Seniors have had a hard time of it lately.
They’ve been usurped by a trendier generation, buffeted by changing times. Now Morgan Stanley analysts want you to consider this frail group. They want you to … focus on senior bank debt, of course!
It’s true, Morgan Stanley says, that the sector has had a rough time of it lately.
Plagued by bail-ins and burdensharing, banks have been issuing far more (collateralised) covered bonds than traditional senior bank debt. They’ve also been deleveraging post the financial crisis.
All of which means senior bank debt issuance has been declining… but its importance?
Morgan Stanley says that’s has actually been increasing, in terms of credit indices:
Negative net issuance of bank senior debt and its continued [substitution] by covered bonds create the impression that the sector’s importance is falling. Yet, for anyone who is measured against an index benchmark, the opposite is true. Although the overall stock of senior bank debt is declining, the sector’s share of the overall investment grade market’s spread (and by extension, the market’s return) has never been higher.
To approximate a sector’s importance relative to an index, we multiply its spread by its market value, relative to the index as a whole … While banks seniors only drove about 6% of the overall spreads for the € corporate market in 2003, today it drives nearly a third of returns, the highest share since our data began. A similar trend can be seen in the £ market, where bank seniors’ contribution to overall credit returns increased from 3% to 13% over the same period. The changes here have been both outright and relative: senior financials command a record share of overall portfolio spread performance, but also now represent more portfolio spread than bank sub debt.
Part of the explanation for this paradox comes from the fact that bank senior bond spreads have lagged both sub financials and corporate spreads. But an even larger reason lies in index-eligibility rules. As banks have retired FRNs (which are not index-eligible), and replaced them with fixed-rate benchmarks (which are), more senior bank debt is index-eligible even if the overall stock of senior bonds is lower. The result has been a heavier index impact, despite system-level deleveraging and negative net issuance.
So that would be a “shrinking asset class, with growing index importance.” Most interesting.
Ah, and look — the analysts have even done a nice hand-drawn cartoon to go with their note:
Well. That’s the cutest bank debt cartoon we’ve ever seen.
Related links:
Warning on fast rise of covered bonds - FT
Towards the limit of covered bond bank funding… - FT Alphaville
The problem with Europe’s bail-ins - FT Alphaville