Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

<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> newly issued Additional Tier 1 (AT1) bond is not worth chasing. HSBC remains adrift and a strategic reset in February could have an outsized impact on longer dated notes. We see better risk adjusted returns in lower duration securities of the issuer.HCBC’s 4.6% coupon 2030 first call AT1 bond priced in-line with similarly long-duration AT1 notes. The market’s preference for duration aided in generating attractive pricing for the issuer. Priced at 10-year Treasuries plus 365 basis points, we see little upside and plenty of market-driven downside at this level. Only <a href="https://www.smartkarma.com/entities/bnp-paribas" target="_blank" data-smartkarma-citation="entities:525:1" rel="noopener">BNP Paribas' (BNP FP)</a> 4.5% coupon 2030 first call AT1 priced at a tighter spread in 10-year AT1 paper this year and BNP’s market timing was perfect.This issuance also suggests to us a sooner than expected restart of stock buybacks. To limit capital leverage, HSBC Holding’s UK regulator generally does not allow banks to issue AT1 while the firm is buying stock in the open market. Stock buybacks can deplete capital buffers faster than regular dividends and, therefore, are not AT1 investor friendly.  Taken together, a flat yield curve combined with<ul><li><ul>
<li>overpriced risk relative to ratings,</li>
<li>spreads that are tight to similar maturity senior bonds</li>
<li>capital buffers that are in-line with peers but driven by high conversion trigger levels that are not priced-in, and</li>
<li>underpriced credit default risk at the long end</li>
</ul></li></ul>leads us to conclude that the newly issued AT1 note has limited upside relative to its shorter duration cohorts.Finally, investor preference for long-duration assets in the low yield environment appears to be having a large impact on valuations. Chasing spread at this point in the cycle can be dangerous. Given better risk / return opportunities on other parts of the credit continuum, we do not recommend chasing HSBC’s new AT1 bond.

HSBC Holdings' (HSBA LN) newly issued Additional Tier 1 (AT1) bond is not worth chasing. HSBC remains adrift and a strategic reset in February could have an outsized impact on longer dated notes. We see better risk adjusted returns in lower duration securities of the issuer.HCBC’s 4.6% coupon 2030 first call AT1 bond priced in-line with similarly long-duration AT1 notes. The market’s preference for duration aided in generating attractive pricing for the issuer. Priced at 10-year Treasuries plus 365 basis points, we see little upside and plenty of market-driven downside at this level. Only BNP Paribas' (BNP FP) 4.5% coupon 2030 first call AT1 priced at a tighter spread in 10-year AT1 paper this year and BNP’s market timing was perfect.This issuance also suggests to us a sooner than expected restart of stock buybacks. To limit capital leverage, HSBC Holding’s UK regulator generally does not allow banks to issue AT1 while the firm is buying stock in the open market. Stock buybacks can deplete capital buffers faster than regular dividends and, therefore, are not AT1 investor friendly.  Taken together, a flat yield curve combined with
overpriced risk relative to ratings,
spreads that are tight to similar maturity senior bonds
capital buffers that are in-line with peers but driven by high conversion trigger levels that are not priced-in, and
underpriced credit default risk at the long end
leads us to conclude that the newly issued AT1 note has limited upside relative to its shorter duration cohorts.Finally, investor preference for long-duration assets in the low yield environment appears to be having a large impact on valuations. Chasing spread at this point in the cycle can be dangerous. Given better risk / return opportunities on other parts of the credit continuum, we do not recommend chasing HSBC’s new AT1 bond.

