The excess yield, or spread, on US Treasuries on regional-bank bonds has in many cases risen by about 2 percentage points or more since early March, when the failures of Silicon Valley Bank and Signature Bank prompted a broad investor retreat. Inspired but the U.S. Largest US Bank.
The spread widening is based on a sample of actively traded bonds from lenders with about $150 billion to $220 billion in assets, such as Columbus, Ohio-based Huntington Bancshares and Buffalo, NY-based M&T Bank. The banks in that group are so small that concerns have been raised about their health but still hold significant amounts of bonds outstanding.
In contrast, the spread on the 10-year JPMorgan Chase bond rose by just 0.1 percentage point, according to MarketAxess, reflecting the firm’s financial strength and the belief that the US will not allow such a large bank to fail. ,
Following bank failures in March, federal regulators have indicated they may eventually force banks with as little as $100 billion in assets to issue more long-term bonds, subjecting them to similar requirements. Because giant banks are now considered systemically important.
Such rules are intended to create a buffer of debt that can be converted into equity if a bank becomes insolvent, reducing the need for taxpayer-funded bailouts. But for regional banks, the effect could be to sell bonds in a market that is not eager to buy them.
“Spreads are wide, so funding costs are up, rates are up, and they need to raise more of this stuff,” said Andrew Arbesman, a senior fixed-income research analyst who covers banks and insurers at Neuberger Berman. “
Mr. Arbesman said, the prospect of higher funding costs is one reason why “a lot of equity analysts are negative on regional banks, because they’re seeing that they won’t be able to deliver returns like they did in the past.”
Higher yields on regional-bank bonds will not immediately translate into higher borrowing costs for regional lenders. Their ultimate impact may also be modest because even after the new rules go into effect, regional banks will be funded by deposits rather than bonds.
But it is clear that higher borrowing costs are a drag on medium-sized banks, especially when they already have to raise deposit rates to retain many customers.
Take Huntington, which had about $169 billion in interest- or dividend-earning assets in the first three months of the year with $8.8 billion in bonds outstanding at the end of the quarter. If the bank, over time, replaced all of its bonds with new bonds that paid 1.5 percentage points more in interest that would reduce its annual net interest income by about $130 million.
For context, the bank generated about $5.3 billion in net interest income last year and $1.4 billion in its most recent quarter. That latter figure was up 23% from a year ago, due to rising rates on its floating-rate assets, but down about 4% from the previous quarter, due to rising deposit costs.
According to a recent Barclays report, Huntington may also need to issue up to $6 billion in new bonds to meet expected regulations. Assuming it continues to issue bonds at current rates, there could be some further margin erosion, although the impact could vary depending on how Huntington invests the proceeds from the bonds. According to Barclays, Huntington may also be required to issue at least $1 billion, and the rules may be structured so that banks can issue bonds over an extended period.
Meanwhile, many investors and analysts say regional-bank bonds are oversold, noting that most banks have reported relatively stable deposit levels despite recent market turmoil.
As of Tuesday, 5.023% of Huntington’s 2033 bonds were trading below 90 cents on the dollar, yielding about 6.6% and a spread over Treasuries of about 3.1 percentage points, up from about 1.7 percentage points before the Silicon Valley bank’s failure. Its more actively traded 4% notes due 2025 were trading at a wider spread of about 4 percentage points. Bonds of its peers such as M&T Bank and Providence, RI-based Citizens Financial are trading at similar levels.
Neuberger’s Mr. Arbesman said he thinks there is a chance that spillovers spread to regional banks and eventually get back to where they were before the Silicon Valley bank failure. After covering banks through various crises including the housing bust in the late 2000s, Mr. Arbesman said the current situation is “one of the largest gaps between perception and reality in the history of the sector.”
Still, even analysts who are bullish on regional-bank bonds caution that sentiment could ultimately shape fundamentals for lenders.
Jesse Rosenthal, a senior analyst at research firm CreditSights who strongly recommends buying regional-bank bonds, said the banks “look very, very solid.”
Still, he added, “if sentiment continues to be bad enough that we actually start to see a new round of massive deposit outflows, that’s going to pose a problem for even the best-run bank.”