The Big Idea

Lessons learned from corporate credit in 2023 I

| December 15, 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.

One big event can reshape an entire market, or at least an entire sector of an entire market. That was true this year in bank debt. And timing of calls was important, too, in both bank debt and in technology, among other places.

One big event can define markets

It’s difficult to look back on the lessons learned in credit throughout 2023 without considering the broad reaching impact of the regional banking crisis. Beginning in the early March with the rapid collapse of Silicon Valley Bank (SIVB), the subsequent fallout became perhaps the defining credit event of the year. Given the overall importance, it is of little surprise that many of the individual calls on corporate credit were directly or indirectly related to regional banks and the fallout of the crisis (Exhibit 1).

The first of those calls came in late January, almost two months before the SIVB collapse, in which banking was highlighted as a sector that was likely to outperform (along with REITs) based on relative wideness of spreads versus the broader sector. This technique would later be developed into a more robust relative value analytic known as spread percentile ranks. Not surprisingly, given the timing of the call, a bullish overweighting of banks would have spelled disaster in the first quarter of the year.

Exhibit 1. IG banking index OAS and major calls in 2023

Source: Santander US Capital Markets LLC, Bloomberg/Barclays Banking Index

Almost every individual credit call that would follow the initial banking sell-off sought to differentiate stronger credits from the criteria that led up to the collapse of SIVB and the subsequent regional bank failures – an approach that would later ultimately lay the foundation for one the six out-of-consensus credit calls for 2024 as well. The first of those attempts to identify banks that were being perhaps unfairly lumped in with the banks that were placed into receivership was focused on Westcoast regional lenders Comerica (CMA: Baa1/BBB/A-) and Zions Bancorp (ZION: Baa2/BBB+) on March 24. Given not only their geographic footprints, but also some of the perceived similarities in risk profile to the failed banks, these two issuers were hit particularly hard in the initial wake of the first three. Both banks still trade with a tremendous amount of historical spread given what are undoubtedly some legitimate concerns about the longer-term stability of the banks. But they have recovered massively off those initial peaks in March and May and have remained in a stable range throughout the second half of the year.

Likewise, two similar bullish takes were later released first on KeyCorp (KEY: Baa2/BBB/BBB+) on May 12 and then subsequently on other mid-sized regional banks with ‘A’ ratings at the bank level, which included KEY (at the time), along with M&T (MTB: Baa1/BBB+/A) and Huntington (HBAN: Baa1/BBB+/A-) in the third week of July. Although KEY later lost ‘A’ ratings at the senior bank level following downgrades by both Moody’s and S&P, the timing of both calls provided a favorable spread opportunity for investors that would have increased exposure to any of the names included in the reports at the time.

Santander US Capital Markets recommendation timeline:

Right in the long run, wrong in the short run

Western Union (WU: Baa2/BBB/BBB) has continued to be one of the higher-beta, mid-BBB credits in broader industrials, and specifically in the technology segment for an extended period of time. Earlier in the year, after close examination of recent operating results and the consistent nature of the company’s credit profile, a call was made to add exposure to WU in the intermediate-to-long portion of the curve given the spread opportunity available. In early February, when the report was published, the company’s most liquid issue, the WU 6.20% 36, was trading at roughly 220 bp over the US 10-year note, about 30 bp wider than where they are indicated this week. After initially gapping out with the broader market at the time of the crisis, WU 36s tightened more than 100 bp from their peak of 293 bp in March.

Santander US Capital Markets recommendation timeline:

Exhibit 2. WU 6.20% ’36 spread timeline for 2023

Source: Santander US Capital Markets LLC, Bloomberg/TRACE spread-to-UST indications

Later in late July of this year, a follow-up publication was released highlighting what still appeared to be good relative value in the WU name. The WU 2036s were once again trading back near the initial level of 220 bp. However, this time the emphasis of the second piece was on the opportunity presented in the front-end of the WU curve. The WU 1.35% 3/26 securities were trading at about 125 bp over the US 3-year at the time. Although it appeared to be good relative value for a 3-year maturity given the continuing stability of the WU credit, the bonds gradually gapped out by about 20 bp on a spread basis to the current level of about +146 to the curve. So while other, longer WU maturities (such as the WU ‘36s) experienced about 30 bp of spread compression over the same time period, technical pressures on the front-end of the curve resulted in a loss on that particular credit call. However, exhibit 4 demonstrates that generic 1-to-3-year credit (illustrated using the Bloomberg/Barclays front-end index on exhibit 4 below) performed very similarly over that same period, widening from a local tight of +60 at the end of July to the current level of about +77. UST 3-year yields went round trip over that same time period.

Exhibit 3. WU 1.35% 3/26 spread timeline for 2023

Source: Santander US Capital Markets LLC, Bloomberg/TRACE spread-to-UST indications

Exhibit 4. IG Corporate Index 1-3 year maturities; technical widening in the front-end in the second half of 2023

Source: Santander US Capital Markets LLC, Bloomberg/Barclays Banking Index

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

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.

Important Disclaimers

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.

The Library

Search Articles