Insights

A Valuable Lesson on Liquidity and Capital Preservation

Volatility continued at the start of 2023, as markets reacted to regional bank defaults in the United States, and a forced takeover of a Globally Systemic Important Bank in Europe. Despite the global uncertainty, floating-rate senior-unsecured AUD bank debt liquidity remained high, and performance was positive during the first quarter.

19 April 2023 2 min read

Simon Mullumby, CFA

Head of Australian Cash and Bonds

Developed market bank debt defaults, aggressive monetary policy tightening cycles implemented by global central banks and heightened risk on / risk off market sentiment, all describe the first three months of 2023. Against this backdrop, liquidity profiles and performance returns were substantially different between categories of bank debt issuance. As noted above, there were a number of defaults in USD regional bank exposures during the quarter. In addition, a bank merger in Switzerland triggered a default in contingent convertible (coco) debt issuance, otherwise known as alternate tier one (AT1) capital.

When bank defaults occur on both sides of the Atlantic, markets become instantly concerned about the real potential of a global banking crisis, or to a lesser extent, prolonged banking stress that could potentially break other banks. This market sentiment helped drive increased price volatility and reduced liquidity in lower ranking styles of debt such as hybrids, subordinated (sub), extendable, coco’s and even debt with a weighted average life (WAL) rather than a bullet/legal maturity. Many market participants argue liquidity of debt assets needs to be at the forefront of investor minds, during volatile times like global markets just went through.

Floating-rate senior-unsecured bank debt continued to trade very well during Q1 and delivered positive returns for the quarter. Despite increased volatility in credit spreads, particularly in mid-March when perceived bank stress was at its most heightened, senior-unsecured bank spreads from 1 January 2023 to 31 March 2023 actually compressed! Owning floating-rate senior- unsecured AUD bank debt during the quarter, proved to be a strong investment compared to other fixed income assets. The portfolio both bought and sold bonds during the quarter. Primary issuance was absorbed by the market with bid-to-cover ratios well above 1:1. Pricing in AUD senior unsecured bullet maturities, although wider in bid/offer was still sharp and liquid. We don’t buy hybrids, sub debt or coco’s in our portfolio – a decision we are very comfortable with given the recent troubles.

Disclosure

Issued by State Street Global Advisors, Australia, Limited (AFSL Number 238276, ABN 42 003 914 225) (“SSGA Australia”). Registered office: Level 14, 420 George Street, Sydney, NSW 2000, Australia · Telephone: +612 9240-7600 · Web: ssga.com.

The views expressed in this material are the views of Simon Mullumby, Head of Australian Cash & Bonds through the period ended 17 April 2023 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

This material is general information only and does not take into account your individual objectives, financial situation or needs and you should consider whether it is appropriate for you. There is no representation or warranty as to the current accuracy of this material, and SSGA Australia shall have no liability for decisions based on such information.

Investing involves risk including the risk of loss of principal.

Floating rate securities are often lower-quality debt securities and may involve greater risk of price changes and greater risk of default on interest and principal payments. The market for floating rate securities is largely unregulated and these assets usually do not trade on an organized exchange. As a result, floating rate bank loans can be relatively illiquid and hard to value. Diversification does not ensure a profit or guarantee against loss.

The value of the debt securities may increase or decrease as a result of the following: market fluctuations, increases in interest rates, inability of issuers to repay principal and interest or illiquidity in the debt securities markets; the risk of low rates of return due to reinvestment of securities during periods of falling interest rates or repayment by issuers with higher coupon or interest rates; and/or the risk of low income due to falling interest rates. To the extent that interest rates rise, certain underlying obligations may be paid off substantially slower than originally anticipated and the value of those securities may fall sharply. This may result in a reduction in income from debt securities income.

Bonds generally present less short-term risk and volatility than stocks but contain interest rate risk (as interest rates rise bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

Government bonds and corporate bonds generally have more moderate short-term price fluctuations than stocks but provide lower potential long-term returns.

All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment.

All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed.

The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA Australia's express written consent.

A Valuable Lesson on Liquidity and Capital Preservation

Related Articles