Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Approximately one-year ago, India-headquartered <a href="https://www.smartkarma.com/entities/yes-bank-ltd" target="_blank" data-smartkarma-citation="entities:767:1" rel="noopener">Yes Bank (YES IN)</a> began to experience a silent run on its deposits. Several months later, this deposit run took the institution past the point of non-viability. To mark this inauspicious anniversary, we undertake a series of short insights to determine if the funding and liquidity lessons from Yes Bank are being applied at India-headquartered banks. Spoiler alert: they are not.As we noted in <a href="https://www.smartkarma.com/insights/india-bank-deposit-flight-risk-lessons-from-yes-bank" target="_blank" data-smartkarma-citation="insights:37617" rel="noopener">Deposit Flight Risk: Lessons from Yes Bank</a>, India-headquartered bank funding franchises are more sensitive to potential deposit flight than displayed in their quarterly financial presentations. With an undue focus on the levels of current, savings and time deposits, the discussion neglects crucial factors which lead to a stable deposit franchise. At the same, undue reliance on Liquidity Coverage Ratios (LCRs) is not warranted.We inaugurate this Yes Bank Deposit Run Anniversary Series by assessing the level of stable deposits and deposit costs. We then compare these items at each US$-issuing bank to see if they are priced-in, from a credit perspective. In follow-up insights, we adjust the assumptions regarding likely deposit flight by type of deposit, incorporate deposits that are not captured in LCR reports and stress the reported LCRs for possible Covid-19 related payment delinquencies while assessing the credit-worthiness of India-headquartered banks.

Approximately one-year ago, India-headquartered Yes Bank (YES IN) began to experience a silent run on its deposits. Several months later, this deposit run took the institution past the point of non-viability. To mark this inauspicious anniversary, we undertake a series of short insights to determine if the funding and liquidity lessons from Yes Bank are being applied at India-headquartered banks. Spoiler alert: they are not.As we noted in Deposit Flight Risk: Lessons from Yes Bank, India-headquartered bank funding franchises are more sensitive to potential deposit flight than displayed in their quarterly financial presentations. With an undue focus on the levels of current, savings and time deposits, the discussion neglects crucial factors which lead to a stable deposit franchise. At the same, undue reliance on Liquidity Coverage Ratios (LCRs) is not warranted.We inaugurate this Yes Bank Deposit Run Anniversary Series by assessing the level of stable deposits and deposit costs. We then compare these items at each US$-issuing bank to see if they are priced-in, from a credit perspective. In follow-up insights, we adjust the assumptions regarding likely deposit flight by type of deposit, incorporate deposits that are not captured in LCR reports and stress the reported LCRs for possible Covid-19 related payment delinquencies while assessing the credit-worthiness of India-headquartered banks.

India-Headquartered Banks: Stable Deposits and Costs 1-Year After the Yes Bank Silent Run

Specialist in Indian Banking and Economic Research

Hemindra Hazari

Thematic (Sector/Industry)

Data from the Reserve Bank of India (RBI) reveal that, in the recent period of declining interest rates, while all banks have been reducing their deposit rates as well as their benchmark rates (marginal cost of fund-based lending rates), in July 2020 private sector banks have increased their effective lending rates on not only fresh loans but also on their outstanding loans. This was first highlighted in the <a href="https://www.thehindubusinessline.com/money-and-banking/why-private-banks-average-lending-rate-on-new-loans-has-gone-up/article32668789.ece#:~:text=Given%20the%20worsening%20business%20environment,the%20lending%20rates%20to%20increase." target="_blank" rel="noopener">Hindu Business Line</a> newspaper of September 23, 2020. Apparently, either private sector banks have turned to higher risk lending, which is unlikely, or have increased the risk spread over their benchmark lending rate to factor the higher risk in the Covid-19-induced slowdown. This has effectively increased the interest rate by 38 basis points (bps), to 9.12%, on incremental rupee loans of private banks in July 2020. It also appears that private sector banks have increased the rate on the entire loans, as the weighted average lending rate (WALR) increased by 5 bps, to 10.71%, in July 2020 as compared with June. The rise in the WALR for private sector banks also may indicate that their quality borrowers too have been penalised, and that these borrowers have not benefited from the overall decline in the interest rates in the economy. As private sector banks continued to lower the term deposit rates in July by 11 bps, and assuming this continues till end-September 2020, the non-risk-adjusted net interest margins (NIMs) of private sector banks may increase in 2QFY2021 as compared with 1QFY2021.

