Of all the asset price movements driven by the banking panic in the past few weeks, one of the few notable pockets of value created in markets appears to be subordinated financial debt.
- A diversified basket of investment grade (IG) preferred equity securities now yields more than sub-investment grade bonds by the highest level in over a decade. Some of these shares and subordinated bonds yield near 8%. Less than half of the Investment Grade Capital Securities Index are banks.
- Regulators in the US and elsewhere acted quickly to reassure investors that the banking sector is sound and they continue to be proactive. In the US, among the 10 largest banks (plus one large brokerage services company) going back to the year 2000, only one bank didn’t pay a dividend for a period of time and it was during the depths of the Great Financial Crisis.
- When market volatility subsides, the relative value of preferreds may allow for appreciation potential. Other potential upside catalysts include a decline in inflation leading to Fed rate cuts over the next 12 months, stabilization in the banking sector as bank management focuses on improving liquidity and additional government measures.
- It is notable that despite all the volatility in IG-rated preferreds, they still have outperformed intermediate Treasuries since last summer on a total-return basis.