More transparent banks "good news for bondholders"

Following the collapse of Lehman's and the AIG bail-out, concerns over possible further bank failures persist and investors now need to consider how comfortable they are with their current exposure.

Fatima Luis, Manager of F&C's Strategic Bond Fund, said: "Governments should now put the sanctity of the financial system ahead of avoiding moral hazard. Unfortunately, that does not necessarily mean that all investors in banks will be saved. Soon though, if not already, the concern will move to the more traditional economic downturn facing much of the developed world. Faced with deteriorating sales and margins, questionable availability of finance and less chance of a government saviour, many non-financial companies will struggle to survive. Banks will not escape the effects but the recapitalisation process, assuming that they complete it, should provide the necessary cushion".

The US Government's proposal for a new rescue vehicle to take on much of the bad debt on bank balance sheets is essential to any financial recovery. "This will help provide support for asset prices at a time when a smaller number of banks are seeking to accelerate their write-downs and sell-off unwanted assets in a market with very little appetite from potential buyers," said Luis. "It will be a challenging task for any new organisation to determine a price acceptable to both the banks and the taxpayer."

Luis argues that the performance of the housing market on both sides of the Atlantic is also essential to any long-term recovery. "It is only once there is some sort of ‘floor' underpinning values that we will start to see the end of asset write downs. The rates being charged to mortgage holders remain high, which is not helping matters, though in the UK we have seen moves by some providers to cut rates to new buyers and a move in the right direction," she added.

According to Luis, banking lending criteria will become stricter and much more transparent both in terms of activity and reporting. "In the short-term banks are likely to be less profitable as activity slows and they focus on reconstructing their balance sheets. But the financial system going forward should be more secure, which is good news for bondholders."

She concluded: "The need for a flexible approach to asset allocation has never been more evident than in the current climate of extreme risk aversion but also when markets start to turn and a rapid response is needed to make the most of emerging opportunities".