The Long and Short

Attractive spreads in ‘A’ credits

| June 2, 2023

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.

Spreads across investment grade corporate credit have moved significantly lately, but historic relationships argue that ‘A’ credits broadly maximize spread compensation right now. This is due in part to recent widening in domestic bank paper, which has a large concentration of ‘A’ rated credits. Until ‘BBB’ spreads move wider, investors seem best served to concentrate more holdings in ‘A’ ratings in their corporate bond portfolios.

Exhibit 1. ‘A’ rated spreads versus ‘AA’ rated spreads – Five-year history

Source: Santander US Capital Markets, Bloomberg Barclays Corporate Bond indices

As demonstrated in Exhibit 1 above, the aggregate spread pick in ‘A’ rated credit relative to ‘AA’ is currently about 49 bp of option-adjusted spread (OAS). That level is just over two full standard deviations of the mean (+28 OAS). The last time single ‘A’ credit was trading with this large of a premium over ‘AA’ was back in October and November of last year. Based on the chart above, that relationship was extremely short-lived before ‘A’ rated credit rallied significantly relative to the higher ratings category, eventually racing down to the mean in early February of this year, a month or so prior to the ongoing banking crisis. This suggests investors should target opportunities to trade down from ‘AA’ rating categories to single ‘A’ rating categories right now.

Exhibit 2. ‘BBB’ rated spreads versus ‘A’ rated spreads – Five-year history

Source: Santander US Capital Markets, Bloomberg Barclays Corporate Bond indices, range of outcomes shortened for visual purposes

As Exhibit 2 above demonstrates, the spread pick available between ‘BBB’ and ‘A’ credit has been on a subtle incline over the past several months. However, the current spread level of +52 OAS still clearly remains below the five-year average of +56 OAS. ‘BBB’ spreads have not moved a full standard deviation over the mean since the heights of the pandemic, last peaking in July of last year at a level of +67 OAS. Therefore, this chart confirms that while the premium for ‘BBB’ credit has in fact been rising as recent articles would indicate, on an historic basis it is still offering below average risk compensation to move down a full ratings category.

Exhibit 3 illustrates the more recent sell-off in banking credit depicted by the Bloomberg Barclays IG Banking corporate index relative to the broad IG corporate index. Bank spreads, given their concentration in higher-rated credits, more traditionally trade tight to the overall IG index.

Exhibit 3. IG banking index OAS versus broad IG corporate Index – Three-year history

Source: Santander US Capital Markets, Bloomberg Barclays Corporate Bond indices

The graphic below in Exhibit 4 breaks out all index-eligible, single ‘A’ rated domestic bank bonds with intermediate maturities in the four-to-eleven year range. Most of the big US money center banks (BAC, C, JPM, WFC), as well as some of the lower-risk “super” regional and processor banks trade in a fairly narrow range of spreads. Meanwhile, some of the more intermediate regional banks (KEY, MTB, TFC, HBAN) with single ‘A’ ratings at both the bank and holding company level are still trading at-or-near dollar price basis, representing a significant discount relative to their larger counterparts. It is among these issuers that we see the greatest relative value for investors seeking to take advantage of soft pricing of single ‘A’ credit in the intermediate part of the curve. Recently, we highlighted the value case for KeyCorp (KEY: Baa1/BBB+/A-) credit instruments, with emphasis on the bonds issued out of the senior holding company structure. Those bonds have performed extremely well over the past three weeks, but still offer compelling upside; as do the bank level instruments that qualify for ‘A’ ratings (A3/A-/A-). KEY 5.0% 01/26/33 bank-level senior notes offer over 300 bp of spread, trading at a dollar price just under $88. Other regional bank notes that appear attractive at current valuation with stable credit include the senior bank-level HBAN 5.65% 01/10/30 (A3/A-/A-) trading at just over $96 dollar price with a spread-to-curve of approximately 267 bp, as well as the MTB 5.053% 01/27/34 senior holding company notes (A3/BBB+/A) trading just over a $92 dollar price, or about +250 bp to the curve.

Exhibit 4. Intermediate single ‘A’ rated bank bonds – spread vs duration

Source: Santander US Capital Markets, Bloomberg/TRACE G-Spread Indications Only

Dan Bruzzo, CFA
dan.bruzzo@santander.us
1 (646) 776-7749

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