Bank of New York Mellon just priced preferred shares with a reset spread of 186.8 basis points. That’s the tightest valuation on this type of bank capital instrument since the 2008 financial crisis. Goldman Sachs and Citizens Financial Group followed within days, each issuing their own preferred stock at similarly unprecedented levels.
The flurry of activity, which took place between July 22 and July 24, signals something important: investors are so hungry for bank-issued yield products that they’re willing to accept returns that would have seemed absurdly thin just a few years ago.
What’s actually happening here
Preferred shares are a hybrid security, part stock, part bond. Banks issue them because they count toward something called Additional Tier 1 capital, or AT1. The “reset spread” is the premium investors demand above a benchmark rate for holding these instruments. A lower spread means investors are accepting less compensation for the risk. At 186.8 basis points for BNY Mellon, we’re talking about a risk premium that hasn’t been this slim since the last time the global financial system nearly imploded.
The timing isn’t accidental. US banking agencies have been actively discussing reforms to capital requirements, with proposals aimed at making compliance more efficient for Category I and Category II banks. Banks are racing to lock in cheap capital while the window is wide open.
The risk nobody wants to talk about
The last time preferred share spreads were this tight, Lehman Brothers still existed. For investors buying these preferred shares, the math is straightforward but unflattering. You’re accepting historically low compensation for holding instruments that, by design, absorb losses before common equity in a stress scenario. AT1 securities were literally engineered to be the first line of defense when banks hit trouble. Just ask anyone who held Credit Suisse AT1 bonds when that institution was absorbed by UBS.
If US banking agencies follow through on reducing capital requirements for GSIBs, it would mark the most significant loosening of post-crisis bank regulation in over a decade.