Bank bonds are the most expensive relative to the debt of non-financial companies since before European leaders crafted a $1 trillion bailout as concern eases the region’s sovereign debt crisis will spark more losses.
Securities sold by lenders from JPMorgan Chase & Co. to BNP Paribas SA yield 203 basis points more than government debt on average, versus 148 for industrial companies, Bank of America Merrill Lynch indexes show. The 55-basis-point gap has shrunk from 88, or 0.88 percentage point, in May, led by gains in bonds of French lenders BNP Paribas and Societe Generale SA.
The relative gains in bank bonds signal investors are growing more confident the world’s biggest financial institutions will weather the sovereign debt crisis. The difference in spreads is the narrowest since April 26, two weeks before the European Union and International Monetary Fund unveiled a loan package to bail out the region’s most indebted nations.
“A number of pretty significant uncertainties have been addressed,” said David Havens, a managing director and financial institution debt analyst at Nomura Holdings Inc. in New York.
Barclays Bank Plc plans a benchmark offering of 10-year subordinated notes denominated in U.S. dollars as soon as today, according to a person familiar with the transaction who declined to be identified because terms aren’t set. Benchmark sales are typically at least $500 million.
New capital rules announced by the Basel Committee on Banking Supervision on Sept. 12, designed to prevent a repeat of the worst financial crisis since the Great Depression, gave bank bonds an added boost.
“The new Basel guidelines and new financial regulations implemented across developed markets are going to leave banks less levered and less risky, and thus better credits,” Goldman Sachs Group Inc. strategists led by Charles Himmelberg in New York wrote in a Sept. 27 research report.
Elsewhere in credit markets, the extra yield investors demand to own company bonds worldwide instead of similar maturity government debt was unchanged at 172 basis points, down 8 basis points from Sept. 1, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. The spread has ranged from a low this year of 142 basis points in April to a high of 201 in June. Average yields were 3.439 percent.
A gauge of corporate credit risk in the U.S. fell for a second day, dropping to the lowest in five months. Credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, fell 1.7 basis points to a mid-price of 96.98, the lowest since May 3, according to index administrator Markit Group Ltd.
The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Before the seizure in credit markets sparked $1.8 trillion in writedowns and losses at the world’s largest financial institutions, investors afforded bank bonds a premium.
Their debentures traded at yields that averaged about 55 basis points more than government debt in the two years ended June 30, 2007, compared with spreads of 85 basis points for industrial companies, according to Bank of America Merrill Lynch index data.
Now, investors are more confident the sovereign debt crisis may be abating, limiting losses for banks at the same time record low interest rates in the U.S, euro zone and Japan are bolstering earnings.
‘Bullish on Banks’
Bank bonds have gained 4.05 percent since June, compared with 3.72 percent in the first half, Bank of America Merrill Lynch’s Global Corporates, Banking index shows. Returns on non-financial debt have slowed, to 4.07 percent from 5.72 percent, based on the firm’s Global Broad Market Industrial index.
Greek bonds were the top performers in Europe last quarter, gaining about 3.9 percent, indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies show. Financial companies in the S&P 500 are projected to post 28 percent profit growth in 2011, the most among 10 industries, Bloomberg data show.
“The premium on bank bonds remains high, and that is among the chief reasons we remain bullish on banks,” Himmelberg and the other Goldman Sachs strategists wrote.
Average spreads on bank bonds have narrowed 48 basis points since peaking this year on June 11, compared with a decline of 19 basis points for industrial debt, according to Bank of America Merrill Lynch global index data.
Subordinated debt, sold by banks as part of their buffer against losses, has rallied the most since lenders were given an incentive to redeem the hybrid securities early under proposed capital rules known as Basel III.
“There was a lot of concern about what would be involved in the Basel III regulations,” Nomura’s Havens said. “The regulations that have come out will have the effect of reducing risk at the banks, increasing liquidity and capitalization. All of those are good things for bondholders.”
The MSCI World Financials Index’s 11.6 percent gain since June 30 trails the 12.9 percent increase in the MSCI World Index. In the first half, global financial shares fell 13 percent, as the broader index tumbled 11 percent.
“From an equity standpoint, the regulations were not necessarily that positive,” said John Hawley, who helps manage $19 billion of investment-grade credit as a portfolio manager at Aviva Investors in Des Moines, Iowa. “From a credit or bondholder standpoint, we would view them as positive because it’s going to require the banks to hold more capital and also limit the amount of what is perceived to be riskier types of business.”
Bill of Health
European regulators gave the region’s banks a clean bill of health on July 23, saying that of 91 lenders subject to their stress tests, accounting for 65 percent of the banking sector, only Germany’s Hypo Real Estate Holding AG, Agricultural Bank of Greece SA and five Spanish savings banks had inadequate capital reserves.
Spreads on bonds of BNP Paribas, including subordinated notes, have narrowed 153 basis points since May to an average 285 basis points, while debt of Societe Generale tightened 145 to 275, Bank of America Merrill Lynch data show. Bonds of Frankfurt-based Commerzbank AG, which was bailed out by Germany during the financial crisis, have had the third-best performance, with spreads shrinking 114 basis points to 190.
In the U.S., the gap between bank and industrial bonds has tightened to 66 basis points from 114 in May. The spread is within 11 basis points of the narrowest since March 2008.
Bank of America Corp. bond spreads have narrowed 58 basis points to 248 since May, and JPMorgan spreads have decreased 29 to 166.
“The biggest standalone sector is financials,” said Tad Rivelle, head of fixed-income investment at Los Angeles-based TCW Group Inc., which has about $115 billion in assets under management. “The fact that you can buy Bank of America paper at 200 over Treasuries, you could still call that compelling valuation.”