A Note from the Credit Desk

As we’ve highlighted in our most recent client updates, credit markets have been frothy since mid-November. Over that time frame, senior bank credit spreads are over 50 basis points wider. Given our disciplined approach to active management, our performance remained positive. In comparison, a passively managed interest-rated hedged credit index of 6yrs would’ve been down 2%-3%.

We wanted to highlight how stretched valuations have gotten recently. TD came to the market in March 2020 at the start of the pandemic with a 5yr senior bank deal at +135 spread. At the time, the coupon set for investors was 1.943%. As of right now, the market is currently trading at same spread context, but given the higher interest rates, a new 5yr senior bank deal would come with a 3% coupon.

Looking at historicals, and completely ignoring the fact that these TD 1.943 25 are now two years shorter, these same bonds are currently trading at May 2020 levels – near the depth of the pandemic (figure 1).

In other words, despite all the central bank stimulus, much stronger bank balance sheets, we are seeing Canadian bank spreads essentially unchanged since May 2020. Meanwhile, the six largest Canadian bank stocks are up between 65% to 116% (figure 2).

Our conclusion: With bank stocks up 65-116% since May 2020, senior bank debt looks either very compelling or equity valuations are stretched. We are mindful that March tends to be a supply heavy month. With discipline, we see this as a great opportunity to add risk in this sector via new debt offerings.

Figure 1 – TD 1.943 historical spreads since May 2020

Figure 2 – Canadian Banks stocks performance normalized to $100 invested on May 1 2020 excluding dividends