Pimco Sees Misunderstood U.S. Bank Bonds Offering Room for Gains

  • Head of credit research says U.S. lenders ‘radically improved’
  • Firm underscores role of tighter financial regulation

Pacific Investment Management Co. reckons debt investors haven’t yet figured out just how good American bank bonds are.

The firm, which manages $1.5 trillion in assets, said U.S. lenders have “radically improved” in recent years because industry regulation became stricter, yet the fixed-income market continues to undervalue their securities.

Lenders such as JPMorgan Chase & Co., Wells Fargo & Co. and Bank of America Corp. have been subject to new global and domestic rules that forced them to bolster the amount of capital they hold and shed riskier assets. That hasn’t stopped credit spreads widening over the past couple of years, even though the measures were aimed at preventing a recurrence of the 2008 financial crisis.

“The regulatory screw continues to tighten and I think that’s underappreciated,” Christian Stracke, Pimco’s global head of credit research, said in an interview in Sydney this week. “There still is a premium that you can receive from investing in the banks, because there’s still a lot of apprehension and also there’s just a lack of understanding.”

Complexity Premium

U.S. banks are currently unaffected by the difficulties bedeviling lenders in Europe who face concerns over asset quality, politics and the economy, Stracke said. Pimco particularly favors senior, unsecured U.S. bank notes, but also likes securities all the way down the capital structure, including preferred issues.

“Prior to the crisis, arguably these credits were low BBB type credits, if not worse, now some of them are solid single A type credits, and yet the yields on them are more like BBBs,” said Stracke, who is based at Pimco’s headquarters in Newport Beach, California. There’s “an opportunity for our investors to take advantage of that complexity premium,” he said.

Stracke said he expects that eventually the spreads on these kinds of bonds will narrow as the market takes account of their improved credit quality, and in the meantime investors can take advantage of the additional running yield they offer.

“Normally if you were late in the cycle you might not like banks because you’d be afraid that the cycle could turn, but because the regulation is as strong as it is, it creates this opportunity,” he said.

While the average yield premium over Treasuries on U.S. financial debt has fallen to 147 basis points from its 2016 high of 192 in February, it remains 45 basis points above the post-crisis low it touched in 2014, according to a Bank of America Merrill Lynch index.

There’s strong interest from investors outside the U.S. in the nation’s investment-grade credit market, Stracke said. The flow of funds and the effect of quantitative easing policies from the European Central Bank means that the American market is “technically very strong,” although even more importantly “the fundamentals remain robust,” he said.

Other investments that Pimco likes include secured notes backed by aircraft, as well as debentures issued by companies that benefit from the U.S. housing recovery, such as homebuilders and suppliers of building materials.

“You still can take advantage of one of the few sectors that’s not late stages in the U.S. economy right now,” he said. “Housing is really in the middle of its cycle. If there were to be a recession in the U.S. in the next 12-to-18 months, housing would be pretty isolated because it just hasn’t gone anywhere, so it would be very difficult for it to fall by much.”

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