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Dash for trash in tier 1

September 15, 2009

Bondholders seem to be relatively undaunted by the European Commission and its various machinations to ensure bank investors share some of the pain for state bailouts.

Tier 1 debt, the lowest-ranking form of bank capital security, is enjoying a rally this week as investors scramble for higher-yielding securities. Among the chief gainers are bonds sold by Royal Bank of Scotland and Lloyds, both of which have taken state-aid, meaning their bonds are likely candidates for the “burden-sharing’’ the EC is keen to see, such as having to defer coupons or worse.

RBS’s 7.0916 percent notes have gained 10 percentage points to 51 cents since last week, according to Societe Generale, while equivalent bonds sold by Lloyds have gained 6 points to 55.

Why are they buying? In some cases, bondholders may be hoping for some kind of buyback. Belgian bank KBC, for example, is offering to buy back four subordinated securities at 70 percent of face value. Alternatively they may just be scrambling for yield.

Given the uncertainties that hang over some of these banks, let’s hope investors are ready for a bumpy ride.

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