Head - Fixed Income Strategy
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Against the backdrop of global recession concerns, we think preferred security valuations are historically attractive and offer long-term value.
To be fair, the sell-off is partially justified. Concerns around a global recession and the ability for banks to pay dividends has crept (back) into investors' minds. Share buyback programs have stopped and US and European banks have both been told by regulators to use precious capital coffers to support continuation of credit to households and businesses. European structures have equity conversion or coupon suspension risks also creating additional nervousness.
Fortunately, US and European bank balance sheets are starting from a position of strength. Post-Financial Crisis regulatory reforms had pushed the sector to raise significant capital to protect against future crisis. Common Equity Tier 1 ratios for most banks are well above the required threshold. Exposures to certain high-risk sectors (i.e., energy) appear manageable.
In our view, preferred security valuations are historically attractive and offer long-term value. However, near risks remain and weakness may continue. Clarity around how severe the spread of Covid-19 virus is difficult to assess. However, the deep (though likely short natured) negative macro impact from public and factory shut downs is easier to predict. Liquidity in credit markets remains poor, though recent central policies should help.
The largest price declines have been in recent new issues, which have low back-end spreads. Tactically, we would expect these structures to have a sharper rebound in normalizing market scenario. For longer-term portfolio construction, we favor high quality issuers. In the US, wider back-end spreads are preferred. More important, taking an incremental investment approach would be suggested.