Pimco, Neuberger Defy Bank Bond ‘Pain Threshold’: Credit Markets
Bond managers from Pacific Investment Management Co. to Neuberger Berman Management LLC are sticking with bets that U.S. banks will withstand a European crisis that’s triggered the biggest losses since early 2009.
More than half of investors said they were “comfortable” holding bank bonds versus non-financial securities, even after the debt underperformed by 6.9 percent since April, according to a JPMorgan Chase & Co. survey. Only 7 percent of the investors said they were “unwinding” positions, JPMorgan strategists wrote in a Sept. 26 note.
Some of the world’s biggest debt investors say U.S. bank balance sheets have been fortified enough since the 2008 failure of Lehman Brothers Holdings Inc. to weather the sovereign-debt crisis that now threatens to infect Europe’s banking system and derail the U.S. economic recovery. That’s giving them confidence to ride out losses of 3.5 percent since the end of July, the biggest slide in 30 months, on lenders from Bank of America Corp. (BAC) to Morgan Stanley.
“We understand and are respectful of the volatility due to issues out of Europe and concerns about U.S. economic growth, but for long-term value, U.S. money-center banks are a good option,” David Brown, a money manager at Neuberger Berman in Chicago, which oversees more than $85 billion in fixed-income assets, said in a telephone interview. They’ve “done a great job improving their capital position and their asset quality has continued to improve.”
Pimco’s Mark Kiesel, global head of corporate bond portfolios at the manager of the world’s biggest bond fund, said in a note on the company’s website last week that investors should be buying U.S. bank debt, while cutting risk elsewhere. Kiesel didn’t immediately respond to an e-mail and a telephone call to elaborate.
While the bets should pay off in the long-term, losses may continue, JPMorgan strategists led by Eric Beinstein in New York said. That’s bringing investors closer to a “pain threshold” at which point some could seek to limit additional declines, exit the trade, and cause a further slump, they said.
Elsewhere in credit markets , a gauge of U.S. corporate risk snapped three days of declines as investor confidence mounted that Europe’s leaders will fail to prevent a default by Greece. Deutsche Bank AG is marketing $609 million of bonds backed by commercial property loans in the first offering of its type since sales revived in November 2009. Georgia-Pacific LLC, the tissue-maker owned by Koch Industries Inc., obtained $3.5 billion of loans due in 2016.
Bonds of Charlotte, North Carolina-based Bank of America were the most actively traded U.S. corporate securities by dealers, with 127 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, added 4.7 basis points to a mid- price of 140.9 basis points, according to Markit Group Ltd.
The Markit iTraxx Europe Index of credit-default swaps linked to 125 companies with investment-grade ratings rose 3.5 basis points to 196, according to JPMorgan Chase & Co. (JPM) at 12 p.m. in London.
The indexes typically rise as investor confidence deteriorates and fall as it improves. 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.
The Deutsche Bank issue will be tied to floating-rate mortgages including debt on the Hotel del Coronado, located on oceanfront property near San Diego, and the Standard Hotel in Manhattan, according to people with knowledge of the offering, who declined to be identified because the discussions are private.
Floating-rate loans, which are short-term and give property owners more flexibility to pay off the debt early, are often taken out when owners are anticipating a significant boost in income from the properties, and can be riskier for investors.
The transaction from the Frankfurt-based lender is the first so-called floater to compile debt from multiple borrowers since the commercial-mortgage bond market slammed shut in 2008 amid a lending freeze. Banks arranged a combined $66.4 billion in floating-rate commercial-mortgage backed securities in 2006 and 2007, according to data compiled by Bloomberg.
Georgia-Pacific’s senior unsecured debt includes a U.S. dollar-denominated loan, an international term piece and a revolving line of credit, the company said yesterday in a statement distributed by PR Newswire.
Proceeds of the loan and equity from Koch will refinance all of the Atlanta-based company’s senior loans, according to the statement. The company had $2.25 billion in term loans and a $1.25 billion revolving credit line, all due in August 2016, according to data compiled by Bloomberg.
The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 index fell for the fourth time in five days, decreasing 0.05 cent to 89.17 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has declined from 89.84 on Sept. 21, which was the highest since Aug. 8. The index decreased to 87.47 cents on Aug. 26, the lowest level since December 2009.
Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- by S&P.
