Banks ramp up preferred issuance at all-time low coupons
admin | January 24, 2020
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.
Last week the big US money center banks announced relatively strong earnings, punctuated by an impressive year-over-year recovery in fixed income trading revenue. The banks wasted no time in bringing a healthy slate of debt offerings as they exited their blackout periods, which were dominated by preferred issues with some of the lowest coupons ever printed for the debt class. Despite the record low coupons the relationship between seniors and these preferred structured deals will likely continue to tighten.
Last week, Citi brought $1.5 billion of PerpNC5 4.7% preferreds, JPM brought $3 billion of PerpNC5 4.6%, and WFC $1.75 billion of $25 par PerpNC5 4.75%. Those deals were followed this week by BAC’s $1.1 billion 4.3% deal — the lowest coupon of the bunch, benefiting from optimal timing. The tone was so strong that markets saw an extraordinarily rare event where BAC actually re-launched the deal at 4.30% from the original level of 4.375%, even if it meant losing a couple participants from the oversubscribed deal. GS capped the week-plus of activity with a smaller $350 million (will not grow) PerpNC5 4.4% preferred deal.
The APS 2020 Outlook) focused on expected bank issuance, taking a look at the upcoming maturity schedule and issuance behavior over the past several years. The graph depicting issuance by debt class has been updated to include both $1,000 and $25 par preferred deals (Exhibit 1). The roughly $8 billion already issued has roughly matched or beaten preferred volume over the past several years, and comprised the lion’s share of funding so far from the big 6 banks. Additional issuance is expected, with the total likely topping the rather healthy ~$12 billion issued during same period in 2019.
Exhibit 1. Subordinated debt issuance has waned (reducing supply of overall non-senior debt), but preferreds remain a desirous class for issuers and investors alike.
Exhibit 2. Big 6 bank maturity schedules – BAC has the least debt maturing over the next two years, and could therefore have the most limited supply over the next several quarters; WFC has the most maturities over the same period.
Back-end floating rates at record lows
For an extended period of time, preferred issuance largely adhered to an unwritten bogey for the back-end of callable no-call 5-year fix-to-float structures of roughly >375 bp (+3M Libor). As appetite for yield increased and spreads tightened, that bogey moved through 350 bp to 325 bp, and is now at levels even inside of <300. The January no-call 5-year perpetual preferred deals were priced with back-end rates as follows:
Citi 4.7%: Callable 1/30/2025 SOFR +323.4 bp (currently yielding: 4.28%/4.20%)
JPM 4.6%: Callable 2/1/25 SOFR+312.5 bp (currently yielding: 4.15%/4.04%)
BAC 4.3%: Callable 1/28/25 3M Libor +266.4 bp (currently yielding: 4.24%/4.19%)
GS 4.4%: Callable 1/28/25 CMT USD 5yr +285 bp (currently yielding: 4.30%/4.27%)
Should Investors be buying record low coupons?
The very short answer is yes, as the relationship between seniors and these preferred structured deals will likely only continue to tighten. The subordinated holding company structure that was very popular through the 2013-2016 period has been in extremely limited supply. In fact, there were no public subordinated deals from the Big 6 all of last year. Although it is difficult to gauge given the absence of supply and increasing illiquidity, the existing relationship between subordinated and senior holding company notes is roughly a +15-20 bp pick in the 5- to 10-year part of the curve to move down in the capital structure. That compares with an average closer to 50 bp at the peak of issuance back in 2015-2016 (see Exhibit 3 below). During that same period, big 6 bank PerpNC5 notes offered about a 300 bp pick to 5-year senior holding company notes and PerpNC10 notes (which we saw more of back then) offered about a 230-250 bp pick to seniors. That compares today with pick of roughly 215 bp and 125 bp, respectively, to move from 5-year and 10-year seniors to the new preferred deals. The relationship is moving tighter in the absence of subordinated supply, and with investor confidence in bank balance sheets at the most stable levels since the financial crisis.
LIBOR float vs SOFR and CMT
More corporate debt securities are making the transition from LIBOR to the presumed successor SOFR or the Constant-Maturity-Treasury benchmark (or comparable structure) as the expiration of mandatory LIBOR approaches at the end of 2021. This recent batch of issues was divided across all three benchmarks. Interesting—but again largely a function of timing—the BAC deal that was priced to LIBOR launched with the lowest overall coupon and lowest back-end. This at least suggests that the market is not concerned at the transition of these instruments, the newer of which contained more detailed LIBOR transition language.
Exhibit 3. Changing landscape – bank capital structure relationships at the height of subordinated debt issuance