Barcap sees increasing value in investment grade debt

In its "Global Outlook: Implications for Financial Markets" research report today, Barclays Capital says that despite remaining negative on high yield bonds and leveraged loans it now sees value in investment grade, particularly subordinated and senior bank debt. Barcap notes implied default rates remain high in these areas, but with authorities providing substantial liquidity to the banking system, the risk of bank runs is significantly reduced.

Furthermore, says Barcap, plans to allow GSEs to expand their mortgage books suggest that high quality mortgage paper may stabilise. There is a possibility that the agencies may also move towards the triple A Alt-A sector.

Head of credit analysis Mark Howard says that after recent actions a perceived line of support has been drawn under major borrowers such as GSEs, banks, and brokers. In addition, regulatory oversight of these critical intermediaries will most likely increase and self-imposed risk practices improve. This, he says, would make these entities more secure credits and more attractive counterparties once the credit crunch has run its course. Some investors are exploiting this new development via capital structure arbitrages between the debt and equity securities of US banks and especially brokers, says Howard.

EM credit is likely to continue being driven by global credit deterioration, says head of emerging markets research Piero Ghezzi. Sovereign credit, given limited supply, may outperform US corporates but absolute performance is likely to be weak, he says. Imbalance countries in EMEA may do poorly, and EM corporates or quasisovereigns are likely to underperform.

Discussing the current market climate, Barcap’s head of research Larry Kantor says the underlying problem of deterioration in the credit quality of US mortgages and worries that underwriting standards elsewhere will prove to have slipped during the credit boom as badly as they did in mortgages will likely persist. The losses in securitised subprime mortgages may now be fully recognised, if not accounted for, but credit quality in the remainder of the non-agency mortgage market is still deteriorating.

The performance of mortgages on bank balance sheets – particularly home equity loans, which are secondary liens – is an increasing focus, says Kantor. Moreover, the quality of credit outside of mortgages – including leveraged loans and securities backed by commercial real estate – is just beginning to be tested under less favorable economic conditions and with reduced credit availability.