The Long and Short
Surveying the new issue landscape for banks
Dan Bruzzo, CFA | October 20, 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 on bank debt have leaked wider in recent weeks in anticipation of supply coming on the heels of earnings. Now that earnings have kicked off from US money center and large regional banks, the influx of supply is underway. As of October 18, nearly $24 billion in new domestic bank debt has hit the market. And despite the heavy supply, banks continue to show some of the best relative value in the investment grade corporate bond market. In particular, MTB and KEY still offer attractive relative value.
There have been interesting developments as bigger banks exited their blackout periods and tapped the debt market. Given some of those trends its not hard to see why mid-sized regional banks like MTB and KEY are choosing to stand down—or, perhaps more accurately, may be getting shut out of the market amidst surging rates. Bank of New York Mellon (BK: A1*-/A/AA-), US Bancorp (USB: A3*-/A/A), and PNC Financial Services (PNC: A3/A-/A) were the only regionals so far to issue debt after earnings – the latter of which might be the threshold for credit risk that investors are willing to tolerate. Meanwhile, the new BK deal, which priced at 140 bp over the Treasury curve for the 6-year non-call 5-year (6NC5) and 158 bp over for the 11NC10, are trading through most of the Big 6 money center banks and roughly in-line with JPM, which is causing some investors to back off.
Exhibit 1. US banking new issues for third-quarter earnings
The bank debt that launched recently has generally performed well, with most of the new issues trading at or just slightly wide of their pricing levels. However, Goldman Sachs’ (GS: A2/BBB+/A) misstep on the 11NC10 tranche of their debt launch demonstrates how tenuous the market might really be. GS was the third of the big banks to bring their deal. They priced the 11NC10 with almost no concession to secondaries, as the on-the-run 10-year notes was trading at a roughly $22 discount, leading to $6 billion in drops from the deal, which eventually launched with just $1.25 billion total – extremely small for a benchmark 10-year. Meanwhile, dollar price discounting has become less of a concern in the secondary market for the benchmark bank deals, as investors are putting a priority on getting into the most liquid on-the-run issues, even if it means sacrificing some relative valuation. Goldman’s troubled launch becomes even more noteworthy when viewed in the context of their decision to wait on the sidelines throughout the first half of the year, leaving the bulk of their issuance needs for the final months of 2023 with interest rates surging.
M&T Bank (MTB: Baa1/BBB+/A) and KeyCorp (KEY: Baa1/BBB/A-) were recently identified as attractive picks in the banking sector according to the previously launched percentile rank relative value analytic. Both banks were among the US regionals to report third-quarter earnings results this week, which were mostly in-line with consensus expectations and exhibited operating stability. Neither issuer has come to market yet with a post-earnings debt launch. Both banks last tapped the public debt market in January of this year but are under less pressure to do so than some of their larger, more regulated regional bank peers. The current 10-year maturity KEY bank notes and the MTB 5-year senior bank notes both continue to offer attractive relative value for their stable credit profiles.
KEY 5.0% 01/26/33 @ 289/10yr, G+288, 7.83%, $81.59 (bank level seniors – A3/BBB+/BBB+)
MTB 4.7% 01/27/28 @ 235/5yr, G+232, 7.32%, $90.56 (bank level seniors – Baa1/A-/A)
Exhibit 2. MTB and KEY vs Single ‘A’ rated domestic regional banks – intermediate debt maturities
Since September when these bonds were both identified was offering attractive risk compensation relative to peers, KEY had its senior rating downgraded by Fitch to BBB+ from A-, knocking the senior bank notes out of the single ‘A’ ratings category. The rating agency cited that “unfavorable funding conditions will challenge KEY’s earnings power” as justification for the downgrade but chose to affirm several of the bank’s peers despite similar challenges. Nevertheless, KEY’s results in the third quarter came in very much in-line with expectations. Revenue of $1.57 billion came in slightly ahead of the consensus forecast, while EPS from continuing operations of $0.29 beat by two cents. Average deposits grew by $2 billion in the quarter. Net interest income was $923 million and the net interest margin was 2.01% — which came in several bp below expectations. The bank’s Tier 1 Common Equity ratio (CET1) improved by 50 bp as risk-weighted assets were reduced by $7 billion, taking pressure off the bank to bolster capital by other methods.