Relative Value Trade Ideas in Credit
These are some of the best ideas in relative value investment grade trading. Feel free to discuss on Harvest or by email jbrook2@optonline.net #credit #investmentgrade #rv #relativevalue
IGTS
Trade Examples
1
GE vs JPM: Embedded Credit Optionality
IGTS
•
GE Capital Corporation (“GECC”) and JP Morgan (“JPM”) are two of the largest
issuers in the corporate bond universe
•
Between preferred, hybrid, and corporate credit both companies have issued a
plethora of bonds with different priorities and embedded options
•
GECC is rated AA
-
and its tight spread levels reflect this view
•
Among GECC bond issues there is one senior note issued in US Dollars in
Europe that is a low 4 5/8% coupon bond that has a par call feature starting in
1/30/18. This
bond is a good
short. It has capped upside due to the call and
substantial downside should interest rates or credit spreads widen
•
To hedge the carry to the call date and also to minimize mark to market
volatility should there be a move lower in the general level of credit spreads or
interest rates, the bond short is paired with a long in a JPM fixed
-
to
-
float hybrid
7.9% coupon bond that will likely be called in 2018
•
Should the GE bond extend and trade to maturity due to either a move higher in
rates or credit spreads, the upside potential on the pair trade is 8 bond points
assuming we get a replay of the taper tantrum
2
GECC vs JPM: Bond Point Differential
IGTS
3
Short DB 5.628% fix to float: Possible Extension Risk
IGTS
•
Deutsche Bank (“DB”) has a larger number of hybrid capital securities.
•
DB 5.628% fixed to float bonds are callable on 1/19/16 after which the coupon
switches from the higher fixed rate to a floating rate of L+ 170. Currently, the
bonds trade at a
ytc
of 2.55%
•
What is extremely odd about the markets pricing of this security is that they
have a similarly structured bond issued out of the same entity which they did
not call. That bond (
cusip
251528aa3) which is also a perpetual was first
callable in 2009 and remains currently callable. The back end floating rate is
Libor + 297.
•
There are also other instances of DB not calling fix to float instruments at the
first call. This issue has actually been reported on in the financial media.
•
Should DB not call 5.628% bond assuming fair value is closer to L +240 where
the JPM perpetual floaters trade, the bonds could trade off over 10 points
4
DB 5.826% fix to float:
Short on Extension Risk
IGTS
5
DB: Example of Uncalled Hybrid
IGTS
6
GS vs ISPIM: Credit Relative Value
IGTS
•
Although the European bank system has somewhat stabilized, trading levels of
financial institutions have far surpassed the underlying improvement in credit
quality.
•
Intesa
Sanpaolo
(“ISPIM”) has the highest percentage of NPLs of the major
Western European banks. NPLs net of reserves is north of 80% of ISPIM’s
CET1 Capital.
•
ISPIM
cds
spreads have rallied massively over the last 12 months coming into
a level of 87 bps off of a high of 387 bps. Bond spreads have also tightened
significantly.
•
The level of ISPIM bonds is quiet near its logical extreme relative to developed
market senior bank bond spreads.
•
By purchasing the senior bonds of Goldman Sachs (“GS”) and shorting ISPIM,
an investor need only pay away approximately 25 bps of carry. This
relationship could easily widen back out another 100 bps which would equate to
6.25 bond points on an unleveraged basis (the wide of the relationship was 390
bps.
7
GS vs INTESA: Credit Relative Value
IGTS
8
Jefferies 36s vs 19s: Credit Flattener
IGTS
•
Jefferies Group (“JEF”), a wholly owned subsidiary of
Leucadia
(“LUK”), is a
client focused investment bank
•
During the European financial crisis of 2012, rumors surfaced of large loses in
JEF’s trading books related to peripheral sovereign bonds
•
As is typical in a distressed situation, the JEF credit curve inverted massively
with the 2019 bonds at one point trading 180 bps north of the 2036 bonds
•
The localized panic around JEF eventually died down after CEO Richard
Handler opened up in great detail about their sovereign exposure which turned
out to be minimal
•
Soon after JEF merged into long time partner insurance company LUK
•
Investors have become very comfortable with the JEF’s short term prospects
with the 8.5% 19 bonds trading at a s spread of 136 bps which is roughly in line
with similarly rated Bank of America (“BAC”) 7.625% 19
9
Jefferies 36s vs 19s: Credit Flattener
IGTS
•
T
here
is extraordinary relative value to be had in the long end of JEFs credit
curve
•
Similarly rated financial issuers such as BAC and PRU trade closer to 140 bps
z spread vs 275 for the JEF 6.25% 36
•
I
nvestors should take
advantage of
this extremely steep credit curve
by putting
dv01 flatteners
going long the 36s and short the 19s
at a z spread pick up of
140 bps and a raw yield pick up of 281 bps
•
Should the JEF curve trade closer to the 40bps generic 5s vs 30s steepness for
BBB financials potential upside could be 14 bond points
10
Jefferies
36s vs 19s
Spread History
IGTS
11
IG Financial Average BBB
5
s vs 30s curve is 40 bps
IGTS
12
Ally Credit Long
IGTS
•
Ally Financial (“ALLY”) is one of the largest automotive lenders in the country.
•
Over the last 5 years, ALLY has taken a number of steps to improve its credit
profile including a public floatation of its stock, an exit from its international
business, a move towards a more bank like funding (35% deposit funding)
structure, and a resolution of the problematic mortgage business (
Rescap
).
•
Currently ALLY is rated B1/BB/BB+ . However, there is a case to be made that
ALLY could obtain investment grade ratings over the next 24 months.
ALLY
CET1 Ratio is 9.1% within the low end of the range for US investment grade
bank holding companies. Asset quality metrics are strong with NCO slightly
north of 50 bps.
•
As
a greater percentage of the market views ALLY as a “crossover” credit with
near term upgrade potential its credit curve should begin to resemble
the
curves of IG banks
•
To take advantage of this,
I recommend purchasing
ALLY 8 31 at a z spread of
250 (pick 65 bps to IG Fin Curve) for potential price appreciation of 8 points.
13
IG Financial Average BBB 15 year bond is 187 z spread
IGTS
14
Ally 8% 31 Have Room to Run
IGTS
15
Indonesia : Credit Flattener
IGTS
•
Indonesia (“INDON”) is a large sovereign issuer whose credit spread has
tightened in from a wide of 300 bps to 150 bps in 5
yr
cds
over the last 12
months
•
D
espite
the amelioration of credit spreads, there could arise a mini panic in
INDON bonds due to markets reawakening to deteriorating credit fundamentals
or simply fund flows out of underperforming EM bond funds into DM securities
•
In order to capture this volatility,
one can
initiate a flattening trade buying 30
year bonds and shorting 7 year bonds currently at the historical wide of their
relationship. The 30
yr
bonds are 45 bps steep to the 7
yr
bond against a 2
year average of 10 bps, a high of 50 bps, and low of 62 bps inverted.
•
This enables
one
to have a notional short position with jump to default
exposure (“JTD”) in a dicey credit while not having the market to market
pnl
volatility associated with a directional trade
•
When Indonesia last went through a mini panic the credit curve flattened
materially as investors reduced positions in high price shorter dated bonds
16
Indonesia: 5 Year CDS trade history
IGTS
17
Indonesia: 43 vs 21 spread history
IGTS
18
Indonesia: 5 Year CDS trade history
IGTS
19
Contact Information
IGTS
20
Please Direct Inquires To:
Jonathan Brook
917
-
566
-
2936
jbrook2@optonline.net
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