banks can skip early redemption options and defer coupon payments, upending investors’ return expectations. The recent volatility has left the market in limbo, with few banks willing or able to sell new notes.
Yields have started to creep down, in part because the European Central Bank and the Bank of England gave assurances that AT1 debt would rank higher than equity in any future bank failures. By Tuesday, the total return index of AT1 bonds had returned close to the level it was at before the Credit Suisse writedown, though not to where it was trading at the start of March before the collapse of SVB.
Romain Miginiac, a credit investor at Geneva-based Atlanticomnium SA, which manages funds for GAM Investments, thinks there’s a high chance a euro fund that is heavily invested in AT1s can deliver double-digit returns this year. The €1 billion fund Atlanticomnium manages is down 5.2% in the past month, according to data compiled by Bloomberg.
“Credit Suisse was an idiosyncratic event,” Miginiac said. “While the underlying story had not changed, spreads have widened for the wrong reasons, which we believe creates an opportunity.”
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