Bank Bonds Losing Stigma as Earnings Boost Trust: Credit Markets
Investors are accepting the smallest yield premiums on bank bonds relative to industrial companies in a year as earnings surpass estimates at lenders from Bank of America Corp. (BAC) to Citigroup Inc. (C)
Relative yields on U.S. financial debt have dropped to 73 basis points more than those of industrial companies in the U.S., from 105 basis points at the start of June and the least since Aug. 2, Bank of America Merrill Lynch index data show. The bonds are on pace to produce the best monthly returns since January, gaining 2 percent through yesterday.
Early readings of second-quarter bank earnings are providing comfort that financial companies worldwide are withstanding Europe’s sovereign debt crisis after spending four years shoring up balance sheets and almost doubling capital cushions that protect lenders from losses. In Europe, the gap between yields on financial institutions and other companies narrowed to an 11-month low of 108 basis points on June 30.
“People went into earnings season a little bit skeptical of financials, and the fact they produced good earnings has been a bit of a relief,” Anthony Valeri, a market strategist in San Diego at LPL Financial, which oversees $350 billion, said in a telephone interview. “That’s been a catalyst to cause investors to take advantage of these cheap valuations at a time when there are still lingering concerns about growth, which are probably weighing more on industrials right now.”
Yields on financial-company bonds in the U.S. rose to 305 basis points, or 3.05 percentage points, more than Treasuries with similar maturities in June amid concerns the crisis in Europe would infect balance sheets globally. Moody’s Investors Service downgraded 15 of the world’s largest lenders on June 21, citing their “significant exposure to the volatility and risk of outsized losses inherent to capital markets activities.”
U.S. financial-company bond spreads have narrowed 114 basis points this year to 250 basis points, index data show. That compares with a 29 basis-point drop during the same period to 177 for the dollar-denominated bonds of companies from retailer Wal-Mart Stores Inc. (WMT) to Anheuser-Busch InBev NV, the maker of Budweiser and Stella Artois.
Banks’ “balance sheets are not as leveraged, and the business models are becoming less complex,” said Jon Duensing, the Boulder, Colorado-based head of corporate credit at money manager Smith Breeden Associates. “That can be an attractive combination for debt investors when considering the likelihood of repayment.”
Elsewhere in credit markets, Party City Corp. plans to sell $700 million of bonds to help fund its buyout by Thomas H. Lee Partners LP in its inaugural offering. Ally Financial Inc. sold $731 million of bonds linked to vehicle debt amid a surge in asset-backed issuance. Hologic Inc., the maker of diagnostic, medical and surgical devices, cut the interest rate on a $1.5 billion loan it’s seeking.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, rose 0.19 basis point to 23.88, the widest in more than a week. The gauge, which has climbed from an 11- month low of 22.5 on July 12, widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.
The cost of insuring European corporate debt declined for a third day, with the Markit iTraxx Europe Index of credit-default swaps tied to 125 investment-grade companies dropping two basis points to a two-week low of 160.5, according to prices compiled by Bloomberg.
The Markit iTraxx SovX Western Europe Index linked to 15 governments fell two basis points to 261, holding near the lowest level since this series of the gauge started trading in March.
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.
Bonds of Goldman Sachs Group Inc. (GS) were the most actively traded dollar-denominated corporate securities by dealers yesterday, with 182 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Party City may sell eight-year notes as soon as today to yield about 9.125 percent, according to a person familiar with the transaction who asked not to be identified because terms aren’t set.
Thomas H. Lee
Thomas H. Lee said June 5 it agreed to buy a majority stake in Rockaway, New Jersey-based Party City in a transaction valued at $2.69 billion including debt after the largest U.S. party- supplies retailer filed for an initial public offering that hasn’t been completed.
Ally (ALLY) paid 70 basis points more than the benchmark swap rate on a top-ranked slice of bonds maturing in 2.89 years and backed by loans to dealerships, according to a person familiar with the offering. The transaction was initially marketed at $409.5 million, the person said.
The deal is part of about $6 billion in securities tied to household and business borrowings being offered to investors this week as rising vehicle sales fuel issuance, according to data compiled by Bloomberg. Citigroup boosted its 2012 asset- backed forecast by about 50 percent to $183 billion last week, with sales linked to autos accounting for about 63 percent of that, analysts led by Mary Kane said in a July 12 report.
The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 index was little changed at 94.21 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, had climbed for 14 straight days, the longest streak since April 2010.
Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s and lower than BBB- by S&P.
Hologic’s seven-year debt, decreased to $1.5 billion from $1.75 billion, will now pay interest at 3.5 percentage points more than the London interbank offered rate, down from 4 percentage points, a person with knowledge of the deal said. The minimum on the benchmark will remain at 1 percent.
Financial bonds globally are trading at an average 105.7 cents on the dollar, the highest price since October 2010, Bank of America Merrill Lynch index data show. That compares with a record 113.7 cents for industrial bonds.
Bank of America bond spreads have declined 270 basis points to 295 this year through yesterday, and Citigroup spreads have narrowed 135 basis points to 267, Bank of America Merrill Lynch data show.
Companies from Goldman Sachs to American Express Co. (AXP) in the S&P 500 Financials index reported an average $4.54 per share of second-quarter earnings through yesterday, compared with analyst estimates of $4.18 a share, Bloomberg data show.
The ratings cuts by Moody’s last month were widely anticipated, so the companies’ bonds have since rallied with the possibility of even greater downgrades removed, Smith Breeden’s Duensing said. As regulatory changes push banks to lower their debt burdens and shift their businesses to lower-risk activities to comply with new capital rules, the debt is more attractive to investors, he said.
At the same time, a slowdown in the global economy is beginning to weigh on industrial companies’ earnings. Firms in the S&P 500 Industrials Sector Index have reported an average of $5.56 a share, compared with an estimate of $6.09, Bloomberg data show.
The bank earnings have been positive for credit investors because “capital levels remain very strong, credit loss trends are improving and there have not been new negative surprises on legal/regulatory issues,” JPMorgan strategists led by Eric Beinstein said in a July 18 research note.
Bank of America, based in Charlotte, North Carolina, reported a second-quarter profit on July 18 as losses in real estate narrowed and the company reduced allowances for losses from bad loans. Shares of Goldman Sachs rose July 17 after it reported the lowest first-half revenue and earnings in seven years. Citigroup, the third-biggest U.S. bank, reported second- quarter profit on July 16 that beat analysts’ estimates on revenue from advising on mergers, corporate lending and underwriting stocks and bonds.
Investors also are chasing a smaller pool of new financial- company bonds, further bolstering prices, the JPMorgan strategists wrote. Banks haven’t issued bonds after reporting earnings this quarter as they have historically, they said, “likely because bank spreads remain relatively wide and banks remain very liquid so their need for funding is limited.”
The face value of U.S. bank bonds in a Bank of America Merrill Lynch index has declined to $905 billion through June 30 from a peak of $947 billion in July 2011. That figure increased every year through 2011, from $34 billion in 1991.
“Valuations do not look stretched and financials are benefitting from reporting earlier than non-financials and from investors’ current view that European risk factors have declined,” the JPMorgan strategists wrote.
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