Despite Warnings, Investors Flock to Big-Bank Debt

Analysts have been telling clients to invest in regional banks' debt and steer clear of multinational banks' paper, but investors are still enthralled by the bigger banks.

In the last week spreads on multinationals-the difference between their yields and those of Treasuries-have tightened by as much as 15 basis points, suggesting that investors have become much more comfortable with the global economy than they were just a few weeks ago.

Bank bond analysts, however, remain skeptical.

"It is almost like deja vu," said bank bond analyst Van Hesser of Goldman Sachs & Co.

"A lot of the same positive sentiment about money-centers was in place last year: Things are getting better, the world is a better place."

But he said there are too many potholes in the global economy that "could upset the apple cart."

Bank bond analyst Thomas Flynn of Morgan Stanley & Co., also remains cautious about money-center debt.

Mr. Flynn said he tells clients to put more of their money in regionals.

"Right now we are focusing on what is happening with Brazil. If that unhinges, money-center debt is going to suffer."

Bank bond analyst David Hendler at Credit Suisse First Boston argued that both money-centers and regionals are good buys because they are trading cheaply by historical standards.

However, he acknowledged that he "recommends regional bank bonds a little bit harder than money-centers."

Still, investors are snapping up money-center debt as much as regional paper, Mr. Flynn said.

"Money-center debt is getting some benefit from the January effect," said Mr. Flynn, who has been cautious about money-centers for a year.

"People have money to put to work and they are just buying bank paper generically."

That may change, however, as more bank bond analysts beat the drum for regional bank securities.

Last week Goldman Sachs kicked off a road show, trumpeting the virtues of regional bank debt.

The spreads on regional bank paper have tightened as much as 10 basis points, and some issues are trading 100 basis points or less over Treasuries, Mr. Hesser said.

"We haven't been at those levels for a long time."

Regional banks make much better credits than multinational banks, Mr. Hesser argued.

The average return on assets for the super regionals is 1.5%, whereas multinational struggle to reach 1%, the analyst noted. "In the last 10 years the multinationals are performing only marginally better.

Mr. Hesser said, "Profitability for money-centers has not improved, volatility in their revenue streams has increased, and their core business franchise is not as strong as it was 10 years ago, because they have moved away from lending to large corporations and moved into investment banking, where they are decidedly second-tier."

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