The Big Idea
Lessons learned from corporate credit in 2023 I
Dan Bruzzo, CFA | 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. This material does not constitute research.
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:
- 1/20/23 – Banks and REITs poised to ouperform
- 3/24/23 – Weighing risks at Comercia and Zions
- 5/12/23 – Relative Value in KeyCorp holdco paper
- 7/21/23 – Single-A regional banks still attractive
- 11/17/23 – Out-of-consensus calls on corporate credit in 2024 (regional banks)
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:
- 2/10/23 – Reports of Western Union’s demise are grossly exaggerated
- 7/28/23 – Still like Western Union
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