Cazenove’s Peter Harvey has recently added one and two-year BP credit default swaps to his Strategic Bond fund, seeing all the bad news as priced in.
Although the manager bought the long risk stake slightly early in June, he is prepared to run the 2% exposure on the call that President Barack Obama needs BP to stay solvent for at least three years.
“At the end of March, the company reported total assets of $241 billion, liabilities of $136 billion and book equity of $105 billion,” adds the manager.
“With two-year bonds yielding 8% per annum, the bad news is already in the price”
“Our worst case scenario sees $65 billion (£41.5 billion) of claims and spill costs, resulting in a $45 billion writedown of US assets. Even after a $45 billion writeoff, the BP group would still have $60 billion of positive net worth and a liabilities/assets ratio of 70%. These are not great numbers for commodity firm but probably survivable.”
In this scenario, Harvey expects BP would remain investment grade, with a BBB/Baa2 rating.
“With two-year bonds yielding 8% per annum, the bad news is already in the price,” he adds.
“The biggest risk to our position is American litigation, which knows no bounds. Judges in Mississippi, Alabama and Louisiana could bring this company down. That is clearly not our view but an extreme case the market has occasionally visited.”
Harvey says the European credit market has stabilised but concerns over bank solvency and liquidity are still weighing on risk appetite. (article continues below)
According to the group, the current bout of risk aversion stems from the extremely low capitalisation of European banks.
By way of example, Deutsche Bank has €1.67 trillion of assets against only €40 billion of ordinary share capital.
“2.4% of equity capitalisation is an insufficient cushion,” adds Harvey.
“That number is not unique to Deutsche and does not inspire confidence among creditors.”