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By Eric Jacobson | 04-11-2011 05:19 PM

Still Some Pockets of Compelling Value in Corporates

The spread premium that financials are currently trading at will come in over time as trends in the sector remain positive, says Metropolitan West's Laird Landmann.

Eric Jacoboson, our director of fixed-income research, recently visited the offices of MetWest TCW, and sat down with Laird Landmann, a generalist portfolio manager at Metropolitan West, to discuss the credit markets and the valuations he's seeing today.

Eric Jacobson: Laird, thank you very much for being with us today.

Laird Landmann: It's a pleasure.

Jacobson: So I want to talk a little bit about the credit markets. Do me a favor, if you would, and tell us where you guys stand right now in terms of your thinking on valuation. Obviously a lot of money has moved in to credit sectors as people have been chasing yield.

Landmann: Well, first maybe address the money coming in. I think the money is driven by the stage of the cycle that we currently find ourselves in, and the lax state of federal reserve policy. I think that will continue to drive money into the sector. So, it's an interesting conundrum.

As you know, Metropolitan West-TCW is a value manager, and given that when you look at the valuations from a relative value standpoint, a historical value standpoint in corporates, I think what you're finding right now is you find that valuations are near the median for most of the sectors. So it makes us want to be very much neutral even though it's still early in this stage of the cycle.

So, broadly as it relates to corporates, we find ourselves in a fairly neutral position, but there are some pockets of very compelling value out there. In investment grades, I certainly think you have to look and realize that the financial sector is still dislocated from what happened in 2008 and 2009. Basically, the credit fundamentals in that sector are still positive. The trends are still positive. You're still seeing deleveraging, increases in capital in that sector, and we expect that that will continue for several years, and that over that time period you'll see the premium or the spread premium that financials are currently trading at, that will deteriorate over time, and they will converge to the other sectors of the marketplace. So there is still some value out there.

We're expressing that with money center banks, your Citi's, your BofA's, the normal sort of areas that are out there. These systemically critical financial institutions will, A) have the backstop of the U.S. government and the Federal Reserve behind them for several more years. That stops at your downside somewhat. But in addition to that, they also have the scrutiny of the policymakers, and they'll continue to have to build capital and treat the bondholders preferentially versus the equityholders.

In other sectors of the corporate bond market, I think it's very likely that you'll see in industrials and maybe a little bit in utilities, but not as much, you'll see basically that the policymakers there will be a little laxer, and you'll begin to see preferential treatment for equityholders as we move through this stage of the cycle and away from the bondholders, and we'd like to avoid that.

Jacobson: If I could go back to banks for a second: Is the implication that investors are overestimating the risk involved with the systemically important banks even beyond the federal government backstopping and what have you?

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