* Financials play bigger role in high-yield portfolios
* Higher coupons, returns, brighter outlook drive demand
* Ignoring banks seen as a huge bet for global funds
By Natalie Harrison
LONDON, Feb 14 (IFR) - High-yield investors are increasinglyturning to financials, lured by the better returns availablecompared to those on offer in the industrials sector.
The high-yield buyside has traditionally shied away fromFIG, but financials outperformed in 2012. Factor in the superiorreturns available, and that has changed many investors' minds.
Bank subordinated debt, including both Contingent Capital(CoCo) instruments and Tier 1 perpetual hybrids, is now at ornear the top of the wanted list for many accounts.
"The interesting development is the higher qualitybuy-and-hold high-yield investors that are now looking at theseinstruments," said Chris Cote, a syndicate banker at Bank ofAmerica Merrill Lynch.
"It's a healthy sign for the market in general, withincremental sources of demand helping to provide more stabilityto secondary trading."
While supply has been somewhat limited, banks need to issuethese kinds of instruments in order to meet new capitalregulatory requirements.
And the burst of interest will surely only fuel demand, asinvestors come to terms with the fact that high-yield looks setto dwindle to high single-digit returns - at best - in 2013.
Including financials, high-yield returned 27% last yearcompared to 23.25% excluding financials. Year-to-date they havereturned 0.041% and -0.125% respectively, according to Bank ofAmerica Merrill Lynch data.
"Ignoring financials is a huge bet that can offset all thebenefits of smart security selection elsewhere," said DavidNewman, head of global high-yield at Rogge Global Partners.
RELATIVE VALUE
The pick-up in demand goes right back to the Barclays CoCoin November, which was sold mainly to European and U.S.institutional investors rather than high net worth investors inAsia that have driven previous subordinated deals denominated indollars.
"Despite the large size of the Barclays CoCo, theinstitutional investor demand for that deal has helped the bondsremain stable in the secondary market," said BAML's Cote.
High-yield investors also accounted for a significantportion of the EUR5bn order book for Bank of Ireland's (BoI)EUR1bn three-year convertible CoCo, and the USD8.5bn book forBelgian bank KBC's USD1bn 10-year CoCo, which went a stepfurther in testing risk appetite because of its permanentwritedown structure.
The BoI and KBC CoCos, both rated Ba2/BB+, pay coupons of10% and 8% respectively - substantially higher than thoseoffered by similarly rated corporate issuers.
Irish-listed packaging firm Smurfit Kappa, rated Ba2/BB+,offered a 4.125% coupon on a EUR400m seven-year bond issued lastmonth, while British cable company Virgin Media's Ba3/BB- seniorsecured dollar and sterling tranches, which priced earlier inFebruary, offer 5.75% and 6% coupons respectively.
Meanwhile the improved stability in the financial sector hasalso helped to make banks more attractive, and there is ageneral feeling that a lot of banks in troubled regions haveturned the corner.
"Investors are now more willing to spend time assessingrelative value of specific credits," said Cote.
A NATURAL FIT?
To some extent, high-yield investors who track indices havealready gone heavily into financials due to a spate of bankdowngrades. Financials now account for about 18% of BAML'sglobal high-yield index.
In any case, high-yield investors are arguably more naturalbuyers of CoCos than traditional FIG investors, who are lesscomfortable with the instrument's loss features.
"High-yield investors are used to riskier instruments andare more familiar with distressed situations and scenarios wheredebt is swappped into equity," said Gerald Podobnik, head ofcapital solutions at Deutsche Bank.
Unlike in corporate restructurings - when losses forcreditors vary case by case - CoCo investors know from theoutset that they will be either converted into equity or writtenoff completely if capital ratios fall below a certain level.
Of course, that means CoCos are definitely a riskierinvestment - but that shouldn't necessarily deter investors,said Rogge's Newman.
"As with any credit investment, it is key that you only buywhat you fundamentally like and understand," he said.
Barclays (BARC)
