Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Executive Summary: European bank AT1 significantly outperformed Asia as each EU benchmark Basel III bond tightened during the week. Concurrently, increased risk appetite resulted in performance across the credit continuum in Asia bank bonds. A steepening US Treasury yield curve and risk-on market sentiment drove bank credit spreads tighter, globally. Please see our <a href="https://www.smartkarma.com/insights/bank-macro-manifest-risk-rally-gathers-steam-as-bad-news-more-stimulus" target="_blank" data-smartkarma-citation="insights:47886" rel="noopener">Bank Macro Manifest: Risk Rally Gathers Steam as Bad News = More Stimulus</a> for more details.Europe’s AT1 performance further compressed option adjusted spreads between European AT1 and Asia financial institutions to 50bps inside 2019 levels. This begs the question of how much more spread compression is possible.Globally, <a href="https://www.smartkarma.com/entities/unicredit-spa" target="_blank" data-smartkarma-citation="entities:21234:1" rel="noopener">UniCredit's (UCG IM)</a> 8% coupon 2024 callable note led AT1 and broader bank bond performance, tightening 102bps over the week. This outperformance coincided with positive risk asset sentiment following the announcement that former ECB President Mario Draghi was asked to form Italy’s next government. Investors may wish to consider what additional catalyst could drive spreads tighter. UniCredit is expected to report earnings on Thursday, 11 February.In Asia, Nanyang Commercial Bank led AT1 bond performance by tightening another 54bps on the week. Relative to <a href="https://www.smartkarma.com/entities/bank-of-east-asia-ltd" target="_blank" data-smartkarma-citation="entities:341:1" rel="noopener">Bank of East Asia's (23 HK)</a> 5 5/8% coupon 2022 callable note, the Nanyang outperformance is beginning to look overdone. Please see <a href="https://www.smartkarma.com/insights/bank-credit-compass-credit-tourist-may-vacate-if-real-fundamentals-do-not-catch-up" target="_blank" rel="noopener">Bank Credit Compass: Credit Tourist May Vacate if Real Fundamentals Do Not Catch-Up</a> for more details.<a href="https://www.smartkarma.com/entities/state-bank-of-india" target="_blank" rel="noopener">State Bank of India's (SBIIN)</a> prediction of double-digit returns following results that were better than expectations, drove its shares to a 40% gain during the week. SBIIN’s credit was already there, in our view, but other India-headquartered bank credits may benefit.Meanwhile, in the broader Emerging Market (EM) Senior Unsecured HY area, Turkish bank bonds continued to catch-up with their higher rated EM peers with several notes tightening by +60bps over the week. Given the positive developments in Turkey over the last few weeks and the global risk-on environment, several of these banks continue to trade wide relative to most other EM banks.Market Outlook: Investors remain susceptible to management’s prophecies. Asset quality indicators may greatly underestimate the level of troubled debt due to continued forbearance, restructuring efforts and early-stage aging. This is driving provisioning costs lower than would be expected in a more normal operating environment. The value of these reports is significantly diminished for credit investors. Financial repression creates a market, which in its nature, is always a one-sided bet with the Fed / ECB/ BOJ. There is limited price discovery.  As such, credit value should remain driven by larger market forces.

