T. Rowe Price, Invesco Ready to Pounce on Lagging Bank Bondsby
Big banks’ earnings reports starting Friday may spur buying
‘Bonds are cheap’ compared with other forms of corporate debt
Money managers including T. Rowe Price Group Inc. and Invesco Ltd. are getting ready to start buying one of the corporate-bond market’s biggest laggards.
Bank bonds have high yields relative to riskier securities and are safe havens in a market where some fund managers are growing less comfortable with valuations broadly, said Jacob Habibi, a senior credit analyst at Invesco, which oversees $820 billion in assets. The U.S. stock market has fallen about 1 percent this week, and some investors are bracing for corporate bonds to weaken. U.S. banks started posting earnings on Friday and often sell debt after releasing results.
“As U.S. banks’ earnings come in, it may make sense to buy new bank debt," Habibi said on Friday. “Today’s results mark a clear improvement in banks’ fixed-income trading and energy lending” and improving profitability should help bank bonds perform better, he said.
Some investors are shying away from the debt. So far this year, financial bonds maturing between five and 10 years have risen just 6.8 percent, trailing the 9.4 percent gains for industrial bonds with similar duration and the 8.6 percent increase for similar-duration investment-grade corporates overall, Bank of America Merrill Lynch Index data show. The gap between yields for banks and industrial companies is close to its widest in more than three years.
But over the rest of this year, bank bonds could perform in line with overall investment-grade corporate bonds or better, said Steven Boothe, a money manager at T. Rowe Price Group Inc., which oversees $777 billion. Boothe said he’s looking at buying bank bonds after they release earnings.
JPMorgan Chase & Co. and Citigroup Inc. kicked off third-quarter earnings on Friday by posting stronger-than-expected results, buoyed by a rise in bond-trading revenue, while Wells Fargo & Co. saw profit drop 2.6 percent as expenses climbed and the bank set aside more money for soured loans. Next week, Bank of America Corp., Goldman Sachs Group Inc. and Morgan Stanley are due to report.
"Bank bonds are cheap -- I think they’re really attractive," Michael Collins, a money manager at Prudential Financial Inc.’s fixed income unit, said Friday on Bloomberg TV. "That’s been the trade for a long time. The senior debt, even the subordinated debt of the banks is really safe, they have pristine credit quality. The equity has been the challenge."
Federal Reserve officials expect to hike rates by a quarter percentage point this year, according to materials the central bank released last month. Small rate increases can allow banks to raise the interest they charge on long-term loans, without usually forcing them to lift the rates they pay depositors, resulting in higher profit.
"Modestly rising interest rates should be a net positive for U.S. banks and their bonds," said David Brown, head of global investment-grade credit at Neuberger Berman, which oversees $246 billion of assets.
Bank bonds were among the strongest performers in the corporate debt market in 2015. One reason they have lagged this year is that big financial holding companies are issuing more debt to comply with new regulations known as Total Loss-Absorbing Capacity rules. Some banks could sell more TLAC debt after posting earnings, said T. Rowe Price’s Boothe.
Other investors are looking at banks’ riskier securities, such as subordinated bonds or preferred shares. There are more than $10 trillion of bonds in Europe and Asia with negative yields, and fund managers in those regions that are starved for yield may grow more interested in riskier bank instruments in the future.
"You can make an argument for some bank debt down the capital structure including subordinated and preferred securities relative to high-quality junk debt," said Jeff Cucunato, head of U.S. investment-grade credit at BlackRock Inc., which has $4.9 trillion under management.
Any strength in the economy could help as well, said Mark Kiesel, chief investment officer for global credit at Pacific Investment Management Co., which has $1.5 trillion under management. The firm has a higher proportion of its portfolio in bank debt than its index does.
"Bank debt is a pure play of the economy, and the U.S. economy is going to modestly pick up," Kiesel said.