What are convertible bonds and why Church House’s James Mahon would like to buy more
James Mahon, co-manager of Church House Tenax Absolute Return Strategies fund, sits down with senior...
On Monday 15th September 2008, I remember walking into the office, not knowing quite what to expect. Over the weekend, the news headlines had been dominated by the failed rescue talks for Lehman Brothers and the company had declared bankruptcy. The unimaginable had happened and the US government had allowed the institution to fail.
No-one had really expected this to be the case. Indeed, a few fund managers had bought more bombed-out shares the week before, fully expecting the company to survive. Some of these managers never managed to make good their subsequent losses.
The harsh reality of the sub-prime mortgage problem was suddenly upon us and the global financial crisis began in earnest. The UK stock market fell 10% that week, and had fallen 25% within the month.
The likes of RBS and Lloyds then had to be rescued by government bailouts, and an astonishing 465 US banks failed in total. Dividends which, until then, were the stalwart of many UK equity income portfolios, were scrapped overnight. Almost $10 trillion was wiped off global equity markets.
“Most UK investors seem to view banks as one of the riskiest sectors in the market, a view I understand but fundamentally disagree with. The trauma of the financial crisis and its aftermath still looms large in the collective imagination of the market, and seems to be preventing investors from recognising the profound changes that have occurred inside banks and in the external operating environment.
“It is no secret that in the years prior to the financial crisis, banks were aggressively competing with each other to write loans at great speed without paying much attention to the credit-worthiness of their borrowers. But the past decade couldn’t have been more different. Many lenders have exited the market or been absorbed by larger players, and balance sheets have shrunk considerably. Corporate culture in banks no longer places growth on a pedestal above all else. Instead, there is an increased focus on caution and stability.”
“While there is still an element of state ownership among UK banks, a lot of them have gone a long way to strip back some of the non-core parts of their businesses.
“UK banks are also subject to regular stress tests and increased regulatory oversight, so we are confident that, 10 years on, UK banks are in good health.”
“Banks are my largest sector weighting in the portfolio. While one could be dissuaded from investment by regulatory fears, we believe this overlooks a number of positive factors: underlying profitability remains strong in the sector and it appears regulators are now comfortable with the amount of capital held.
“We expect dividend payments to increase markedly in the next few years and believe that any increases in bad debts could, to some extent, be mitigated by margin expansion. Low interest rates have created a very difficult backdrop for banks and any further rises would be positive.”
“At the time of the Lehman Brothers’ collapse, banks globally were deploying high levels of leverage and there was a lack of transparency in their reporting. Fast forward 10 years and from a fundamental perspective, most banks have repaired their balance sheets and are significantly better capitalised now than they have ever been in the past. Technicals in the sector are supportive and there are some good yields on offer.
“That said, individual company selection remains critical. There is still a wide range of quality across the banking sector, and some of the fixed income offerings are relatively complex products. The required research and due diligence is time-consuming but is handsomely rewarded.
“The bank capital sector continues to offer bond investors an opportunity to hunt for relative value in a world where yield remains a scarce commodity.”