Assessing the debt market fallout from banking sector instability

Supply was interrupted but limited issuance restarted within days

The regulatory intervention of Silicon Valley Bank stopped corporate and financial sector issuance altogether for four working days. However, the market reopened on March 17 with a sub-investment grade deal, when Norway's PGS AGA sold a USD450 million USD450 million senior secured junk bond. Pricing was set at a 13.5% coupon, with a 98% issue price. PGS is an Oslo-listed (and based) marine geophysical company primarily providing seismic and reservoir services to the oil and gas sector.

Despite remaining volatile bond market conditions have improved more this week, following Credit Suisse being taken over last weekend by UBS under an emergency ordinance, and with US authorities providing further guidance designed to ease fears of loss among corporate and larger high net worth depositors with regional banks. The most notable sign of market resilience was a highly successful USD1.8 billion 10 and 31-year sale by Republic of Panama. It sold USD1 billion of 2054 bonds priced at 6.853%, and a USD800 million tap of its 2035 bond at 6.161%, gaining USD9.5 billion in demand from over 260 accounts.

This week's supply has been limited, also including two domestic US utility issues on March 20, a EUR500 million five-year sale by the German region of Saxony, while MetLife also placed USD1 billion of ten-year bonds with a 5.125% coupon on March 21. In addition, Turkey started "non-deal" discussions with investors this week to revive its plans for ESG issuance. Market commentary suggests that this could lead to a sizeable social bond to assist reconstruction efforts following the country's severe recent earthquake.

Our take: Market impacts

While primary market activity has been limited, also reflecting this week's FOMC meeting, secondary markets offer clearer indicators, summarized below.

• Reference rates have fallen, with investors now assuming a lower peak level for US policy rates, a view reinforced by subsequent FOMC guidance.
• Investment grade spreads have widened only slightly despite heavy initial inflows to cash funds. This extends to investment grade emerging market debt, with the increase in the ICE BofA Emerging Market spread index effectively offset by lower US Treasury Yields.
• Within the St. Louis Federal Reserve's published data set, the worst affected debt categories include US sub-investment grade debt and "junk" rated Emerging Market securities, where spreads widened by roughly a full percentage point during the dislocation.
• The worst affected category in response to Credit Suisse's emergency takeover by UBS was that of European Additional Tier 1 debt, reflecting the decision of the Swiss regulator FINRA to write Credit Suisse's bonds down to zero value, rather than "bailing them in" to convert them by force to equity. While reportedly permitted by the bond's documentation, this reversed the conventional ranking under which AT1 bondholders (and preference shareholders in US banks) rank above common equity holders: in the Credit Suisse takeover, holders of common stock were granted some UBS shares, howbeit without their consent and at well below prior market valuations.
• After initial falls of up to 12-15 percentage points in price for large European bank AT1 deals, these generally recovered as the European Banking Authority, ECB, Bank of England, and other global regulatory bodies stressed that they would follow the conventional ranking of creditors in the event of other bank resolution events. Preference shares of large US banks were far less volatile, with major US banks benefitting from deposit migration from smaller firms. Nevertheless, Reuters flagged on March 24 that Deutsche Bank's 7.5% AT1 debt was yielding 22.87%, double its return two weeks ago.
• Pending AT1 issuance - previously slated for two major Japanese banks - at least faces delay: lasting deterioration in the segment would increase "extension risk" for holders of outstanding European perpetual bond holders which have call dates this year. Unsurprisingly, two European issuers (Deutsche Pfandbriefbank and Aerial Bank) have elected not to call EUR300 million AT1 bonds on their next call dates falling in late April.
• Another badly affected area is the debt of weakly-rated emerging market borrowers already struggling to access bond markets at sustainable cost levels. As an example, Nigeria's 2033 bond has moved from a yield of 11.98% on March 10 to 13.35% returns one week later, according to the country's Debt Management office. Similarly, Kenya's latest weekly central bank report noted an average increase in yields on its outstanding dollar bonds of 155.7 basis points in the week to March 16, bringing them to yields between 11.58% (for 2034 debt) and 13.99% in its 2024 bond
• Such deterioration does not apply to the wider EM asset class, with revived receptiveness already indicated by Panama's success. Yields on stronger credits have even fallen: Costa Rica's reference 2043 bond was some three percentage points higher in price as of March 24 than prior to SVB's failure, with a yield of 6.95%, a positive indicator for its pending planned bond sale.
• Additionally, Bloomberg reported on March 23 that in the week to March 17, foreign inflows to South Korean bonds were the strongest for eight months, with Indonesia recording the largest net inflows for 2023. Thailand and India also were reported as gaining investor support, according to the same report.

While the failure of three US banks and Credit Suisse's forced takeover by UBS represent a major event of financial stress, our assessment is that current events involve dislocation on a clearly smaller scale than in 2008/9. At present, bond market pricing has most affected sub-investment grade instruments, and particularly hurt weaker sub-Saharan African debt. The degree of damage for bank funding is unclear, in the absence of primary supply, but is likely to focus more on junior debt - particularly AT1 - and smaller and weaker credits.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.