Executive Summary: European bank AT1 significantly outperformed Asia as each EU benchmark Basel III bond tightened during the week. Concurrently, increased risk appetite resulted in performance across the credit continuum in Asia bank bonds. A steepening US Treasury yield curve and risk-on market sentiment drove bank credit spreads tighter, globally. Please see our Bank Macro Manifest: Risk Rally Gathers Steam as Bad News = More Stimulus for more details.Europe’s AT1 performance further compressed option adjusted spreads between European AT1 and Asia financial institutions to 50bps inside 2019 levels. This begs the question of how much more spread compression is possible.Globally, UniCredit's (UCG IM) 8% coupon 2024 callable note led AT1 and broader bank bond performance, tightening 102bps over the week. This outperformance coincided with positive risk asset sentiment following the announcement that former ECB President Mario Draghi was asked to form Italy’s next government. Investors may wish to consider what additional catalyst could drive spreads tighter. UniCredit is expected to report earnings on Thursday, 11 February.In Asia, Nanyang Commercial Bank led AT1 bond performance by tightening another 54bps on the week. Relative to Bank of East Asia's (23 HK) 5 5/8% coupon 2022 callable note, the Nanyang outperformance is beginning to look overdone. Please see Bank Credit Compass: Credit Tourist May Vacate if Real Fundamentals Do Not Catch-Up for more details.State Bank of India's (SBIIN) prediction of double-digit returns following results that were better than expectations, drove its shares to a 40% gain during the week. SBIIN’s credit was already there, in our view, but other India-headquartered bank credits may benefit.Meanwhile, in the broader Emerging Market (EM) Senior Unsecured HY area, Turkish bank bonds continued to catch-up with their higher rated EM peers with several notes tightening by +60bps over the week. Given the positive developments in Turkey over the last few weeks and the global risk-on environment, several of these banks continue to trade wide relative to most other EM banks.Market Outlook: Investors remain susceptible to management’s prophecies. Asset quality indicators may greatly underestimate the level of troubled debt due to continued forbearance, restructuring efforts and early-stage aging. This is driving provisioning costs lower than would be expected in a more normal operating environment. The value of these reports is significantly diminished for credit investors. Financial repression creates a market, which in its nature, is always a one-sided bet with the Fed / ECB/ BOJ. There is limited price discovery.  As such, credit value should remain driven by larger market forces.

Bank Credit Weekly: AT1 Outperformance in Risk-On Environment

Silver Point

Thomas J. Monaco

Independent Insight Provider

Silver Point is a boutique research firm that focuses on the broader financial services sector, with a particular focus on troubled institutions globally. 

Asia Ex Japan

Equity Bottom-Up

*Costs Now An Issue: Ping An Bank (000001.CH) [PAB], the Ping An Insurance (2318.HK) [Ping An] banking subsidiary, reported CNY 6.5 bn – declining CNY 2.2 bn (25.1%) on a linked quarter basis. In this environment, credit troubles no doubt are a foregone conclusion. However, this was not necessarily PAB’s biggest issue in its most results announcement, where the bulk of the earnings decline was attributed to a CNY 1.9 bn (17.1%) linked quarter increase in costs;*Credit Is WEAKER Still:  We find that credit weakness is actually deteriorating at an even more accelerated pace than in 3Q20, as net new NPLs have increased CNY 20.5 bn or a massive 241% (223% in 3Q20) on an annualized basis. We also find that PAB’s reserves still remain quite light by CNY 152 bn if we assume a 2x NPL ratio. This shortfall represents 60% of stated equity; and*Fundamentally Challenged Still: Despite the Investor Day cheerleading session, Ping An P&amp;C operating profits declined CNY 2.6 bn (29.2%) HOH in 1H20, as the overall combined ratio eroded 1.5% to 98.1% due primarily to continued weakness within the credit insurance unit where the combined ratio came in at 125.6% (up 32.4%). The credit insurance segment reported a CNY 3.5 bn underwriting loss, due to defaults on underlying loans.

*Costs Now An Issue: Ping An Bank (000001.CH) [PAB], the Ping An Insurance (2318.HK) [Ping An] banking subsidiary, reported CNY 6.5 bn – declining CNY 2.2 bn (25.1%) on a linked quarter basis. In this environment, credit troubles no doubt are a foregone conclusion. However, this was not necessarily PAB’s biggest issue in its most results announcement, where the bulk of the earnings decline was attributed to a CNY 1.9 bn (17.1%) linked quarter increase in costs;*Credit Is WEAKER Still:  We find that credit weakness is actually deteriorating at an even more accelerated pace than in 3Q20, as net new NPLs have increased CNY 20.5 bn or a massive 241% (223% in 3Q20) on an annualized basis. We also find that PAB’s reserves still remain quite light by CNY 152 bn if we assume a 2x NPL ratio. This shortfall represents 60% of stated equity; and*Fundamentally Challenged Still: Despite the Investor Day cheerleading session, Ping An P&amp;C operating profits declined CNY 2.6 bn (29.2%) HOH in 1H20, as the overall combined ratio eroded 1.5% to 98.1% due primarily to continued weakness within the credit insurance unit where the combined ratio came in at 125.6% (up 32.4%). The credit insurance segment reported a CNY 3.5 bn underwriting loss, due to defaults on underlying loans. 

