Current Banking Crisis May Provide Opportunities for Corporate Bondholders

The banking sector has been subject to numerous scandals over the past few years. First there was the credit crunch followed by corporate governance issues over the casino banking culture at the major banks. Derivatives have not been managed well with banks entering into increasingly complex and risky transactions.  This was followed by the government bailout of Lloyds, RBS and Northern Rock in the UK. The issues have been replicated across Europe with the Spanish banks making the major headlines with several banks being subject to bailout conditions.

The bad news doesn’t stop there. The mis-selling of PPI insurance is still ongoing with most major banks involved in the UK. Last year we had the issue of unacceptable bonuses being paid at Barclays followed by the Libor scandal which spelt the end for Chief Executive Bob Diamond. In March 2012, a leaked document revealed that a senior manager at Goldman Sachs was found to have referred to his clients as “muppets”. We also have the money laundering allegations concerning Standard Chartered and HSBC who were fined earlier in the year.

Many feel that the banks have been largely responsible for the Euro crisis. The new Basle regulations reveal that a number of the major international banks have solvency issues and need to recapitalise their balance sheets. The Rating agencies have downgraded the credit rating of a number of major banks to reflect this. Even the big named banks are not immune to the recent spate of downgrades.

Both the Bank of England and the European Central Bank have engaged on a program of quantitative easing (QE) to print money and effectively recapitalise the weaker banks. However, despite the recent bouts of QE the banks have yet to repair their balance sheets and are reluctant to lend to eachother. This in turn, means that businesses are finding it difficult to obtain credit from the major banks.

The credit downgrades mean that the Banks find it difficult to raise money internationally and that the cost of funds has increased to the extent that it is above that of most large corporations. Major multinational corporations tend to be cash generative and are therefore in a better position to receive cheap credit. This has given rise to the opportunity for large corporations such as Tesco, Severn Trent and the National Grid to provide competitive bonds to the market.

Corporate bonds are now providing higher yields than both bank and government securities. The cash rich corporates often represent a lower credit risk than dealing with sovereign states, some of which have been downgraded in Europe. Corporate bonds could be a useful option for investors. Cash rich businesses and wealthy contractors should explore these options if they are looking to invest excess funds.

In the UK we have an increased reliance on the top 4 clearing banks which pretty much dominate the market. The effects of QE have not filtered down to the market in the form of increased borrowing as refinancing dominates banking activity. Interest rates are at an all time low to the effect that savers and investors are finding it difficult to attain a reasonable return on their investments. Most savings accounts pay well below inflation.  Businesses are therefore stockpiling cash and paying off their loans. In some cases excess cash is being paid out in the form of additional dividends due to the absence of a suitable alternative.

The banking crisis creates market opportunities for well managed businesses in the UK. Large well rated companies will find that they are still able to secure finance, often at low rates of interest. Large businesses with sufficient liquidity will be able to access different capital markets. This creates opportunities for raising finance for the acquisition of competitors who may be in difficulty. Alternately, cash rich companies can look to explore opportunities in corporate bonds.

The downside however, is that smaller growing companies continue to have less access to finance and will be subject to higher rates of interest to reflect their risk profile. The lack of alternative banks remains an issue for SME’s in the UK.

Going forwards we expect to see a smaller number of core banks as the Eurozone crisis unravels. Eventually we should see a split between the retail and investment arms of the major banks. Some continental banks may well relocate from the UK. The large banks will survive and the smaller ones are likely to merge. Banks will remain cautious and will stick with their best clients. It is important that your business is well known to your bank. You should also ensure that your bank is well informed of your plans.