Bank CP Rate Gap to Bills at Lowest Since August: Credit Markets

Bank CP Rate Gap to Bills at Lowest Since August
Bonds of Anheuser-Busch InBev NV were the most actively traded dollar-denominated corporate securities by dealers last week, with 614 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Photographer: Ken James/Bloomberg

Short-term borrowing costs for financial institutions have fallen to the lowest since August relative to U.S. Treasury bills in a sign of growing investor confidence that banks will weather Europe’s escalating debt crisis and the slowing economy.

The difference between what U.S. financial institutions and the government pay to borrow for three months has narrowed by almost 50 percent since December to 32 basis points. The gap between the commercial paper and Treasury bill rates has shrunk from a 2 1/2-year high of 58 basis points on Dec. 8. A separate measure of debt-market stress, the two-year interest-rate swap spread, is near an 11-month low.

Money managers are accepting lower rates to lend money to U.S. financial institutions even after they were among 15 global lenders downgraded by Moody’s Investors Service on June 21. Dollar-denominated bonds from banks are returning more than twice as much as stocks this year as lenders boost capital to meet new risk-curbing regulations.

“From a banking sector standpoint the U.S. is much further along than the European banking sector,” said Dan Greenhaus, the chief global strategist at broker-dealer BTIG LLC in New York. “This is what the Federal Reserve wants of course, for yields to come down everywhere. For the Fed, anytime you see the narrowing of the spread of a risk-asset to a safer asset, all else equal, they have to be encouraged.”

The cost of protecting U.S. bank bonds from default is at the lowest relative to European lenders ever in records going back to 2005, according to data compiled by Bloomberg.

Rate Swaps

The U.S. two-year interest-rate swap spread shrank to 23 basis points at the end of last week, from 59.25 basis points on Nov. 22, an 18-month high. The spread increased 1.1 basis points today to 24.13.

The gap between two-year swap rates and comparable maturity Treasury note yields has averaged 48 basis points since January 2007. The swap spread is based in part on expectations for the dollar-denominated London interbank offered rate and is used as one measure of investor perceptions of bank credit risk.

Elsewhere in credit markets, the extra yield investors demand to hold corporate bonds globally rather than government debt fell for a sixth week, reaching the lowest in almost two months. Offerings worldwide soared as the cost of protecting the debt from default in the U.S. fell. In emerging markets, spreads narrowed to the least in two months.

Spreads Narrow

Relative yields on company bonds from the U.S. to Europe and Asia narrowed two basis points to 212 basis points, or 2.12 percentage points, the lowest since May 15, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. Spreads have declined from 236 on June 1, the highest since January. Yields fell to 3.124 percent from 3.194 percent July 6.

The Barclays Global Aggregate Corporate Index has returned 0.64 percent this month, bringing returns for the year to 4.84 percent.

Bonds of Anheuser-Busch InBev NV were the most actively traded dollar-denominated corporate securities by dealers last week, with 614 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

A $7.5 billion offering from the maker of Budweiser and Stella Artois led $75.4 billion of corporate bond sales worldwide last week, a 42 percent increase from $52.9 billion in the week ended July 6, Bloomberg data show. Weekly sales have averaged $74 billion this year. Anheuser-Busch’s $3 billion of 2.5 percent, 10-year notes rose 1.3 cents from the issue price on July 11 to 100.8 cents on the dollar to yield 2.4 percent, Trace data show.

Leveraged Loans

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index rose 0.54 cent last week to 94.09 cents on the dollar, the highest since May 16. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has climbed from 91.8 on June 5, the lowest since Jan. 6.

Leveraged loans and high-yield bonds are graded below Baa3 by Moody’s and lower than BBB- at S&P.

In emerging markets, relative yields narrowed 12 basis points to 357.9 basis points, the least since May 10, according to JPMorgan Chase & Co.’s EMBI Global index. The benchmark has tightened from this year’s high of 440.9 on Jan. 13.

The Markit CDX North America Investment-Grade index, which investors use to hedge against losses or to speculate on creditworthiness, decreased 0.8 basis point to a mid-price of 111.9 basis points, according to prices compiled by Bloomberg.

Bail-In Bets

The cost of insuring against default on European senior bank bonds rose after the region’s central bank was said to drop its opposition to holders of the securities taking losses in bailouts.

The Markit iTraxx Senior Financial Index of credit-default swaps on 25 banks and insurers climbed seven basis points to 280 as of 12:21 p.m. in London, the highest in a week. The European Central Bank supported imposing losses on senior bondholders of ailing Spanish banks at a Brussels finance ministers meeting on July 9, though the proposal didn’t get much traction, said an official with knowledge of the matter, who asked not to be identified because the talks were private.

Credit-default swaps typically fall as investor confidence improves and rise as it deteriorates. Contracts 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.

IMF Forecast

The International Monetary Fund will cut its 3.5 percent estimate for global growth this year, Managing Director Christine Lagarde said. The “key emerging markets” of Brazil, China and India are showing signs of slowdown and the IMF’s growth outlook “has regrettably become more worrisome,” Lagarde said July 6 in Tokyo.

“Financial conditions look like they are relatively stable and growth supportive in the U.S.,” Michael Darda, chief market strategist at MKM Partners LP in Stamford, Connecticut, said in a telephone interview. “That’s a silver lining because the recent economic data flow has been weak. The credit markets and other indicators tend to give us a forward look on what might happen to the business cycle.”