Data from the Reserve Bank of India (RBI) reveal that, in the recent period of declining interest rates, while all banks have been reducing their deposit rates as well as their benchmark rates (marginal cost of fund-based lending rates), in July 2020 private sector banks have increased their effective lending rates on not only fresh loans but also on their outstanding loans. This was first highlighted in the Hindu Business Line newspaper of September 23, 2020. Apparently, either private sector banks have turned to higher risk lending, which is unlikely, or have increased the risk spread over their benchmark lending rate to factor the higher risk in the Covid-19-induced slowdown. This has effectively increased the interest rate by 38 basis points (bps), to 9.12%, on incremental rupee loans of private banks in July 2020. It also appears that private sector banks have increased the rate on the entire loans, as the weighted average lending rate (WALR) increased by 5 bps, to 10.71%, in July 2020 as compared with June. The rise in the WALR for private sector banks also may indicate that their quality borrowers too have been penalised, and that these borrowers have not benefited from the overall decline in the interest rates in the economy. As private sector banks continued to lower the term deposit rates in July by 11 bps, and assuming this continues till end-September 2020, the non-risk-adjusted net interest margins (NIMs) of private sector banks may increase in 2QFY2021 as compared with 1QFY2021.

Private Sector Banks Increase Lending Rates: Securing Themselves Against the Coming NPA Wave?

The lack of shock and awe from this week’s FOMC meeting did not derail market sentiment as risk tolerance returned to the fixed income markets, albeit without strong conviction. Supply, the US election and vaccine progress are back to the forefront of risk sentiment drivers over the near term while the degree of additional monetary policy stimulus that can be affected remains open to debate. Against this backdrop, Asia and the US high yield markets tightened by similar amounts.   
In rate markets, US Treasury curve steepening returned after two weeks of clear flattening following the Fed Chairman’s Jackson Hole speech. Curve steepening is generally associated with increased bank net interest income from maturity transformation. The return of the reflation trade, along with slightly higher oil prices, suggests that investor’s economic demand expectations rose slightly during the week, despite the lackluster FOMC result. Next week’s record supply of 2-year, 5-year and 7-year Treasury notes should weigh on the rates market, particularly with Japan on holiday on Monday and Tuesday. 
At the shorter end of the interest rate curve, Eurodollar futures rates ticked-up in the +4-year area to suggest one interest rate increase in 2024 and another in 2025. This is hardly consistent with a meaningful attempt to overshoot a 2% inflation target and begs the question of how the Fed can achieve this target with its current policy toolkit. It appears as if lower-for-longer is a five- to seven-year look forward.   
In-line with steepening of the US Treasury yield curve and a return of risk sentiment in Asia, ten bond spreads tightened for every one that widened during the week. The tightening to widening ratio was more than three times the prior week. Almost every bond in our +100-universe tightened. Bank of China’s 2025 callable AT1 bond outperformed all others, tightening by 17bps. <a href="https://www.smartkarma.com/entities/bank-of-china-ltd" target="_blank" data-smartkarma-citation="entities:24574:1" rel="noopener">Bank Of China (BCHINA)</a>AT1 bond has become somewhat of a bellwether of Asia bank risk sentiment over the last few weeks.
In bank debt capital markets, over US$15 billion of securities were issued as banks continued to take advantage of low rates and sustained demand. Amongst Asia-centric banks, Bangkok Bank, Bank of China, HSBC Holdings, ICBC and Sumitomo Mitsui Financial Group brought US$ bonds during the week. We expect <a href="https://www.smartkarma.com/entities/ind-comm-bk-of-china-h" target="_blank" data-smartkarma-citation="entities:1119:1" rel="noopener">ICBC's (H) (1398 HK)</a> new AT1 note to trade in-line with BCHINA’s AT1 over the near term. HSBC’s new note came at a meaningful 20bps new issue concession relative to its holding company Senior Unsecured curve. We suspect that <a href="https://www.smartkarma.com/entities/hsbc-holdings-plc-a723bd63-0890-486f-aaa0-3bb9ad2b95ce" target="_blank" data-smartkarma-citation="entities:21976:1" rel="noopener">HSBC Holdings' (HSBA LN)</a> new issue bond will tighten by at least 10bps relatively quickly. Please see <a href="https://www.smartkarma.com/insights/bangkok-bank-s-new-at1-overweight-on-relative-value" target="_blank" data-smartkarma-citation="insights:43402" rel="noopener">Bangkok Bank’s New AT1 – Overweight on Relative Value</a> for our views on this debt issuer and its new security.
Market Outlook The current issue is that Fed policy is now more unpredictable, absent greater guidance on how its new longer-run strategy will influence near-term policy decisions. This past week’s FOMC meeting disappointed by not adding depth to the monetary policy canvas. As such, risks may now be materially higher for EM credit. Until now, perceptions were that lower-for-longer interest rates would cause US$-investors to reach for yield, in turn raising demand for longer maturities and non-US assets. Following Fed Chairman Powell’s speech, if the Fed permits long bond yields to rise, then marginal flows into emerging market credit may slow on increasing dollar strength.
Inside: In this weekly, we elaborate on these themes as we review global credit index levels, interest rates, Eurodollar futures and fund flows as well as bank bond spread moves and recent debt issuance to identify possible investment opportunities and potential pitfalls in Asia-headquartered bank bonds.