In emerging markets, relative yields rose 1 basis point to 447 basis points, or 4.47 percentage points, according to JPMorgan’s EMBI Global index. The index has expanded from 259 basis points on Jan. 5.
Bond traders are demanding the biggest premiums in two years to hold financial company debt instead of bonds of industrial companies, according to Bank of America Merrill Lynch index data.
Financial debt is trading at 338 basis points more than Treasuries, 128 basis points more than the 210 basis-point spread for industrial bonds, index data show. The gap reached 132 basis points on Sept. 23, the widest since September 2009.
Pimco’s Kiesel has advocated for much of the past two years that investors buy the senior debt of U.S. lenders. Bank of America and Citigroup Inc. (C) were poised to be “two of the stars” in fixed-income markets this year, Kiesel said in December. Senior-ranked bank bonds are among a handful of assets that remain a safe bet “given strengthening capital and balance sheets,” he said in the note last week.
‘Much Better Shape’
U.S. banks “are in much better shape than they were pre- financial crisis, and Basel 3 requirements are only going to improve that strength,” said Brian Machan, a money manager at Aviva Investors North America in Des Moines, Iowa, where he helps oversee $57 billion. Machan was referring to new international capital standards set by the Basel Committee on Banking Supervision.
The weighted average Tier 1 capital ratio for banks in a JPMorgan index, a measure of the lenders’ financial strength, climbed to 12.2 percent in the second quarter, the seventh straight quarterly increase and a 60 percent improvement over the past four years, JPMorgan strategists said in a note to clients last month.
“Capital raises, write-downs and general de-risking of balance sheets have made U.S. banks harder to topple,” Marc Pinto, head of corporate bond strategy at broker-dealer Susquehanna Financial Group said in a Sept. 19 note to clients. That’s “even if their European counterparts, which had been similarly reinforced (except with respect to funding), now face a new potential series of sovereign debt writedowns and liquidity challenges,” he wrote.
Wall Street Dealers
The increased capital cushions are doing little to ease broader market concerns as Federal Reserve data show corporate bond holdings by Wall Street dealers plunge to the lowest since April 2009. Bank of America bonds lost 5.2 percent this month and Morgan Stanley (MS) debt declined 3.8 percent, Bank of America Merrill Lynch index data show.
Bank of America’s $1.5 billion of 5.875 percent, notes due in January 2021 that were issued in December have declined 5.2 cents to 94.1 cents on the dollar as of yesterday, Trace data show. Its stock has also plunged this year on both the European crisis and concerns that it faces larger losses tied to faulty mortgages.
‘Fund Our Business’
The lender had a record $402 billion of liquidity at the end of the second quarter, spokesman Jerry Dubrowski said.
“We have roughly two years worth of liquidity on hand to fund our business operations without having to go to the market,” Dubrowski said in a telephone interview. “We did that in part because we wanted to be somewhat insulated from the volatility of the market and be able to fund.” Bank of America doesn’t comment on stock and bond movements, he said.
“Simply adding capital right now to already conservative balance sheets will not be sufficient for spreads to improve,” Neuberger Berman’s Brown said. “We must see some resolution and clarity to the risks in Europe and potential liabilities from legacy mortgage loans.”
DoubleLine Capital LP, the $17 billion investment firm run by Jeffrey Gundlach, is avoiding U.S. banks in a bid to avert losses stemming from the region’s fiscal imbalances.
Thomas Chow, a senior money manager who helps invest $120 billion of fixed-income assets at Philadelphia-based Delaware Investments, said investors need to be cautious with the trade, “especially given the kind of news that can move these sectors around quite a bit.”
“Those who have held onto this trade for a long time,” he said, are “certainly feeling it much more.”
Money managers holding the debt will likely be able to endure bigger losses than the hedge funds and bank proprietary trading units that in 2008 unloaded assets as declines accelerated, said JPMorgan’s Beinstein in New York.
“When high-grade bonds were more heavily owned by hedge funds and bank prop desks, they were more short-term focused, and when the positions weren’t working they would unwind them more quickly,” Beinstein said in a telephone interview. “Now most high-grade bonds are held by asset managers and insurance companies. They’re long-term investors, and when they believe in something they are generally able to hold it for quite some time. That’s why it’s difficult to determine the pain threshold at which they would unwind.”
----With assistance by Sarah Mulholland and John Parry in New York. Editors: Pierre Paulden, Alan Goldstein
To contact the editor responsible for this story: Alan Goldstein at email@example.com;