Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

It sounds quite serious when one of the main credit-rating agencies suddenly downgrades the biggest U.S. banks. But the people who really matter -- the financial companies’ bond investors -- are as enamored of them as ever.

Standard & Poor’s late Wednesday lowered credit grades by one level on eight banks, including JPMorgan Chase, Bank of America and Citigroup, on the prospect that the U.S. government is less likely to provide aid in a crisis. The move seems somewhat out of touch with a market that has wholeheartedly embraced their debt over the past few years.

A $1.2 trillion pool of these U.S. bank bonds has returned 2.5 percent this year, a percentage point more than gains on similarly-rated dollar-denominated corporate notes, according to Bank of America Merrill Lynch index data. JPMorgan’s dollar-denominated bonds have returned 8.4 percent since the end of 2012, while Bank of America’s notes have gained 10.5 percent. Citigroup’s debt has generated an 11.2 percent return. That compares with a 7 percent return on the Bank of America Merrill Lynch Single-A U.S. Corporate Index since the end of 2012.

Surging Debt
U.S. banks have been issuing a lot of bonds in recent years.
Source: Bank of America Merrill Lynch index data

While investors used to think of Wall Street debt as riskier than notes of big stable corporations, it has been the opposite since the beginning of 2013, with the bank bonds predictably yielding less than similarly-rated company notes. There was no discernible wholesale upset of that trend in early trading Thursday.

Bank-Debt Boom
Bonds of U.S. banks have been yielding less than notes of similarly rated companies.
Source: Bank of America Merrill Lynch data

This makes sense. Big U.S. banks have reduced their more-speculative holdings relative to their equity positions. They have trimmed payrolls and are investing in more technology-heavy disciplines that are cheaper to maintain and can generate profits by virtue of volume, not risk. This has been appealing to debt investors, who are seeing a lower likelihood of a full-scale bank collapse, even without the prospect of a government safety net.

The gains have come despite new Federal Reserve rules that would require large U.S. banks to have debt that could be converted to equity in a squeeze. While the financial firms’ stock investors would lose everything in a bank’s collapse, the bondholders would receive equity in a reconstituted version of the firm.

At the end of the day, bond investors look at the fundamental math underpinning a company’s ability to repay its obligations. Money in, money out. There are still billions of dollars of profits filling the coffers of the biggest U.S. banks at a time when they’re generally taking less risk.

So S&P can say what it wants about these banks and their potential for collapse. Bond investors aren’t listening.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net