The lack of shock and awe from this week’s FOMC meeting did not derail market sentiment as risk tolerance returned to the fixed income markets, albeit without strong conviction. Supply, the US election and vaccine progress are back to the forefront of risk sentiment drivers over the near term while the degree of additional monetary policy stimulus that can be affected remains open to debate. Against this backdrop, Asia and the US high yield markets tightened by similar amounts.   
In rate markets, US Treasury curve steepening returned after two weeks of clear flattening following the Fed Chairman’s Jackson Hole speech. Curve steepening is generally associated with increased bank net interest income from maturity transformation. The return of the reflation trade, along with slightly higher oil prices, suggests that investor’s economic demand expectations rose slightly during the week, despite the lackluster FOMC result. Next week’s record supply of 2-year, 5-year and 7-year Treasury notes should weigh on the rates market, particularly with Japan on holiday on Monday and Tuesday. 
At the shorter end of the interest rate curve, Eurodollar futures rates ticked-up in the +4-year area to suggest one interest rate increase in 2024 and another in 2025. This is hardly consistent with a meaningful attempt to overshoot a 2% inflation target and begs the question of how the Fed can achieve this target with its current policy toolkit. It appears as if lower-for-longer is a five- to seven-year look forward.   
In-line with steepening of the US Treasury yield curve and a return of risk sentiment in Asia, ten bond spreads tightened for every one that widened during the week. The tightening to widening ratio was more than three times the prior week. Almost every bond in our +100-universe tightened. Bank of China’s 2025 callable AT1 bond outperformed all others, tightening by 17bps. Bank Of China (BCHINA)AT1 bond has become somewhat of a bellwether of Asia bank risk sentiment over the last few weeks.
In bank debt capital markets, over US$15 billion of securities were issued as banks continued to take advantage of low rates and sustained demand. Amongst Asia-centric banks, Bangkok Bank, Bank of China, HSBC Holdings, ICBC and Sumitomo Mitsui Financial Group brought US$ bonds during the week. We expect ICBC's (H) (1398 HK) new AT1 note to trade in-line with BCHINA’s AT1 over the near term. HSBC’s new note came at a meaningful 20bps new issue concession relative to its holding company Senior Unsecured curve. We suspect that HSBC Holdings' (HSBA LN) new issue bond will tighten by at least 10bps relatively quickly. Please see Bangkok Bank’s New AT1 – Overweight on Relative Value for our views on this debt issuer and its new security.
Market Outlook The current issue is that Fed policy is now more unpredictable, absent greater guidance on how its new longer-run strategy will influence near-term policy decisions. This past week’s FOMC meeting disappointed by not adding depth to the monetary policy canvas. As such, risks may now be materially higher for EM credit. Until now, perceptions were that lower-for-longer interest rates would cause US$-investors to reach for yield, in turn raising demand for longer maturities and non-US assets. Following Fed Chairman Powell’s speech, if the Fed permits long bond yields to rise, then marginal flows into emerging market credit may slow on increasing dollar strength.
Inside: In this weekly, we elaborate on these themes as we review global credit index levels, interest rates, Eurodollar futures and fund flows as well as bank bond spread moves and recent debt issuance to identify possible investment opportunities and potential pitfalls in Asia-headquartered bank bonds.

