Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Executive Summary: <a href="https://www.smartkarma.com/entities/banco-santander-sa" target="_blank" data-smartkarma-citation="entities:21296:1" rel="noopener">Banco Santander (SAN SM)</a> is one of the few institutions which did not engage in loan loss reserve releases this quarter. It did not even release reserves for the sake of appearance, as occurred at <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>. As regards credit quality, unfortunately, there is more than meets the eye and it is not spectacular. However, we believe that this is priced into the bank’s Additional Tier 1 (AT1) notes.The big issue for Santander is Brazil. Santander is essentially a Brazilian bank, headquartered in Madrid. Brazil contributes the largest amount of pre-provision profits amongst the bank’s well diversified franchise. Notably, the bank effectively managed to achieve an overall similar revenue result in the first quarter of this year as in last year, despite Brazil’s contribution declining by 16% year-on-year. This speaks to the diversification benefits inherent in the firm’s franchise. We believe this is undervalued by the market.Santander may face continuing revenue challenges in Brazil this year if the country is unable to tame its Coronavirus outbreaks. However, this appears to already be priced into Santander’s AT1 bonds.Santander’s longest dated AT1 bond trades 30 bps higher than the spread on <a href="https://www.smartkarma.com/entities/credit-suisse-group-ag" target="_blank" data-smartkarma-citation="entities:22253:1" rel="noopener">Credit Suisse Group's (CSGN VX)</a> similar first call note, despite being higher rated and having an effective capital buffer which is greater than 200bps higher, relative to their respective risk-weighted assets. Santander’s longest-dated AT1 note also trades almost 100bps higher than <a href="https://www.smartkarma.com/entities/standard-chartered-plc" target="_blank" data-smartkarma-citation="entities:193:1" rel="noopener">Standard Chartered's (STAN LN)</a> similar first call bond. Again, this is despite being higher rated and having a similar capital buffer. As such, we see more upside and recommend that investors overweight Santander’s AT1 notes.

Executive Summary: Banco Santander (SAN SM) is one of the few institutions which did not engage in loan loss reserve releases this quarter. It did not even release reserves for the sake of appearance, as occurred at HSBC Holdings (HSBA LN). As regards credit quality, unfortunately, there is more than meets the eye and it is not spectacular. However, we believe that this is priced into the bank’s Additional Tier 1 (AT1) notes.The big issue for Santander is Brazil. Santander is essentially a Brazilian bank, headquartered in Madrid. Brazil contributes the largest amount of pre-provision profits amongst the bank’s well diversified franchise. Notably, the bank effectively managed to achieve an overall similar revenue result in the first quarter of this year as in last year, despite Brazil’s contribution declining by 16% year-on-year. This speaks to the diversification benefits inherent in the firm’s franchise. We believe this is undervalued by the market.Santander may face continuing revenue challenges in Brazil this year if the country is unable to tame its Coronavirus outbreaks. However, this appears to already be priced into Santander’s AT1 bonds.Santander’s longest dated AT1 bond trades 30 bps higher than the spread on Credit Suisse Group's (CSGN VX) similar first call note, despite being higher rated and having an effective capital buffer which is greater than 200bps higher, relative to their respective risk-weighted assets. Santander’s longest-dated AT1 note also trades almost 100bps higher than Standard Chartered's (STAN LN) similar first call bond. Again, this is despite being higher rated and having a similar capital buffer. As such, we see more upside and recommend that investors overweight Santander’s AT1 notes.

