Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Three macro events this week should drive near term returns. The outcomes may appear fiendish to over-extended investors, much in the same way that Krampus, the mythical counterparty to St. Nicholas, taunts naughty children.The events include the outcome of the Fed’s Federal Open Market Committee meeting, the final week for the US Congress to agree addition US federal stimulus bill this year and the almost final week towards a Brexit deal. Resulting US dollar strength could snuff out the recent rally in Asia and broader EM US$-denominated credit.Expectations that the Fed could alter its bond purchase program at its upcoming meeting has limited bearish sentiment in the long end of the Treasury market. Look for a decision to extend the weighted average maturity of its bond purchases. The failure of the Fed to deliver could embolden the market to break a psychological 1% barrier on the 10-year Treasury bond. This would be beneficial to bank securities over the short term, especially if it occurs in tandem with continued bear steepening from the short end of the curve. However, this would raise the real effective rate and could be dollar negative. Asia and EM securities could react.Even if the Fed delivers what one-half of the market expects by altering its bond buying program, there are other extenuating circumstances that could result in a flight to quality, such as renewed lockdowns, the lack of a federal fiscal package and / or Brexit agreement. In a reversal of the recent trend of bad news = buy, the lack of federal stimulus would lower risk sentiment. We remain unconvinced that an actual agreement is the underlying goal of these negotiations. Control of the US Senate is at stake and the political posturing plays right into that race. Failure to reach an agreement would move all eyes to the Senate run-off races in January. Please see out last weekly, <a href="https://www.smartkarma.com/insights/bank-credit-weekly-new-equation-is-bad-news-buy" target="_blank" data-smartkarma-citation="insights:46058" rel="noopener">The New Equation is Bad News = Buy</a>, for more details. The continuing saga of Brexit negotiations may also change investor risk preferences. As we approach a no deal deadline, signaling to prepare for a ‘hard Brexit’ or ‘Australian-option’ trade agreement, depending on your Brexit stance, is already impacting rates. The lack of an agreement could revive flight to quality trades as we cross into the new year.Against this backdrop, Asia High Yield securities continued to outperform US HY, as in the last few weeks. Caa-rated US credits softened slightly, although by less than Ba and B rated securities. Risk remains over-bid and the consensus trade on rates, the dollar and trade is disconcerting. Regarding over-bid risk, please see <a href="https://www.smartkarma.com/insights/yes-bank-par-is-plenty-move-to-underweight" target="_blank" data-smartkarma-citation="insights:46120" rel="noopener">YES Bank: Par is Plenty- Move to Underweight</a>. As regards a trade to counter the over-consensus market, please see <a href="https://www.smartkarma.com/insights/societe-generale-at1-resolution-or-resilience-in-the-retail-restructuring-take-shorter-duration" target="_blank" data-smartkarma-citation="insights:46244" rel="noopener">Société Générale AT1: Resolution or Resilience in the Retail Restructuring? Take Shorter Duration</a>.Market Outlook: A strong start in Asia on the back of the US FDA approval of Pfizer’s vaccine may begin the week. However, the cognitive dissonance trade which ignores distribution and time extension risk may be overcome by a buy the rumor, sell the fact tactical trade since positive sentiment from vaccine news is already priced in. Event risk should take hold as the week progresses. With economic recovery increasingly priced-into risk assets but mispriced in risk-free assets due to central bank policies, the ability to hedge market downturns may be impaired. This could exacerbate a market correction.

