6 Min Read
By Danielle Robinson
NEW YORK, Oct 19 (IFR) - US banks are trading through one of the major industrial sectors in terms of spread for the first time since the 2008 crisis, and are just a few basis points away from regaining their long-held position of having tighter spreads than corporates in the US.
The Financial Institution Group's (FIG) option adjusted spread, as measured by the Barclays Corporate Index, closed at 150bp on Thursday, compared with Basic Industries' OAS of 170bp.
And if subordinated debt is removed from the FIG segment of another index, the Bank of America Merrill (BofA Merrill) Master Index, to give a more like-for-like comparison with corporates, the OAS of banks is now just 4bp away from the industrial segment's 137bp, as measured by BofA Merrill's index.
"This is exactly what we thought would happen," said Michael Collins, a chief investment officer at Prudential, whose team was one of the few to go out on a limb and buy US banks at their widest levels last year.
"The big question now is whether the FIG sector can trade on top or through the industrial sector," Collins said.
Credit strategists have little doubt that it will.
"It's all come together for the US banks this year, in terms of their much better capital structure, improving US real estate market and a significant drop in European tail risk," said Hans Mikkelsen, senior credit strategist at BofA Merrill.
"The US's biggest banks are now solidly in transition from being a high beta sector to becoming low beta again, as they were before the credit crisis."
Banks have been on a tear since the summer, and received a further boost this week on better US housing price news, money center financials generally reporting better-than-expected third-quarter earnings, and the fact that the top four US banks have improved their Tier 1 capital by an average of 58bp since the second quarter.
The improving credit and macro news sparked a bout of short-covering on Monday and Tuesday, as some who put shorts on certain FIG names going into the Fall were forced to throw in the towel. They were seen buying certain names as much as 20bp-30bp inside their marked levels.
"Some people were doubting this recent rally in FIG, and have been waiting for weeks for spreads to back up," said David Knutson, senior FIG strategist at Legal & General Investment Management America.
"But in the early part of this week we saw a new phase in the FIG rally, because of (investors') capitulation," he said.
US banks took advantage of the red-hot conditions this week. JP Morgan issued US$2.85bn of three-year fixed- and floating-rate notes on Monday and a US$500m five-year floater on Tuesday.
PNC Bank issued US$1bn of subordinated Tier 2 debt on Wednesday at the operating company level; while Goldman Sachs raised US$750m in the retail market with a Tier 1 perpetual preferred. Morgan Stanley raised US$2bn of 10-year Tier 2 debt on Thursday at the holding company level.
On Thursday Bank of New York Mellon paid the lowest cost any US bank has ever paid for three-year and five-year debt, issuing a US$600m 2015 with a coupon of just 0.7%, or 33bp over Treasuries, a US$500m 1.3% 2018 at 55bp.
It also issued a US$400m three-year floater at three-month London Interbank Offered Rate (Libor) plus 23bp.
The 0.7% coupon on the three-year ties with John Deere Capital Corp for the lowest ever FIG coupon in that maturity and takes the title as the lowest ever bank coupon in three-years away from Bank of Nova Scotia's 0.75% 2015s.
BNY's 0.7% coupon compares with JPM's recent 1.1% 2015 priced on Monday.
The 1.30% coupon on BNY's 2018s is the lowest cost of five-year funding of any bank, beating Bank of Montreal's 1.40% 2017s priced in September and US regional bank, BBT's 1.60% 2017s.
As big as the week's achievements were, however, FIG demonstrated it was still very much the proxy for market direction and the most liquid high beta sector on Thursday, when spreads widened out on profit taking.
"We came so far so fast; it's no surprise things are softer today," said one trader on Thursday.
Although FIG is expected to continue to grind tighter, analysts expect future spread improvement to come much slower than what has been experienced in recent months.
"Some of these tighter trading financials have limited room to run further," said Shobhit Gupta, credit strategist at Barclays.
The BofA Merrill high-grade spread index has tightened by more than 100bp this year, compared with FIG's 384bp tightening.
Once, the average five-year CDS for the top four banks (BofA Merrill, Citigroup, JP Morgan and Wells Fargo) was just 10bp at the end of 2006. They widened out to 390bp in April 2009 and on October 18 were at 121bp.
The investment-grade CDX index, which does not include FIG, was at 34bp at the end of 2006; 184bp in April 2009 and 91bp on October 18.
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