Bank Credit Weekly: Risk Sentiment Returns as Markets Ignore FOMC Disappointment

India Financials

Saumya Agarwal

Capital is King, more so in times of crisis and uncertainty. With the pandemic showing no signs of abating, Banks have been conserving capital to withstand any potential adverse impact. Higher the ‘Excess capital’ (i.e. capital over and above the regulatory threshold), greater will be the capital cushion available to Banks to absorb any potential losses.Our analysis suggests Top Indian Banks hold more than Rs 8Trillion of “Excess capital”. However,  Banks will have to set aside around Rs 500 Billion for the last tranche of Capital Conservation Buffer (CCB), which kicks-in from September 30, 2020.

Capital is King, more so in times of crisis and uncertainty. With the pandemic showing no signs of abating, Banks have been conserving capital to withstand any potential adverse impact. Higher the ‘Excess capital’ (i.e. capital over and above the regulatory threshold), greater will be the capital cushion available to Banks to absorb any potential losses.Our analysis suggests Top Indian Banks hold more than Rs 8Trillion of “Excess capital”. However,  Banks will have to set aside around Rs 500 Billion for the last tranche of Capital Conservation Buffer (CCB), which kicks-in from September 30, 2020.

Capital Is King: Top Indian Banks Hold ~Rs 8 Trillion of Excess Capital

The Council of Ethics of the Government Pension Fund Global (GPFG), the Norwegian sovereign fund, recommended on February 19, 2020 that <a href="https://www.smartkarma.com/entities/page-industries-ltd" target="_blank" data-smartkarma-citation="entities:4940:1" rel="noopener">Page Industries (PAG IN)</a> (<a href="https://www.jockey.in/page/page-industries-ltd" target="_blank" rel="noopener">licensed</a> to produce the Jockey brand of clothing and Speedo in India) be excluded from investment by the fund. GPFG is the world’s largest sovereign fund, with assets under management of around US$ 1 trillion, and it owns around 1.4% of global equities. For the world’s largest sovereign fund to specifically exclude an Indian company for investment should have been prominently highlighted by the Indian media but strangely, only BusinessLine carried this <a href="https://www.thehindubusinessline.com/markets/norges-bank-excludes-page-industries-from-fund-portfolio/article32487001.ece" target="_blank" rel="noopener">news</a>  on August 31, 2020, and while other media platforms reported it in the last 2 days, an in-depth analysis of its implications have been ignored. The <a href="https://etikkradet.no/files/2020/08/Page-ENG.pdf" target="_blank" rel="noopener">report</a> by the Council of Ethics to Norges Bank, Norway’s central bank, with manages the GPFG, highlighted the “systematic human rights abuses” practised by Page Industries. The Council observed some of these on an inspection of one of the company’s units at Bangalore: harsh punishments meted out to staff who returned from lawful leave or sick leave, penalties for failing to meet production targets even when  production stalled for reasons beyond the control of labour, unhealthy and unsafe working conditions, and the company’s active involvement in not allowing workers right to organise. The Council also found that the company’s actions violated “internationally recognised human rights and national laws.” The Council was also concerned that Page Industries neither clarified these concerns nor permitted an inspection of the factory units. While Speedo International <a href="https://uk.fashionnetwork.com/news/Speedo-looks-into-report-of-human-rights-violations-at-indian-partner-page,1240634.html" target="_blank" rel="noopener">stated</a> it would investigate the possible human rights violations by Page Industries, as it takes “all matters relating to workers and violation of human rights extremely seriously”, the issues raised (e.g. the right to form and join a labour union, fair wages and safe and healthy work conditions) by the Council of Ethics report are prevalent to one extent or another in major success stories of the Indian economy, where foreign institutional ownership is significant, such as  <a href="https://frontline.thehindu.com/cover-story/pain-of-separation/article9721113.ece" target="_blank" rel="noopener">information technology enables services (ITES)</a> , export-oriented garment (<a href="https://rupe-india.org/72/rage1.html" target="_blank" rel="noopener">here</a> and <a href="https://rupe-india.org/72/rage2.html" target="_blank" rel="noopener">here</a>) industry, the <a href="https://www.jstor.org/stable/41720062" target="_blank" rel="noopener">automobile</a>/auto ancillaries and private sector banking. To supress wages and maintain a compliant work force, labour laws are violated with near impunity by the Indian corporate sector. In their drive to attract investment, the Union and state governments actively cooperate in these violations. If such issues were to be seriously examined by foreign institutional investors, it would render a significant component of corporate India to be uninvestible.