Three macro events this week should drive near term returns. The outcomes may appear fiendish to over-extended investors, much in the same way that Krampus, the mythical counterparty to St. Nicholas, taunts naughty children.The events include the outcome of the Fed’s Federal Open Market Committee meeting, the final week for the US Congress to agree addition US federal stimulus bill this year and the almost final week towards a Brexit deal. Resulting US dollar strength could snuff out the recent rally in Asia and broader EM US$-denominated credit.Expectations that the Fed could alter its bond purchase program at its upcoming meeting has limited bearish sentiment in the long end of the Treasury market. Look for a decision to extend the weighted average maturity of its bond purchases. The failure of the Fed to deliver could embolden the market to break a psychological 1% barrier on the 10-year Treasury bond. This would be beneficial to bank securities over the short term, especially if it occurs in tandem with continued bear steepening from the short end of the curve. However, this would raise the real effective rate and could be dollar negative. Asia and EM securities could react.Even if the Fed delivers what one-half of the market expects by altering its bond buying program, there are other extenuating circumstances that could result in a flight to quality, such as renewed lockdowns, the lack of a federal fiscal package and / or Brexit agreement. In a reversal of the recent trend of bad news = buy, the lack of federal stimulus would lower risk sentiment. We remain unconvinced that an actual agreement is the underlying goal of these negotiations. Control of the US Senate is at stake and the political posturing plays right into that race. Failure to reach an agreement would move all eyes to the Senate run-off races in January. Please see out last weekly, The New Equation is Bad News = Buy, for more details. The continuing saga of Brexit negotiations may also change investor risk preferences. As we approach a no deal deadline, signaling to prepare for a ‘hard Brexit’ or ‘Australian-option’ trade agreement, depending on your Brexit stance, is already impacting rates. The lack of an agreement could revive flight to quality trades as we cross into the new year.Against this backdrop, Asia High Yield securities continued to outperform US HY, as in the last few weeks. Caa-rated US credits softened slightly, although by less than Ba and B rated securities. Risk remains over-bid and the consensus trade on rates, the dollar and trade is disconcerting. Regarding over-bid risk, please see YES Bank: Par is Plenty- Move to Underweight. As regards a trade to counter the over-consensus market, please see Société Générale AT1: Resolution or Resilience in the Retail Restructuring? Take Shorter Duration.Market Outlook: A strong start in Asia on the back of the US FDA approval of Pfizer’s vaccine may begin the week. However, the cognitive dissonance trade which ignores distribution and time extension risk may be overcome by a buy the rumor, sell the fact tactical trade since positive sentiment from vaccine news is already priced in. Event risk should take hold as the week progresses. With economic recovery increasingly priced-into risk assets but mispriced in risk-free assets due to central bank policies, the ability to hedge market downturns may be impaired. This could exacerbate a market correction.

Bank Credit Weekly: Krampus Is Coming to Town: Fed, Stimulus & Brexit to Taunt Over-Eager Investors

Pan-Asia Index Rebalances/ Events/ Delta One, Periscope Analytics

Brian Freitas

Pan-Asia Index Rebalances/ Events/ Delta One

Event-Driven

The Indian mutual fund industry has assets of almost INR 5 trillion across Multi cap, Large Cap, Large and Mid Cap, Mid Cap and Small Cap equity schemes. Equity schemes classified as large cap need to have at least 80% of their assets invested in large cap stocks, large and mid cap schemes need to have at least 35% of their assets in large cap stocks and at least 35% in mid cap stocks, mid cap funds need to hold at least 65% of their assets in mid cap stocks, and small cap funds need to hold at least 65% of their assets in small cap stocks.The Association of Mutual Funds in India (AMFI) publishes the list of the stocks in each market cap segment in January and July each year and mutual funds have one month to rebalance their portfolios to adhere to the new categorization.In the upcoming recategorization in January 2021, we see 6 stocks moved from the mid cap segment to the large cap segment with an equal number of stocks moving the other way, and 12 stocks are expected to move from the small cap segment to the mid cap segment with the same number moving the other way. There are quite a few IPOs that will join the small cap list, with just 1 joining the large cap list and 1 joining the mid cap list.Historically, the stocks migrating upward to a higher market cap segment have outperformed stocks that migrate to a lower market cap segment over the 1 month and 2 month period post the publishing of the AMFI list. This can be attributed to fund managers realigning their portfolios to meet the new categorization. This provides opportunities to pre-position for the move and unwind post the announcement of the reclassification.

The Indian mutual fund industry has assets of almost INR 5 trillion across Multi cap, Large Cap, Large and Mid Cap, Mid Cap and Small Cap equity schemes. Equity schemes classified as large cap need to have at least 80% of their assets invested in large cap stocks, large and mid cap schemes need to have at least 35% of their assets in large cap stocks and at least 35% in mid cap stocks, mid cap funds need to hold at least 65% of their assets in mid cap stocks, and small cap funds need to hold at least 65% of their assets in small cap stocks.The Association of Mutual Funds in India (AMFI) publishes the list of the stocks in each market cap segment in January and July each year and mutual funds have one month to rebalance their portfolios to adhere to the new categorization.In the upcoming recategorization in January 2021, we see 6 stocks moved from the mid cap segment to the large cap segment with an equal number of stocks moving the other way, and 12 stocks are expected to move from the small cap segment to the mid cap segment with the same number moving the other way. There are quite a few IPOs that will join the small cap list, with just 1 joining the large cap list and 1 joining the mid cap list.Historically, the stocks migrating upward to a higher market cap segment have outperformed stocks that migrate to a lower market cap segment over the 1 month and 2 month period post the publishing of the AMFI list. This can be attributed to fund managers realigning their portfolios to meet the new categorization. This provides opportunities to pre-position for the move and unwind post the announcement of the reclassification.