Real credit fundamentals have yet to catch-up with spreads in bonds which continue to outperform. True fundamentals have a considerable gap to close relative to spread compression. Global monetary accommodation is in large part responsible for recent outperformance. However, credit tourists may have booked too early.Deeply subordinated Additional Tier 1 (AT1) bonds led in terms of spread tightening during January in Asia. Increased risk tolerance and a reach for yield, possibly by credit tourists, drove results as global vaccination efforts raised economic growth expectations. As such, Hong Kong and Thai- based bank securities outperformed, albeit for differing reasons.As Asia-headquartered banks report earnings, the quality of disclosure varies considerably from bank-to-bank. Even where disclosure is adequate, asset quality indicators may greatly underestimate the level of troubled debt due to continued forbearance, restructuring efforts and early-stage aging. This is driving provisioning costs lower than would be expected in a more normal operating environment. The value of these reports is significantly diminished for credit investors. Financial repression creates a market, which in its nature, is always a one-sided bet with the Fed / ECB/ BOJ.  There is limited price discovery. As such, credit value should remain driven by larger market forces.In terms of economic growth, the IMF projects 11.5% and 8.1% GDP growth this year for India and China, respectively. The near-term future is South Asian, but this may not apply to all. Most India-headquartered banks already price-in considerable recovery prospects. However, significant bank recapitalized in needed for the economic forecasts to materialize and for these banks spreads to be maintained.Eventually, it will be time to deliver real fundamental performance. In the meantime, monetary accommodation should remain the main driver of credit spreads while economic growth plays catch-up. Credit tourists are fickle and may vacate if either are delayed.

Real credit fundamentals have yet to catch-up with spreads in bonds which continue to outperform. True fundamentals have a considerable gap to close relative to spread compression. Global monetary accommodation is in large part responsible for recent outperformance. However, credit tourists may have booked too early.Deeply subordinated Additional Tier 1 (AT1) bonds led in terms of spread tightening during January in Asia. Increased risk tolerance and a reach for yield, possibly by credit tourists, drove results as global vaccination efforts raised economic growth expectations. As such, Hong Kong and Thai- based bank securities outperformed, albeit for differing reasons.As Asia-headquartered banks report earnings, the quality of disclosure varies considerably from bank-to-bank. Even where disclosure is adequate, asset quality indicators may greatly underestimate the level of troubled debt due to continued forbearance, restructuring efforts and early-stage aging. This is driving provisioning costs lower than would be expected in a more normal operating environment. The value of these reports is significantly diminished for credit investors. Financial repression creates a market, which in its nature, is always a one-sided bet with the Fed / ECB/ BOJ.  There is limited price discovery. As such, credit value should remain driven by larger market forces.In terms of economic growth, the IMF projects 11.5% and 8.1% GDP growth this year for India and China, respectively. The near-term future is South Asian, but this may not apply to all. Most India-headquartered banks already price-in considerable recovery prospects. However, significant bank recapitalized in needed for the economic forecasts to materialize and for these banks spreads to be maintained.Eventually, it will be time to deliver real fundamental performance. In the meantime, monetary accommodation should remain the main driver of credit spreads while economic growth plays catch-up. Credit tourists are fickle and may vacate if either are delayed.