Dollar strengthening, continued equity market weakness and the panoply of Fed speakers crying for more fiscal stimulus did not help Asian or US HY credit sentiment. Against this backdrop, Asia’s HY index gapped wider on Friday while the US HY index steadily weakened throughout the week. Investors may see more attractive valuations following this secondary market selloff.In rate markets, the US Treasury curve flattened on supply technicals and risk-off momentum. The volatility of the reflation trade, on one week and off the next, along with rangebound oil prices, suggests that investor’s economic demand expectations are in flux. Reports that US legislators may try to pass another stimulus bill was met incredulity that this could be accomplished while a Supreme Court nominee is vetted.The Bloomberg index of emerging market capital inflows finished the materially lower as the US dollar strengthened in a flight to safety trade. We anticipate that this index could be a bit whippy over the next few weeks as the potential for the most contentious US election in history drives flows back to the US dollar.   Despite the softer tone in global risk sentiment, Asia bank credit was unchanged to slightly tighter in spread terms. Additional Tier 1 bonds outperformed other asset classes. This result is at odds with sentiment in other markets and we are not convinced that it is sustainable. Concurrently, despite a poor start to the week in bank debt capital markets, over US$8billion was issued by banks in USD and Euros in the form of Senior Unsecured and Tier II bonds. This follows from over US$54 billion in bank bonds issued over the prior four weeks. The recent funding frenzy suggests that issuers are aware that the currently optimal issuance landscape will not last forever. With credit spreads unlikely to tighten much further, next years’ debt issuance may be considerably more expensive on a relative basis.Amongst Asia-centric banks, <a href="https://www.smartkarma.com/entities/china-merchants-bank-co-ltd" target="_blank" data-smartkarma-citation="entities:714:1" rel="noopener">China Merchants Bank A (600036 CH)</a>, CDB Leasing and <a href="https://www.smartkarma.com/entities/china-huarong-asset-management" target="_blank" data-smartkarma-citation="entities:968:1" rel="noopener">China Huarong Asset Management (2799 HK)</a> brought US$ bonds during the week. Meanwhile three banks and two countries announced mandates for new debt issuance in the near term. Over upcoming week, the pace of supply likely to slow in Asia because of China’s Golden Week holiday starting Oct. 1. At the same time, spreads in Asia are unlikely to move with conviction until this festival is over. Notably, <a href="https://www.smartkarma.com/entities/bnp-paribas" target="_blank" data-smartkarma-citation="entities:525:1" rel="noopener">BNP Paribas' (BNP FP)</a> issued a new note at a similar structure and risk layer as was issued by <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> last week; however, BNP’s bond was issued 10 basis points (bps) tighter while HSBC’s bond widened 27bps during the week.  Market Outlook Aggregate demand remains structurally weak. This realization is offsetting the unrealistically high optimism which followed from the Fed’s change in inflation policy stance. We may now have a period of Fed optimism unwinding combined with heightened concerns on the economic outlook post-US election. 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. This weeks’ confluence of risk-off indicators is a reminder that investors flee to the US dollar in times of heightened uncertainty, to the detriment of EM assets.  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.

Dollar strengthening, continued equity market weakness and the panoply of Fed speakers crying for more fiscal stimulus did not help Asian or US HY credit sentiment. Against this backdrop, Asia’s HY index gapped wider on Friday while the US HY index steadily weakened throughout the week. Investors may see more attractive valuations following this secondary market selloff.In rate markets, the US Treasury curve flattened on supply technicals and risk-off momentum. The volatility of the reflation trade, on one week and off the next, along with rangebound oil prices, suggests that investor’s economic demand expectations are in flux. Reports that US legislators may try to pass another stimulus bill was met incredulity that this could be accomplished while a Supreme Court nominee is vetted.The Bloomberg index of emerging market capital inflows finished the materially lower as the US dollar strengthened in a flight to safety trade. We anticipate that this index could be a bit whippy over the next few weeks as the potential for the most contentious US election in history drives flows back to the US dollar.   Despite the softer tone in global risk sentiment, Asia bank credit was unchanged to slightly tighter in spread terms. Additional Tier 1 bonds outperformed other asset classes. This result is at odds with sentiment in other markets and we are not convinced that it is sustainable. Concurrently, despite a poor start to the week in bank debt capital markets, over US$8billion was issued by banks in USD and Euros in the form of Senior Unsecured and Tier II bonds. This follows from over US$54 billion in bank bonds issued over the prior four weeks. The recent funding frenzy suggests that issuers are aware that the currently optimal issuance landscape will not last forever. With credit spreads unlikely to tighten much further, next years’ debt issuance may be considerably more expensive on a relative basis.Amongst Asia-centric banks, China Merchants Bank A (600036 CH), CDB Leasing and China Huarong Asset Management (2799 HK) brought US$ bonds during the week. Meanwhile three banks and two countries announced mandates for new debt issuance in the near term. Over upcoming week, the pace of supply likely to slow in Asia because of China’s Golden Week holiday starting Oct. 1. At the same time, spreads in Asia are unlikely to move with conviction until this festival is over. Notably, BNP Paribas' (BNP FP) issued a new note at a similar structure and risk layer as was issued by HSBC Holdings (HSBA LN) last week; however, BNP’s bond was issued 10 basis points (bps) tighter while HSBC’s bond widened 27bps during the week.  Market Outlook Aggregate demand remains structurally weak. This realization is offsetting the unrealistically high optimism which followed from the Fed’s change in inflation policy stance. We may now have a period of Fed optimism unwinding combined with heightened concerns on the economic outlook post-US election. 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. This weeks’ confluence of risk-off indicators is a reminder that investors flee to the US dollar in times of heightened uncertainty, to the detriment of EM assets.  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: Return of Risk-Off, Save for Asia Bank Credit

France

BNP Paribas SA attracts deposits and offers commercial, retail, investment, and private and corporate banking services. The Bank also provides asset management and investment advisory services to institutions and individuals in Europe, the United States, Asia, and the emerging markets.

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BNP Paribas (BNPQY US)

HSBC’s New AT1: Not Worth Chasing

HSBC remains adrift and a strategic reset could have an outsized impact on longer dated notes. The newly issued AT1 is not worth chasing. We see...

Hank Calenti, CFA

Bank Credit Weekly: Return of Risk-Off, Save for Asia Bank Credit

Dollar strengthening, continued equity market weakness and the panoply of Fed speakers crying for more fiscal stimulus did not help Asian or US HY...

Hank Calenti, CFA

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Market Cap (USDm)

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