India: AMFI Stock Categorization Changes to Drive Active Portfolio Churn

<a href="https://www.smartkarma.com/entities/yes-bank-ltd" target="_blank" data-smartkarma-citation="entities:767:1" rel="noopener">YES Bank's (YES IN)</a> US$-bond hit par-value recently. Par is plenty for investors. Having delivered 20 price points in return since our Buy recommendation, pre-rescue in February, Smartkarma readers should be satiated with this above average return. Upside is now much less likely, although temporarily pricing slightly over par could occur during the next few months. As such, we move to Underweight YES Bank’s 3 ¾% coupon Nov. 2023 maturity bond, from Overweight on a relative value basis.We put YES Bank’s recent bond outperformance down to a combination of a broad risk asset rally and positive news flow plus the lack of negative news regarding the recovery of the institution. The Reserve Bank of India’s take-over of <a href="https://www.smartkarma.com/entities/lakshmi-vilas-bank-ltd" target="_blank" data-smartkarma-citation="entities:17552:1" rel="noopener">Lakshmi Vilas Bank (LVB IN)</a> has both removed the spotlight from YES Bank and reminded investors that this entity was rescued.Delivery on management’s restructuring goals remains to be seen while headwinds build for India, post-COVID-19. As such, with less than two-years to maturity and spreads at less than one-half their levels of one-year ago, now is not the time to jump in. We believe it is time to lighten allocation to this security and reposition elsewhere.

YES Bank's (YES IN) US$-bond hit par-value recently. Par is plenty for investors. Having delivered 20 price points in return since our Buy recommendation, pre-rescue in February, Smartkarma readers should be satiated with this above average return. Upside is now much less likely, although temporarily pricing slightly over par could occur during the next few months. As such, we move to Underweight YES Bank’s 3 ¾% coupon Nov. 2023 maturity bond, from Overweight on a relative value basis.We put YES Bank’s recent bond outperformance down to a combination of a broad risk asset rally and positive news flow plus the lack of negative news regarding the recovery of the institution. The Reserve Bank of India’s take-over of Lakshmi Vilas Bank (LVB IN) has both removed the spotlight from YES Bank and reminded investors that this entity was rescued.Delivery on management’s restructuring goals remains to be seen while headwinds build for India, post-COVID-19. As such, with less than two-years to maturity and spreads at less than one-half their levels of one-year ago, now is not the time to jump in. We believe it is time to lighten allocation to this security and reposition elsewhere. 

YES Bank: Par Is Plenty- Move to Underweight

The worse the economic news, the greater the expectation of US federal stimulus, the more the market rallies. Investors may be surprised to find that recent federal stimulus discussions are more appearance than substance. The balance of the US Senate is at stake and this posturing plays right into that election.Despite the overall improved risk tone, emerging market capital inflows flattened to remain at their highest levels since mid-February. This is surprising as almost everyone expects a weakening dollar next year. This is not a good sign. So long as yields are rising due to economic growth expectations, all is good; however, if yields are rising due to increasing inflation expectations, then a market correction is inevitable as investors re-assess policymaker’s commitment. Much depends on what and how the Fed communicates. Signs of wavering from overshooting inflation targets could spark a mini-taper tantrum.While global risk sentiment strengthened, Asia’s high yield markets outperformed the US indexes. Asia’s outperformance was likely due to more encouraging news from the region in terms of November’s PMIs which went down well with increased US federal stimulus expectations. Nonetheless, Asia’s HY index still has considerable room to catch-up with the US index. This difference was at its widest level in over 10-years recently and had hit a low of 1.45pp three months ago. This volatility seems overdone. We believe this to be due to US market irrational exuberance although increased concerns on the health of China’s debt issuers also played a part. Rising expectations for the Fed to take bond-supportive policy steps and the potential for another round of fiscal stimulus also play in the market dynamics. However, the Fed may not move before knowing the outcome of the Senate elections and federal stimulus discussions may be a false dawn. As such, we continue to suggest positioning for spread compression between the US and Asia HY indexes via the US Caa-rated index level.Within this environment, Asia’s High Yield bank bonds continued to outperform, although almost all bank bond prices rose on increased risk sentiment. Asia’s lowest rated bank bonds led in terms of spread outperformance. However, a Fed-influenced cap on US longer-term rates may not be bank friendly. We caution bank investors that Fed programs are forever, so be careful what you wish for. Remember when Quantitative Easing ended?Market Outlook: The question now is whether the federal stimulus discussion is about economic or political reality. We hope that our US federal stimulus cynicism is proven incorrect. Assuming we are incorrect, tension between longer-term optimism from vaccine driven economies and the shorter-term reality of increasing Coronavirus lockdowns may then weigh on the market. The recent surge in bullish sentiment raises the question of whether it is sustainable or if a correction may be around the corner, possibly due to the lack of Fed action in its asset purchase program. We are now more deeply set-up for buy-the-rumor, sell-the-fact profit taking.

