Bond managers with holdings in Royal Bank of Scotland and NatWest debt could see their performance hit after a shock Financial Services Authority (FSA) and European Commission ruling last week.
The FSA is blocking the banks’ attempts to repay holders of their lower- quality debt using bail-out money from the government. This means they could fail to meet the repayments on £950m worth of lower and upper tier two bonds – as defined by the regulators’ international bank capital adequacy requirements – due in October.
Many fixed-income managers will have this debt in their portfolios, says Paul Owens, co-head of fixed-income research at Liontrust. “Those that own any securities that were callable but were not called [repaid] will eventually lose money,” he says. Owens expects these bonds to sell off at least five points, which would result in a significant loss.
“This is quite a dramatic twist on what has been happening up to this point – for example, coupon deferral only,” says Brian Dennehy, the managing director of Dennehy Weller.
“Such regulatory intervention, whether from the European Commission or the FSA, on lower tier two bonds is a new departure. It is also a symptom of much wider and deeper invention and adds a new dimension of risk. This action will create uncertainty throughout the sector.”
Alan Steel, the chairman of Alan Steel Asset Management, calls it an “astonishing decision” and questions whether regulators considered the potential knock-on effect on shareholders and financial markets.
After an investor call last week, Paul Allen, a senior credit analyst at F&C, said: “RBS said they were disappointed to have to announce a non-call, which gives the impression they would have called if they could have done.”
The ruling has also had an impact across Europe. Allen says some European banks, such as Commerzbank, have been asked to defer coupons where they have the option to do so. There are expectations that other banks, such as Lloyds, will also have to defer coupons of certain hybrid securities.
Dennehy says the news shows that the gains from the March bottom of the corporate bond market will not be so easily repeated in the coming six months.
Yet as companies are strengthening balance sheets, and interest rates are set to stay low, he says this remains a corporate bond-friendly environment.