The Long and Short
Attractive spreads in ‘A’ credits
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
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.