The worse the economic news, the greater the expectation of US federal stimulus, the more the market rallies. Investors may be surprised to find that recent federal stimulus discussions are more appearance than substance. The balance of the US Senate is at stake and this posturing plays right into that election.Despite the overall improved risk tone, emerging market capital inflows flattened to remain at their highest levels since mid-February. This is surprising as almost everyone expects a weakening dollar next year. This is not a good sign. So long as yields are rising due to economic growth expectations, all is good; however, if yields are rising due to increasing inflation expectations, then a market correction is inevitable as investors re-assess policymaker’s commitment. Much depends on what and how the Fed communicates. Signs of wavering from overshooting inflation targets could spark a mini-taper tantrum.While global risk sentiment strengthened, Asia’s high yield markets outperformed the US indexes. Asia’s outperformance was likely due to more encouraging news from the region in terms of November’s PMIs which went down well with increased US federal stimulus expectations. Nonetheless, Asia’s HY index still has considerable room to catch-up with the US index. This difference was at its widest level in over 10-years recently and had hit a low of 1.45pp three months ago. This volatility seems overdone. We believe this to be due to US market irrational exuberance although increased concerns on the health of China’s debt issuers also played a part. Rising expectations for the Fed to take bond-supportive policy steps and the potential for another round of fiscal stimulus also play in the market dynamics. However, the Fed may not move before knowing the outcome of the Senate elections and federal stimulus discussions may be a false dawn. As such, we continue to suggest positioning for spread compression between the US and Asia HY indexes via the US Caa-rated index level.Within this environment, Asia’s High Yield bank bonds continued to outperform, although almost all bank bond prices rose on increased risk sentiment. Asia’s lowest rated bank bonds led in terms of spread outperformance. However, a Fed-influenced cap on US longer-term rates may not be bank friendly. We caution bank investors that Fed programs are forever, so be careful what you wish for. Remember when Quantitative Easing ended?Market Outlook: The question now is whether the federal stimulus discussion is about economic or political reality. We hope that our US federal stimulus cynicism is proven incorrect. Assuming we are incorrect, tension between longer-term optimism from vaccine driven economies and the shorter-term reality of increasing Coronavirus lockdowns may then weigh on the market. The recent surge in bullish sentiment raises the question of whether it is sustainable or if a correction may be around the corner, possibly due to the lack of Fed action in its asset purchase program. We are now more deeply set-up for buy-the-rumor, sell-the-fact profit taking.

Bank Credit Weekly: New Equation Is Bad News = Buy

In this, the fourth of several short insights in our Yes Bank Deposit Run Anniversary Series, we adjust Liquidity Coverage Ratios (LCR) for anticipated cash inflows which may not materialize in the current COVID-19 environment. We then append this result to deposits that are not captured in LCR reports derive a COVID-19 adjusted LCR.LCRs are based on a set of assumptions which may not prove to be valid during periods of stress, as recently occurred at <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>. One of the many assumptions is that cash inflows from performing loans can offset projected deposit outflows in a stressed situation. However, in an environment of widespread payment moratoriums or interest-only repayments, projected cashflow may be materially overstated. This could result in misleadingly higher LCR ratios. At the same time, some banks report non-lending related cash inflows at higher levels than projected loan-related amounts. This is surprising. As such, we remove all cash inflows to derive a cash inflow adjusted LCR. We also incorporate deposits that are not captured by the LCR report to derive a COVID-19 stressed LCR ratio and assess this ratio to see if this is priced-in from a credit perspective.Approximately one-year ago, India-headquartered Yes Bank began to experience a silent run on its deposits. 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">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 is not warranted as per recent experience.In our first insight, we derived the amount of stable deposits at each major India-headquartered bank and determined if a stable deposit franchise is priced-in, from a credit perspective. Please see <a href="https://www.smartkarma.com/insights/india-headquartered-banks-stable-deposits-and-costs-1-year-after-the-yes-bank-silent-run" target="_blank" data-smartkarma-citation="insights:43981" rel="noopener">Stable Deposits and Costs 1-Year After the Yes Bank Silent Run</a>. In our second, we adjusted deposit flight assumption to the reality of what occurred at Yes Bank. We then determined if this “Yes-stressed” LCR is priced-in. Please see <a href="https://www.smartkarma.com/insights/india-headquartered-banks-yes-stressed-deposit-flight-simulation" target="_blank" data-smartkarma-citation="insights:44213" rel="noopener">Yes-Stressed Deposit Flight Simulation</a>.   In our third insight, we incorporated deposits that are not captured in LCR reports. This is the analysis required to understand what broke Yes Bank. We then determined if the Missing Deposit LCR is priced-in from a credit perspective. Please see <a href="https://www.smartkarma.com/insights/india-headquartered-banks-missing-deposit-miasma-1-year-after-yes-bank-s-silent-run" target="_blank" data-smartkarma-citation="insights:45438" rel="noopener">Missing Deposit Miasma 1-Year After Yes Bank’s Silent Run</a>.  In follow-up insights we intend to assess extraordinary government actions that recently inflated LCR ratios and then adjust for all of these elements for apocalyptic scenario analysis.

