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Bank stock sell-off: time to panic or hold tight?
admin | May 15, 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.
US bank stocks have been in rapid decline, with heavy selling over the past week. Equity investors have grown increasingly wary of the likely inevitable cuts to shareholder payouts, and the prospect that a deeper US economic recession will result in lower-for-longer rates. Despite the spike in stock price volatility, domestic bank credit has remained steady, with spreads little changed over the past week. Bond investors should continue to maintain an overweight in domestic bank credit, and look at add exposure if any equity-related selling spills over into corporate debt markets.
Since the early weeks of the COVID-19 crisis we have been stressing an overweight on domestic bank credit with an emphasis on the big US money center banks (APS Strategy: adopt-defensive-posture). This point was further emphasized during heightened volatility (APS Strategy: remain-defensive) and highlighted as the banks reported 1Q20 earnings (APS Strategy: Bank Earnings) with sizable provisions for current and future credit costs.
Exhibit 1. Bank Stock Returns (4/29 – 5/14) vs S&P 500
Source: Bloomberg LP
Bank stock selling took a pause on Thursday, as reports of a rumored tie-up between Goldman Sachs (GS: A3/BBB+/A) and Wells Fargo (WFC: A2/A-/A+) surfaced, fueling some speculative relief in bank stocks, but ultimately leaving valuations significantly lower from late April (although it’s not the topic of discussion here, the prospects of a GS/WFC tie-up are extremely dim from a regulatory perspective; politically indefensible).
Exhibit 2. Banking OAS vs Broad IG Index
Source: Bloomberg/Barclays IG Corporate Indices
Banking has maintained its position as the top performing sector within the entire IG Index* since the start of the crisis. From February 17 through yesterday, the Banking sector recorded a -5.70% excess return (vs comparable US treasuries) with just +105 bp in aggregate OAS widening. That compares with -9.19% excess return and a +117 spread change for the IG Index, and compares with the double digit losses among some of the worst performing segments in the market, including: Energy (-18.91%, +243 bp), Finance Cos (-17.15%, +321 bp), Basics (-11.86%, +144 bp) and REITs (-111.62%, +182 bp). Banks have even outperformed the most traditionally defensive segments of the Index, including Tech (-6.01%, +80 bp), Consumer Non-Cyclical (-7.59%, +86 bp) and Utilities (-8.61%, +82 bp). Investors are best served maintaining an overweight of domestic bank credit, or seeking opportunities to add exposure if any selling related to equity concerns materializes in the corporate bond market in the immediate term.
In last year’s US bank stress test, there were record allotments of capital approved by the Fed for dividend and repurchase activity in the approved Comprehensive Capital Analysis and Review (CCAR) results announced mid-summer 2019. Bank of America (BAC: A2/A-/A+) alone instituted a +20% dividend increase and raised their buyback program by $10 billion to a staggering $31 billion for the upcoming 4 quarters. To put that into context, regulators were enabling BAC’s plan to pay out nearly $9-10 billion more to shareholders than they were actually forecast to generate over that time period – meaning that they were very likely to dip into their existing capital surplus to do so. Moving forward, this provides a tremendous amount of flexibility for BAC to postpone, scale back or otherwise eliminate plans for shareholder enhancements in order to preserve their balance sheet and maintain capital ratios. The bank booked a $4.8 billion provision for credit losses in 1Q20 (including a $3.6 billion reserve build), and appears more than likely to follow with additional charges in subsequent quarters. With over $168 billion in Tier 1 capital on the balance sheet as of quarter end, with a Tier 1 Common CET1 ratio in excess of 10%, we believe that BAC can easily scale back its existing shareholder enhancement program and maintain strong capital ratios in even the more pessimistic of economic scenarios to come. Bank bondholders should not be swayed by the inclinations of equity holders, or the prospect of overvaluation based on expected payouts.
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john.killian@santander.us
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