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New issue 10-year subordinated bank paper highlights increasingly rare supply

| October 25, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Zions Bancorp (ZION) priced a $500 million 10-year subordinated note on 10/24/19, which was upsized from $400 million on demand, and priced at +153/10-year versus initial price talk of +175 bp. Bonds are indicated several bp tighter on the turn making the eventual price level not particularly attractive. Relatively rare new issues of 10-year subordinated bank paper amid elevated demand, resulted in an optically tight spread at launch. While there is nothing wrong with the ZION credit fundamentally, opportunities exist elsewhere for better spread compensation among the few subordinated debt opportunities outstanding in this part of the curve.

Subordinated debt issuance from US banks rapidly dried up in 2017 after an unprecedented run from 2013 through 2016. The bigger US banks were building out their regulatory capital levels in accordance with new Dodd-Frank and Basel III requirements for Total Loss Absorbing Capacity (TLAC). The Tier 2 eligible subordinated holding company paper that was issued over those four years was initially priced very attractively, with huge discounts to senior level paper (which also was granted TLAC status). Those spreads quickly compressed as investors’ collective confidence in the capital stability of the big money center banks rapidly improved. Before long, the banks’ need for this type of paper was well covered, and issuance of both Tier 2 debt and TLAC-eligible debt in general has ebbed over the past several years – even as appetite for the additional spread remains fervent in the current  environment.

Exhibit 1. Debt raised ($M) by U.S. public banks and thrifts (2006-2019 YTD)

Source: S&P Global Market Intelligence

The ZION 10-year subs issued yesterday are unique structurally, because many of the “subordinated” notes issued in the intermediate space from bigger investment grade regional names are issued out of the bank level versus the holding company. ZION dropped the holding company/operating company structure that most US banks established post-crisis. Therefore, all of ZION’s outstanding debt is technically holding company debt. Capital structures of regional banks are generally simpler given the absence of significant non-bank operations, so it is less meaningful for valuation purposes, but is a distinction worth noting.

More of the regional sub notes in the 7- to 10-year part of the curve that remain outstanding are classified as subordinated bank notes. Those include the PNC 2.7 ’29s, BBT 3.875 ’29s, USB 2 ’39s, and probably the closest comp to yesterday’s ZION deal, the KEY 3.9 ’29 at ~120 bp to the curve (Exhibit 2). These KEY notes are rated higher at Baa1/BBB+, in-line with senior holdco, as the bank is roughly twice the size as ZION – so not necessarily a perfect fit as similar comp. Most of these issues are priced at a very tight spread relative to comparable seniors.

Exhibit 2. U.S. banks – intermediate subordinated paper (5- to 10-year final maturity)

Source: Amherst Pierpont Securities, Bloomberg/Trace Indications Only

A good example that shows the new ZION 10-year may not be paying quite enough spread, are the WTFC 2029s that priced in June. Those bonds are indicated wide of where they priced, closer to ~300 bp to the curve. The WTFC 10-year is a bullet structure, subordinated at the holding company level. The size of $300 million is index-eligible, while the debt is rated BBB by Fitch and DBRS, and BBB+ by EJR. While it is a smaller bank with roughly $31 billion in total assets versus $69 billion for ZION, and has a smaller debt-market presence, the ~150 bp more in additional spread adequately compensates investors for the additional risks versus ZION’s debt deal.

Exhibit 3. Attractive alternatives in subordinated bank segment

Source: Amherst Pierpont Securities, Bloomberg/Trace Indications Only

The other segment of the market previously highlighted is callable community bank paper, which provides an opportunity for investors seeking additional spread/yield opportunities in the sector, with yields in the low-to-mid 4% range. Several of these callable notes are illustrated in Exhibit 3. In addition, Signature Bank NY (SBNY: Fitch BBB, EJR A, KBRA A) priced a non-index ($200 million) 10NC5 subordinated note on 10/24/19 at 4.125% (~250), which was tighter than IPT (4.375%) on strong demand, and is already yielding below 4% in secondary indications.

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