Global credit investors are jumping back into bank bonds following a sector-wide rout — though concerns about additional tier 1 debt remain.
Money managers from T. Rowe Price Group Inc. to Voya Investment Management see a chance to scoop up bond bargains, betting that the worst is over for financial institutions as the Federal Reserve works to stem contagion.
“If you are willing to buy into the fear, there is definitely an opportunity,” said Samuel Wilson, portfolio manager at Voya. “There is still room for spreads to heal,” he said in a phone interview Wednesday.
The risk premium on US financial-sector debt eased to 171 basis points on Wednesday, having soared to 188 basis points on March 15, the highest since May 2020. It’s still unusually elevated compared to the rest of US high grade, which it tends to track fairly closely — and investors are betting there’s room to rally for bank bonds, a significant holding of index-tracking portfolios.
“It’s not a stretch to describe the current market as a once-in-a-decade buying opportunity for bank paper, especially the high-quality regional and custody banks that have blown out amid the panic,” wrote Jesse Rosenthal and Peter Simon, strategists at 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.
“Some sense of stability has been returning to the banking sector,” said Anastasia Amoroso, chief investment strategist at iCapital in a phone interview Wednesday. “The regulators have taken the right steps and they can double down on that.”
Amoroso predicts that spreads could tighten by 50 basis points in the debt of well capitalized, systemically-important banks, recouping losses caused by the turmoil from US regional bank failures. She also likes the debt of large European lenders due to higher liquidity coverage ratios than US peers.
Voya’s Wilson is waiting for smaller US lenders to issue new bonds after quarterly earnings. That will provide a fresh look at riskier lenders’ financial health, while also helping to satisfy demand for bank debt after a disappointing first quarter for issuance.
Until then, he is steering clear of lower-quality regional lenders that could still be vulnerable to knock on effects from recent bank failures. Lending conditions are expected to materially tighten, particularly for smaller financial firms.
“You are going to see many more banks, especially the small banks, playing defense,” he said.
Voya, which was underweight regional bank debt heading into 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 preferred bank shares via an index or exchange-traded fund. She draws the line at AT1 debt, however, after a government-brokered acquisition of Credit Suisse Group AG by UBS Group AG wiped out the riskiest tier of debt while still preserving $3.3 billion in equity.
“I would be careful with AT1,” she said. “We can’t rule out any more bank failures — and you probably don’t want to be in the highest risk tier of preferred.”
While many others also shun AT1s, asset manager Robeco says recent spread widening created the possibility for “equity-like returns” in the financial sector.
“The financial sector has become a buying opportunity again,” Victor Verberk and Sander Bus, the firm’s co-heads of credit wrote in a quarterly outlook Tuesday. “At above 8% yield, let alone at current much wider levels, we normally like these bonds,” the firm said, referring to AT1 valuations.
“We do think the AT1s are a buy,” CreditSights’ Rosenthal said in an emailed response to questions on Thursday.
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