by Saboor Zahir
Silicon Valley Bank’s failure has impacted stock prices for regional banks, which have lost over 25% in the short period since the announcement that the bank needed to raise more capital on Thursday. However, how has this affected the credit markets?
We compared debt issued by a basket of regional banks to that of large banks to understand how the market is pricing in the credit spread risk. Specifically, we review the senior and subordinate issuer Axioma Credit Spread CurvesTM over the period of March 8, 2023 to March 10, 2023 to understand how the market is pricing such risks in the credit market.
The Axioma Credit Spread Curves are Qontigo’s proprietary Bond OAS (option-adjusted spread) curves for both issuers and clusters (groupings by rating, region, and sector.) They allow you to assess the term structure of OAS across issuers and across groups.
Regional Bank OAS Change – Senior Debt
First, we reviewed the changes in average option-adjusted spreads of Regional Bank senior debt across the term structure.
On average, issuer bond spread curves have jumped between 20 and 33 bps on the front end of the curve. Spread durations past 7 years have seen much more muted results.
We can take the Banc of California curve as an example to analyze how the market is pricing its spread risk.
The figure above shows the senior debt OAS curve for Banc of California. There is a pronounced change in OAS on the short end of the curve (nearly 100 bps) and relatively little change on the long end. This is the same effect we’re seeing across all regional banks.
Next, we review a basket of large banks: Citigroup, JP Morgan Chase, Wells Fargo, Bank of America, Capital One, Goldman Sachs, and US Bancorp to contract the impact on credit spreads.
In contrast to the regional debt, the large banks were impacted less on the short end of the curve. Rather, the long end of the curve is where we see the largest change in spreads.
We can take the curve for JP Morgan Chase as an example to analyze how the market is pricing its spread risk.
The above figure shows the spread curve for JP Morgan & Chase senior debt. The spread decreased on the front end of the curve but increased on the long end of the curve. This is similar spread changes for other large banks.
Subordinate vs Senior Spread Gap
Going across the capital structure can give us a better handle of how the market measures perceived recovery value of the underlying debt.
The spread between subordinate and senior debt (difference in OAS curves) is very muted on the short end of the curve but much more pronounced on the long end of the curve.
We can look at the same analysis of subordinate vs senior debt for large banks on average.
In contrast, the spread curves for larger banks show a more pronounced widening of the subordinate vs senior spreads on the short end of the curve.
Conclusions
In short, markets are pricing spread risk for regional banks and large banks differently. There is more risk priced in on the short end of the OAS curve for regional banks. In contrast, large banks show a larger jump in OAS on the long end of the curve.
We believe there are many reasons for this. Firstly, the market is pricing in stronger financial strength of larger banks due to tighter regulatory scrutiny. Furthermore, it is pricing in relative weakness in regional banks like Silicon Valley Bank. Large banks are in position to grow market share from failed banks or even through acquisition of failing regional banks.
In addition, regional bank OAS gaps between subordinate and senior debt are only being seen for longer duration debt. In contrast, the large bank OAS gaps between subordinate and senior debt is being seen more on the short end of the curve. The spread between subordinate and senior debt is related to market perceived recovery in the scenario of a default. Hence markets are pricing larger losses given default for larger banks.
