Basel III promising for bonds

8th November 2010

Basel III, alongside other measures aimed at upgrading the regulatory structure for banks worldwide, are set to play a major role in helping to ensure banks in future are safer and more creditworthy. 

The aim of the Basel III, is to help prevent another financial crisis of the kind that brought the global economy to its knees in 2008.  This Guardian article looks at the main measures being proposed under Basel III.

The 2008 crisis saw the Lehman Brothers made bankrupt, in turn leading to a collapse in confidence on a global scale, with the fallout hitting not only financial markets but also trade, employment, housing and credit availability.

With the help of support from the taxpayer, banks have been busy repairing their balance sheets. But the experience has also led to a determination on the part of governments and financial regulators to impose stricter conditions on banking operations, with Basel III spearheading their moves.

Basel tussle

Basel III still to be ratified formally, with some banks including Standard Chartered and HSBC already calling for a toning down of rules relating to trade finance, as reported by the Financial Times here.  

On the other hand, some policy makers, notably Mervyn King, governor of the Bank of England, as reported by the Wall Street Journal, insist that Basel III does not go far enough in preventing another financial crisis.

It seems highly, however, that once the tussling between banks and regulators is resolved, we will have Basel III implemented in a fairly rigorous form.

In the light of this likelihood, Schroders credit analyst Roger Doig and colleague Sarang Kulkarni, fixed income fund manager, reckon Basel III some "interesting opportunities" in the financial sector bonds arena.

Once Basel III revisions being currently consulted on are implemented, as Doig and Kulkarni, expect them to be, the result "will be safer, more creditworthy banks".

They add:  "Even though there is a generous timetable for implementation, we expect many regulators to require banks under their jurisdiction to move to Basel III as soon as possible.

"Indeed, since 2008, a number of banks have recapitalised to the extent that they are already compliant with the new rules."

Good for bondholders

It certainly looks for bondholders as the key tenet of Basel III, that banks must have more equity and less leverage, thereby improving overall credit quality, will mean a greater cushion against default.  

As a result, Doig and Kulkarni believe the financial sector corporate bonds offers a good opportunity for investors in terms of building a good quality portfolio that can generate both income and capital growth over the long term.

They add: "All in all some strong opportunities in financial sector bonds are being created. The sector currently offers better value than non-financials, with improving credit metrics, attractive valuations and market technicals underpinning the opportunity for credit investors."

Attractive fundamentals

Doig and Kulkarni are convinced that, as result of Basel III and the upgraded regulatory framework, banking sector fundamentals could improve "substantially" over the coming years: "Balance sheets within the sector are already recovering, having come under severe stress during the credit crunch, and yet financial sector valuations within the corporate bond market have not returned to the levels witnessed before the crunch.

"As such, we believe the fundamentals of the financial sector, combined with attractive valuation prospects, create an attractive package for corporate bond investors. "

In particular, Schroders sees particularly good value in European financial sector bonds, especially when compared to their non-financial investment grade counterparts.

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