The Fed’s Federal Open Market Committee, which has kept its benchmark interest rate near zero since December 2008, reiterated last month that it expects to keep rates “exceptionally low” at least through late 2014.

The Fed under Chairman Ben S. Bernanke bought $2.3 trillion of Treasury and mortgage-related debt to stimulate the economy. It decided in June to extend a policy known as Operation Twist, in which it sells short-term securities and uses the proceeds to buy longer-term debt, through December by an additional $267 billion.

Treasury Bills

Selling commercial paper is one way that banks can obtain short-term loans. The instruments are issued at a premium to Treasury bills, which are viewed as riskless because they’re backed by the full faith and credit of the U.S. government. In the 10 years prior to 2007, when the subprime mortgage market collapsed and triggered a global financial crisis, three-month commercial paper rates averaged 30.5 basis points more than Treasury bills, Bloomberg data show.

“At this time, commercial paper is not as good an economic indicator as it would be under more normal interest rate circumstances,” Leonard Santow, managing director at economic and financial consulting firm Griggs & Santow Inc., said in a telephone interview. “When you get close to zero on Treasuries, it creates distortions.”

Relative Yields

Rates on three-month, non-asset backed commercial paper were 0.41 percent last week, according to an index of A1/P1/F1-rated programs compiled by Bloomberg that consists of a majority of financial firms. While three-month Treasury bills traded at 0.09 percent and three-month dollar Libor was 0.4551 percent.

“The fact that commercial paper rates have come in relative to Treasury bill yields, which have barely moved from near-zero levels all year, signals that investors are now happier to lend to U.S. corporations,” said Moorad Choudhry, treasurer at Royal Bank of Scotland Plc’s Corporate Banking Division in London.

While U.S. investment-grade corporate bond yields fell to a record 3.18 percent on July 13, spreads are wider than before the credit crisis, according to Bank of America Merrill Lynch data. Dollar-denominated bank bonds have returned 8.5 percent this year, according to Bank of America Merrill Lynch data, compared with 4 percent for bank stocks.

‘Demand for Yield’

“With three month Treasury bills rates so low, unless you are really forced to invest in them, few want to purchase them,” said Jim Lee, head of short-term markets and futures and options strategy in Stamford, Connecticut, at Royal Bank of Scotland Group Plc’s RBS Securities Inc. “There is demand by investors for yield in this lower for longer Fed rate environment.”

The commercial paper market has declined since the failure of Lehman Brothers Holdings Inc. ignited a financial crisis, with the total amount outstanding falling to $982 billion from more than $2.2 trillion in July 2007. Joseph D’Angelo, head of money market fixed income at Prudential Financial, who oversees about $50 billion in assets, said it may never regain the same levels, with regulatory concerns affecting both companies supplying new issues and funds investing in the securities.

“When Lehman collapsed, that effectively brought all kinds of scrutiny to the money market fund industry,” D’Angelo said. “For companies, plenty of issuance was related to long-term leverage financed by short-term liabilities and obviously that whole model was not acceptable anymore.”

Ratings Cut

In the Moody’s downgrades of global banks, Citigroup Inc. and Morgan Stanley were pushed out from the top-tier of investment-grade, with their respective ratings cut to Baa2 from A3 and Baa1 from A2.

New regulations from U.S. Congress and the Basel Committee on Banking Supervision are spurring the biggest banks to pare holdings of corporate bonds to $42.3 billion as of July 4 from a peak of $235 billion in October 2007, according to Fed data. The face value of bank bonds in a Bank of America Merrill Lynch index has fallen to $905.3 billion from a peak of $947.2 billion in July 2011.

The top U.S. prime money-market mutual funds allocation of assets invested in euro-zone banks slid 67 percent in the 12 months through May, according to a Fitch Ratings report on June 22. As money funds have cut investment in euro-zone banks they’ve increased allocation to U.S. government securities and repurchase agreements, a form of collateralized lending, Fitch wrote in a separate note published on July 12.

Credit-default swaps on 13 European banks such as BNP Paribas SA and UBS AG have diverged from those tied to the six largest U.S. banks, with the gap at 67.3 basis points on July 13. In February, there was no gap in the average price of the contracts.

‘Recovery Cycle’

“I would personally rather give money to U.S. banks as BBBs than give the money to single-A rated companies in Europe,” D’Angelo said. “If you are going to lend money to financial institutions in the current environment, you feel most comfortable lending to U.S.A.”

U.S. money funds reduced their euro-zone debt holdings by the most in 2012 last month, cutting their exposure by $73.5 billion to $286 billion in June, according to data compiled by Westborough, Massachusetts-based research firm IMoneyNet Inc.

The European Central bank’s cut in its benchmark rate to a record low led JPMorgan, Goldman Sachs Group Inc. and BlackRock Inc. to close money market funds to new investments.

“The further we move along in this recovery cycle -- long, slow and painful though it may be -- we are starting to see some signs of generally healthier balance sheets in the corporate sector,” said Jeffrey Caughron, a partner at Baker Group LP in Oklahoma City who advises community banks on investments of more than $30 billion. “There is also the realization that we are going to be at very low levels of interest rates generally longer than people had previously thought.”

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