Bank bonds, like the Boston Red Sox, have a proclivity for late-season swoons. But this year is different.
Though the Red Sox remained true to form this fall, bank bonds have not only maintained their appeal for investors, but have actually shown some improvement in the last few weeks after a summer of consistent and strong performance.
Last week, investors showed a stronger appetite for most bank debt than many analysts expected, thanks to a merger-strengthened industry and a pool of yield-hungry investors.
Spreads tightened three to five basis points on most bank debt before widening slightly on Tuesday on the expectation of new issuance. Citicorp's notes due in 2004 tightened to 65 basis points over Treasuries from 70, those of First Union due in 2009 tightened to 90 from 95, and BankAmerica's 2003 paper also closed five to 65.
Spreads represent the premium over comparable Treasuries that investors demand in trading bank bonds. A tightening of spreads shows that investors are making more competitive bids for the debt.
These numbers represent a new signal from the market. "We definitely have come in from the historic trading range," said Allerton G. Smith, a bank bond analyst at Donaldson, Lufkin & Jenrette.
Mr. Smith attributes this tightening to the mergers in the banking sector. "The sense is that you're creating a more stable and stronger banking system," said Mr. Smith.
Upgrades of Citicorp and most recently BankAmerica Corp. have "had a tightening effect on spreads," said Mr. Smith.
Others said that the market follows the bellwether Citicorp, moving in sync with the money-center bank's bonds.
"There is a lot more interest in Citicorp, which is helping to pull the market," said Jay Weintraub, a bank bond analyst at Merrill Lynch.
Generally, analysts said the recent appeal of the bank bond market stems from a lack of competition from alternative investments.
"It's a buying opportunity for investors relative to industrials," said Ethan M. Heisler, a bank bond analyst at Salomon Brothers Inc.
Even though a spread of 65 basis points over comparable Treasuries for Citicorp's 10-year debt is relatively tight, it gives investors an additional 10 basis points over the typical industrial debt.
The current spread compression makes a gain of 10 basis points fairly substantial, said analysts, especially since the risk of new bank crises is considered low.
"Banks present an opportunity for investors to outperform in a yield-to- maturity basis by taking wider spreads versus similarly rated industrials," said Mr. Smith. "The banking sector continues to look as if there is nothing imminent that would send a shock through the credit rating."
Additionally, industry experts said that other markets have been slow.
"In the first quarter of 1994, there was $17 billion in collateralized mortgage obligations," said a bank bond trader. "In the first quarter of 1995, that number went down to $2 billion."
Analysts said there generally wasn't much upside left for investors in bank debt, although the debt of several companies remains undervalued.
"Hold is the key word," said Merrill Lynch's Mr. Weintraub. "We have been anticipating some upgrades, but it's hard to get very enthusiastic at the kind of levels we see."
Some analysts said NationsBank is a good candidate for an upgrade, and undue concern about a potentially dilutive acquisition kept its bond spreads unnecessarily wider than others in the market.
"Thus far, nothing NationsBank has done has justified the spread gap," said a bank bond analyst.
Other names with upgrade potential include Wells Fargo & Co. and First Interstate Bancorp, which might benefit from the Bank of America upgrade.
"The upgrade at BankAmerica has to make you think about the two notch distinction between BankAmerica and Wells Fargo and First Interstate," said Mr. Weintraub.
"To the extent that (the upgrade) might reflect your feeling about California, it could also be beneficial to their thinking about the other two."
Analysts pointed out that the market has already discounted the BBB+ subordinated debt ratings for the two companies from Standard & Poor's ratings, bidding the bonds on First Interstate and Wells Fargo a few basis points tighter than the A- rated U.S. Bancorp.
