selling at the biggest discount to comparable Treasury issues since the 1998 financial crisis.
Average spreads between yields on 10-year bank bonds and 10-year U.S. Treasuries have widened 20 basis points, to 147, since mid-July, according to a 20-bank index compiled by Keefe, Bruyette & Woods Inc.
The current spread is below the record high of 168.8 last October, when the bond market all but dried up in the wake of Russia's default.
Analysts attribute the widening of the spread to a flood of bank and corporate issues this summer and growing skittishness over prospects of rising interest rates. Investors also want high levels of near-cash assets in case year-2000 computer bugs reduce the financial system's liquidity. Bonds do not fit that bill.
Banks are not alone in facing higher costs of longer-term borrowing; nonbank corporations also are under pressure. Companies fear that investors may be unwilling to buy bonds in the fourth quarter because, like corporations, they may want to be as liquid as possible as 2000 approaches. If no one wants long-term bonds and everyone wants cash, investors holding bonds will not be able to sell them without losing substantial amounts of principal.
Having to prepare for such liquidity problems has caused many corporations to issue more bonds than usual, flooding the market with supply at the same time demand is down.
Everybody is operating under the assumption that you won't be able to issue debt in the fourth quarter, said Thomas Finucane, an analyst at John Hancock Advisors in Boston. If you want to fund into the new year, you want to do that now.
With spreads on all U.S. corporate bonds widening, plus the recent increase in Treasury yields, issuers are facing a double whammy, said Eric Grubelich, an analyst at Keefe. The cost of issuing is more than it was at most points last year.
That, coupled with fears of another hike in the federal funds rate by the Federal Open Market Committee on Aug. 24, has led to a phenomenon in which every corporate treasurer in America is trying to lock in funds, Mr. Finucane said.
Investors buying bonds now do not want to step in front of a freight train, said Carl De Jounge, an analyst for Deutsche Bank Securities in New York. Most are saying it's not just worth it.
To entice investors, banks and other companies offer newly issued bonds at discounted prices, driving up spreads further. Investors are conditioned to expect better pricing from new issuers, Mr. De Jounge said.
Also pushing down bond prices are the rising spreads on interest rate swaps. Using a third party, banks often swap fixed-rate interest rate payments for floating-rate payments. On Tuesday a Keefe index of 10-year interest rate swaps rose to 108 basis points. Though an increase in rate swap spreads does not necessarily translate to wider spreads between corporate bonds and Treasuries, many investors perceive a correlation, Mr. Grubelich said.
As a result, banks will face higher costs of funds if they choose to issue more debt in the near -term.
For example, bids Tuesday on Bank of America Corp. 10-year bonds were at 144 basis points above Treasuries on Tuesday, up from 103 on May 3, according to one trader. Bids on Citigroup 10-year bonds rose to 140, from 102 in May.
J.P. Morgan's spread rose to 150, from 115 in May.
It's hard to ascertain what will motivate the spreads to tighten, Mr. Grubelich said.