Bank Credit Compass: Credit Tourist May Vacate if Real Fundamentals Do Not Catch-Up

Pan-Asia Catalysts/Events, Quiddity Advisors

David Blennerhassett

Pan-Asia Catalysts/Events

Quiddity Advisors

Event-Driven

Last Week in Event SPACE: Toshiba, Cathay, OFAC's Walk Back, Trad Chi Med, Enplas, Car, Japan Asia

*Major BEA Shareholder Under Stress In Front Of Merger: CaixaBank SA (CABK.SM), an 17.3% holder of Bank of East Asia’s (23.HK) [BEA] shares, and still has significant capital concerns. Combined with the acquisition of Bankia (BKIA.SM), pro forma CaixaBank’s (surviving entity) core CET1 target is 11.9%. With CaixaBank's restructuring charge only sufficient to fund EUR 1 bn in cost cuts, CaixaBank will need to find additional ways to manufacture capital in order to fund the restructuring - including asset sales, lower dividends, and/or capital raise; and*Expecting A BEA Offload: With an ownership value at EUR 786 mn, a capital charge of EUR 1.6 bn at pro forma CaixaBank under Basel III, the aforementioned solvency constraints at Caixabank, a fundamentally struggling BEA, and a resurgent mainland China, CaixaBank would have to finally be looking for an exit – which would be a massive overhang on the shares of BEA. The key terms of the CaixaBank/BEA Shareholder  Agreement likely cannot be upheld by the former given that its financial problems prevent it from fulfilling its responsibilities.

*Major BEA Shareholder Under Stress In Front Of Merger: CaixaBank SA (CABK.SM), an 17.3% holder of Bank of East Asia’s (23.HK) [BEA] shares, and still has significant capital concerns. Combined with the acquisition of Bankia (BKIA.SM), pro forma CaixaBank’s (surviving entity) core CET1 target is 11.9%. With CaixaBank's restructuring charge only sufficient to fund EUR 1 bn in cost cuts, CaixaBank will need to find additional ways to manufacture capital in order to fund the restructuring - including asset sales, lower dividends, and/or capital raise; and*Expecting A BEA Offload: With an ownership value at EUR 786 mn, a capital charge of EUR 1.6 bn at pro forma CaixaBank under Basel III, the aforementioned solvency constraints at Caixabank, a fundamentally struggling BEA, and a resurgent mainland China, CaixaBank would have to finally be looking for an exit – which would be a massive overhang on the shares of BEA. The key terms of the CaixaBank/BEA Shareholder  Agreement likely cannot be upheld by the former given that its financial problems prevent it from fulfilling its responsibilities.  

Bank of East Asia – How Much Longer Can Caixa Hold On?

Hong Kong

The Bank of East Asia, Limited and its subsidiaries provide general banking, related financial, business corporate, and investor services.

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Bank of East Asia (23 HK)

Bank Credit Weekly: AT1 Outperformance in Risk-On Environment

European bank AT1 significantly outperformed Asia as each EU Basel III AT1 note tightened. Concurrently, increased risk appetite drove performance...

Hank Calenti, CFA

Ping An Insurance - Awful Bank Result

PING AN INSURANCE: PAB reported a 25.1% lower linked quarter result. The bulk of the earnings decline was attributed to a 17.1% increase in costs;...

Thomas J. Monaco

Bank Credit Compass: Credit Tourist May Vacate if Real Fundamentals Do Not Catch-Up

Credit tourists may vacate if economic growth and real credit fundaments are not delivered. The gap between credit spreads and fundamentals is...

Hank Calenti, CFA

Last Week in Event SPACE: Toshiba, Cathay, OFAC's Walk Back, Trad Chi Med, Enplas, Car, Japan Asia

The weekend is here! Pour yourself a coffee, grab a comfortable seat, and sift through a brief summary of insights on various events discussed...

David Blennerhassett

Bank of East Asia – How Much Longer Can Caixa Hold On?

BANK OF EAST ASIA: CaixaBank is a 17.3% holder of BEA, and still has significant capital concerns. CaixaBank needs to find additional ways to...

Thomas J. Monaco

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