The Council of Ethics of the Government Pension Fund Global (GPFG), the Norwegian sovereign fund, recommended on February 19, 2020 that Page Industries (PAG IN) (licensed to produce the Jockey brand of clothing and Speedo in India) be excluded from investment by the fund. GPFG is the world’s largest sovereign fund, with assets under management of around US$ 1 trillion, and it owns around 1.4% of global equities. For the world’s largest sovereign fund to specifically exclude an Indian company for investment should have been prominently highlighted by the Indian media but strangely, only BusinessLine carried this news  on August 31, 2020, and while other media platforms reported it in the last 2 days, an in-depth analysis of its implications have been ignored. The report by the Council of Ethics to Norges Bank, Norway’s central bank, with manages the GPFG, highlighted the “systematic human rights abuses” practised by Page Industries. The Council observed some of these on an inspection of one of the company’s units at Bangalore: harsh punishments meted out to staff who returned from lawful leave or sick leave, penalties for failing to meet production targets even when  production stalled for reasons beyond the control of labour, unhealthy and unsafe working conditions, and the company’s active involvement in not allowing workers right to organise. The Council also found that the company’s actions violated “internationally recognised human rights and national laws.” The Council was also concerned that Page Industries neither clarified these concerns nor permitted an inspection of the factory units. While Speedo International stated it would investigate the possible human rights violations by Page Industries, as it takes “all matters relating to workers and violation of human rights extremely seriously”, the issues raised (e.g. the right to form and join a labour union, fair wages and safe and healthy work conditions) by the Council of Ethics report are prevalent to one extent or another in major success stories of the Indian economy, where foreign institutional ownership is significant, such as  information technology enables services (ITES) , export-oriented garment (here and here) industry, the automobile/auto ancillaries and private sector banking. To supress wages and maintain a compliant work force, labour laws are violated with near impunity by the Indian corporate sector. In their drive to attract investment, the Union and state governments actively cooperate in these violations. If such issues were to be seriously examined by foreign institutional investors, it would render a significant component of corporate India to be uninvestible.

Norwegian Fund’s Stand on Page Industries: Market Can No Longer Ignore Labour Rights Violations

India

Axis Bank Limited provides a full range of banking services throughout India. The Group's activities include retail banking, investment management, merchant banking, treasury and NRI services, cash and credit management services, and ATM facilities.

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Axis Bank Ltd (AXSB IN)

India-Headquartered Banks: Stable Deposits and Costs 1-Year After the Yes Bank Silent Run

Approximately one-year ago, India-headquartered Yes Bank began to experience a silent run on its deposits. To mark this inauspicious anniversary,...

Hank Calenti, CFA

Private Sector Banks Increase Lending Rates: Securing Themselves Against the Coming NPA Wave?

Data from the Reserve Bank of India (RBI) reveal that, in the recent period of declining interest rates, while all banks have been reducing their...

Hemindra Hazari

Bank Credit Weekly: Risk Sentiment Returns as Markets Ignore FOMC Disappointment

The lack of shock and awe outcome from this week’s FOMC meeting did not derail market sentiment as risk tolerance returned to the fixed income...

Hank Calenti, CFA

Capital Is King: Top Indian Banks Hold ~Rs 8 Trillion of Excess Capital

Capital is King, more so in times of crisis and uncertainty. With the pandemic showing no signs of abating, Banks have been conserving capital to...

Saumya Agarwal

Norwegian Fund’s Stand on Page Industries: Market Can No Longer Ignore Labour Rights Violations

The Council of Ethics of the Government Pension Fund Global (GPFG), the Norwegian sovereign fund, recommended on February 19, 2020 that Page...

Hemindra Hazari

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