Investors snapped up bank bonds with continued relish on Tuesday, a day after two mega-sized bank merger deals were announced.
Bond and stock investors were euphoric in the immediate aftermath of announcements that NationsBank Corp. plans to combine with BankAmerica Corp. and that Banc One Corp. plans to buy First Chicago NBD Corp.
Stock investors' enthusiam for those four banks flagged on Tuesday as profit-taking set in and some players took more time to contemplate the deals. Bond investors, however, were still riding a wave of euphoria.
Ten-year bank bond spreads-the basis points difference between Treasury yields and corporate debt yields-have tightened by about 8 basis points since the deals were announced, traders said.
"The bank sector has been red hot for the bond investor," said Joseph J. Labriola, head of corporate debt at PaineWebber Inc. What bond investors see in these recent mergers "are large financial combinations that can leverage their business without leveraging their balance sheet."
Bank bond analyst Caroline J. Smith at ABN Amro agreed that these mergers would create more capital for the newly combined banks. "In general, these deals lead to more diversified business, better credit worthiness and profitability, and no credit migration. There is a positive trend in place."
Analysts said they expect more tightening ahead.
"We see further tightening in coming weeks because the (bank) sector is still cheap relative to last year and it is still cheap compared to industrials," Mr. Labriola said. "What will add fuel to the fire is that there is a prospect of solid bank earnings coming up."
Traders noted that lack of the supply is also going to cause bank bond spreads to tighten. "Banks are not likely to issue more debt because these deals suggest that they will be more profitable," said one trader.
Moody's Investors Service and Standard & Poor's are emboldening investors with favorable ratings. On Monday, Standard & Poor's placed its ratings of BankAmerica and NationsBank on watch with the possibility of an upgrade. It also placed First Chicago NBD on watch with positive implications, while revising the outlook for Banc One from negative to stable.
Analysts said they expect Moody's to upgrade the companies as well.
Still, in spite of the strong fundamentals and trends behind the big deals, some experts point out that bond investors have become over-eager.
"I would not buy more of these bonds (of banks in recent mergers) right now," said one trader. "The spreads on many of these bonds are too tight, and there will be an opportunity when they will trade cheaper."
Meanwhile, bank bond analyst Van Hesser at Goldman, Sachs & Co., which was involved in the three most recent deals, said bond investors remain cautious overall with regard to the financial sector.
"Bond investors are dragging their feet on these deals," said Mr. Hesser. Historically, "they tend to be downside protection-oriented and insist that banks make money one year, only to give some of it back in the next. The spread tightening so far has been warranted, but it has been slow because of this bias."
"The management of many of these new companies have delivered on their promises time and time again. Bank bonds, however, still trade significantly cheaper than industrials."
