Bank chaos creates ‘once in a decade’ opportunity to buy bonds

(Bloomberg) – Global credit investors are jumping back into bank bonds after an industry-wide flight – although concerns about additional Tier 1 debt remain.

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Money managers from T. Rowe Price Group Inc. to Voya Investment Management see an opportunity to bargain for bonds, betting the worst is over for financial institutions while the Federal Reserve works to contain the contagion.

“If you’re willing to embrace fear, there’s definitely an opportunity,” said Samuel Wilson, portfolio manager at Voya. “There is still room for healing from spreads,” he said in a phone interview on Wednesday.

The risk premium for US financial sector debt fell to 171 basis points on Wednesday after rising to 188 basis points on March 15, the highest level since May 2020. It is still unusually high relative to the rest of US senior debt , which it tends to track fairly closely – and investors are betting there is room for recovery in bank bonds, a key holding in index-tracking portfolios.

“It would not be an exaggeration to describe the current market as a one-off buying opportunity for bank securities, particularly for the high quality regional and custodian banks that have been blown up amid the panic,” wrote Jesse Rosenthal and Peter Simon, strategists at the research firm CreditSights Inc. “This is as cheap as bank spreads get outside of a global financial crisis,” they wrote in a March 23 note.

Read more: T. Rowe snatched discounted European bank debt in Monday Rout

“A sense of stability has returned to the banking sector,” Anastasia Amoroso, iCapital’s chief investment strategist, said in a phone interview on Wednesday. “Regulators have taken the right steps and can double that.”

Amoroso predicts that spreads on the debt of well-capitalized, systemically important banks could tighten by 50 basis points to offset losses caused by the turmoil caused by the collapse of regional US banks. It also likes the bonds of major European lenders due to higher liquidity coverage ratios than US peers.

Voya’s Wilson waits for smaller US lenders to issue new bonds after quarterly earnings. This will provide a fresh look at the financial health of riskier lenders while helping to meet demand for bank bonds after a disappointing first quarter for issuance.

Until then, he is staying away from lower-quality regional lenders, which may still be vulnerable to the impact of recent bank failures. Lending conditions are expected to tighten significantly, particularly for smaller financial firms.

“You’re going to see a lot more banks, especially the small banks, playing defense,” he said.

Voya, which was underweight regional bank bonds before the crisis, is also taking advantage of recent spread widening to add some exposure to subordinated debt.

AT1 caution

iCapital’s Amoroso sees opportunities to add exposure to bank preferred stocks through an index or exchange-traded fund. But she is drawing a line on AT1 debt after a state-brokered takeover of Credit Suisse Group AG by UBS Group AG wiped out the riskiest debt class while preserving $3.3 billion in equity.

“I would be careful with AT1,” she said. “We cannot rule out further bank failures – and you probably do not want to be favored in the highest risk tier.”

Read more: The riskiest bank debt is a tough sell after Credit Suisse wipeout

While many others are also avoiding AT1s, asset manager Robeco says recent spread widening has created an opportunity for “equity-like returns” in the financials sector.

“The financial sector has become a buying opportunity again,” wrote Victor Verberk and Sander Bus, co-heads of the company’s credit department, in a quarterly outlook on Tuesday. “At yields above 8%, not to mention much broader levels at the moment, we usually like these bonds,” the company said, referring to AT1 ratings.

“We think the AT1s are a buy,” CreditSights’ Rosenthal said in an emailed response to questions Thursday.

Read more: Boaz Weinstein says junior bank debt is still overrated

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