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Callable bank structures present alternative to corporate bullets
admin | August 23, 2019
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.
Rapid compression in the yield curve since month-end has limited opportunities for yield hungry investors in USD fixed income product. Despite the relative attractiveness of US corporate bond yields versus the global landscape, investors have been reluctant to bid intermediate bullets, seeing valuation as too flat, and seeking better opportunities elsewhere (Exhibit 1).
Exhibit 1: Current yield curves vs. month-end (7/31/19)
Source: Bloomberg, Amherst Pierpont Securities
Likewise, spreads have remained little changed in aggregate from the start of the rate rally, but with much flatter curves that are making it difficult to identify better values or attractive entry points for corporate buyers (Exhibit 2).
Exhibit 2: Current spread curves vs. month-end (7/31/19)
Source: Bloomberg, Amherst Pierpont Securities
An area of the market highlighted previously, in Mining liquidity in private bank placements, as a source of value for corporate bond investors is in the US large community and smaller regional bank space. The sector not only contains a broad cross section of high quality, under-covered credits, but also is heavily populated by callable structures that are particularly attractive in this rate environment. Many of the deals in this cohort that were issued over the last 3-4 years were structured as fix-to-float 10-year final maturities with a 5-year par call (10NC5), and mostly with attractive back-end floating spreads (Exhibit 3). Many of these deals have now aged into 8NC3 and 7NC2 instruments as well, which is an attractive alternative for investors that are currently unimpressed with total yields in intermediate bullets in the financial sector.
Exhibit 3: Examples of community bank bonds with 3- to 4-year call structures
Note: Bonds listed mostly trade by appointment. Source: Bloomberg/TRACE – indications only, Amherst Pierpont Securities
There are good value bonds in this segment on both a yield-to-call (YTC) and yield-to-maturity (YTM) basis. On a pure economic basis is does appear many of the issuers would or should be compelled to call if rates remain under pressure. Nevertheless, these are infrequent (and even first-time) issuers in the public debt markets, which could impact their willingness or motivation to re-issue. In which case, investors are protected with the generous spreads offered in the back-end.
Exhibit 4 illustrates how these bonds are currently pricing on a YTC basis versus:
- a sample of bullet maturities in investment grade regional bank sub notes, and
- senior unsecured bullets of the IG money center banks (BAC, C, JPM, WFC).
This provides additional context of the alternative yield opportunities available to IG investors with the same duration profile (or lack thereof). As indicated in Exhibit 3, there are even opportunities for investors to stay in index eligible deal size as well as achieve one or more investment grade ratings.
Exhibit 4: Attractive YTC opportunities – community bank sub callables vs. regional sub and money center senior bullets
Note: Bonds listed mostly trade by appointment. Source: Bloomberg/TRACE – indications only, Amherst Pierpont Securities
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