In this, the fourth of several short insights in our Yes Bank Deposit Run Anniversary Series, we adjust Liquidity Coverage Ratios (LCR) for anticipated cash inflows which may not materialize in the current COVID-19 environment. We then append this result to deposits that are not captured in LCR reports derive a COVID-19 adjusted LCR.LCRs are based on a set of assumptions which may not prove to be valid during periods of stress, as recently occurred at Yes Bank (YES IN). One of the many assumptions is that cash inflows from performing loans can offset projected deposit outflows in a stressed situation. However, in an environment of widespread payment moratoriums or interest-only repayments, projected cashflow may be materially overstated. This could result in misleadingly higher LCR ratios. At the same time, some banks report non-lending related cash inflows at higher levels than projected loan-related amounts. This is surprising. As such, we remove all cash inflows to derive a cash inflow adjusted LCR. We also incorporate deposits that are not captured by the LCR report to derive a COVID-19 stressed LCR ratio and assess this ratio to see if this is priced-in from a credit perspective.Approximately one-year ago, India-headquartered Yes Bank began to experience a silent run on its deposits. 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 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 is not warranted as per recent experience.In our first insight, we derived the amount of stable deposits at each major India-headquartered bank and determined if a stable deposit franchise is priced-in, from a credit perspective. Please see Stable Deposits and Costs 1-Year After the Yes Bank Silent Run. In our second, we adjusted deposit flight assumption to the reality of what occurred at Yes Bank. We then determined if this “Yes-stressed” LCR is priced-in. Please see Yes-Stressed Deposit Flight Simulation.   In our third insight, we incorporated deposits that are not captured in LCR reports. This is the analysis required to understand what broke Yes Bank. We then determined if the Missing Deposit LCR is priced-in from a credit perspective. Please see Missing Deposit Miasma 1-Year After Yes Bank’s Silent Run.  In follow-up insights we intend to assess extraordinary government actions that recently inflated LCR ratios and then adjust for all of these elements for apocalyptic scenario analysis.

India-Headquartered Banks: COVID-19 Adjusted Liquidity Coverage Ratios

India

Bank of Baroda owns and operates commercial banks in India.  The Group's banks provide the traditional forms of banking services, including CD's, Credit Card services and a variety of car loans, in addition to gold banking and a range of insurance services.  The Group also owns IBU International Finance Limited, an international banking company in Hong Kong.

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Bank Of Baroda (BOB IN)

Bank Credit Weekly: Krampus Is Coming to Town: Fed, Stimulus & Brexit to Taunt Over-Eager Investors

3-macro event outcomes this week may taunt over-eager investors. US-$ strength could halt the recent rally in Asia and broader EM US$-denominated...

Hank Calenti, CFA

India: AMFI Stock Categorization Changes to Drive Active Portfolio Churn

The reclassification of stocks to large, mid and small cap will set off a churn in mutual fund portfolios where historically stocks migrating...

Brian Freitas

YES Bank: Par Is Plenty- Move to Underweight

Despite incredibly poor asset quality, goals that are years from being realized and liquidity which remains well overstated, YES Bank’s US$-bond...

Hank Calenti, CFA

Bank Credit Weekly: New Equation Is Bad News = Buy

The worse the economic news, the greater the expectation of US federal stimulus, the more the market rallies. We are now more set-up for buy-the...

Hank Calenti, CFA

India-Headquartered Banks: COVID-19 Adjusted Liquidity Coverage Ratios

COVID-19 adjusted LCRs exhibit an almost perfectly negative correlation with India-headquartered bank bond spreads. This is the 4’th of several...

Hank Calenti, CFA

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