Executive Summary: <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> Q1 earnings release was one part theater, one part reality and in a large part more of the same. This may be a long and slow recovery and transformation for this institution. Time is not on its side from a debt rating perspective.With respect to reality, there is a glimmer of hope for revenues as HSBC reported an increase in the pipeline of loan applications.  As regards theater, HSBC’s loan loss reserve release appears to be largely signaling, rather than driven by an actual improvement in asset quality. Additional theater is provided in the way HSBC’s underlying profits are calculated.More of the same was seen in that HSBC cannot immediately escape its predicament of being a large conventional lender as opposed to a significant fee generating wealth and asset manager. This may be a long and slow recovery and transformation for this institution.Time is not on its side from a debt rating perspective. Moody’s review for a possible downgrade should be concluded before the end of Q2.  Notably, HSBC’s Additional Tier 1 (AT1) bonds are not at risk of a downgrade. They currently represent a safe harbor from downgrade risk and remain supported by a large buffer of capital. Most of these securities also trade at a meaningful discount, in spread and multiple terms, to the higher seniority Tier 2 securities.Concurrently, HSBC’s Tier 2 bonds trade extremely tight relative to the higher seniority Senior Unsecured bonds issued by HSBC Holdings.  For investors that cannot hold AT1 bonds, given the downgrade risk and the fact that there is little upside to be gained from owning HSBC’s Tier 2 bonds, our general preference would be to own HSBC’s holding company issued Senior Unsecured notes.

Executive Summary: HSBC Holdings' (HSBA LN) Q1 earnings release was one part theater, one part reality and in a large part more of the same. This may be a long and slow recovery and transformation for this institution. Time is not on its side from a debt rating perspective.With respect to reality, there is a glimmer of hope for revenues as HSBC reported an increase in the pipeline of loan applications.  As regards theater, HSBC’s loan loss reserve release appears to be largely signaling, rather than driven by an actual improvement in asset quality. Additional theater is provided in the way HSBC’s underlying profits are calculated.More of the same was seen in that HSBC cannot immediately escape its predicament of being a large conventional lender as opposed to a significant fee generating wealth and asset manager. This may be a long and slow recovery and transformation for this institution.Time is not on its side from a debt rating perspective. Moody’s review for a possible downgrade should be concluded before the end of Q2.  Notably, HSBC’s Additional Tier 1 (AT1) bonds are not at risk of a downgrade. They currently represent a safe harbor from downgrade risk and remain supported by a large buffer of capital. Most of these securities also trade at a meaningful discount, in spread and multiple terms, to the higher seniority Tier 2 securities.Concurrently, HSBC’s Tier 2 bonds trade extremely tight relative to the higher seniority Senior Unsecured bonds issued by HSBC Holdings.  For investors that cannot hold AT1 bonds, given the downgrade risk and the fact that there is little upside to be gained from owning HSBC’s Tier 2 bonds, our general preference would be to own HSBC’s holding company issued Senior Unsecured notes.

HSBC’s Q1 Results: One Part Theater and One Part Reality as We Move To a Downgrade

Executive Summary: <a href="https://www.smartkarma.com/entities/ubs-group-ag" target="_blank" data-smartkarma-citation="entities:22590:1" rel="noopener">UBS Group's (UBSG VX)</a> Archegos surprise provides three lessons for credit investors. The net result is that it is time to lighten exposure to this financial institution.First, the firm is much more than a simple asset manager, it is a material off-balance sheet leverage provider to wealth management clients. Second, this risk, although not incorporated in risk management disclosures, is the reason why UBS’ capital constraint is leverage ratio driven. Third, broader financial market risk exposure may be the biggest risk for credit investors at current trading levels. We elaborate more on each within.UBS’ Additional Tier 1 bonds trade at a material premium to other firms. Considering that UBS is exposed by more than the market expected to idiosyncratic events impacting other banks, juxtaposed with a low capital buffer relative to firms with much less market exposure, and given that financial market conditions are about as good as it can get for investment banking and asset managers, now is the time to lighten exposure to firms like UBS.In light of today’s announcement and the path forward from a financial market perspective, we recommend that investors Underweight exposure to UBS.

Executive Summary: UBS Group's (UBSG VX) Archegos surprise provides three lessons for credit investors. The net result is that it is time to lighten exposure to this financial institution.First, the firm is much more than a simple asset manager, it is a material off-balance sheet leverage provider to wealth management clients. Second, this risk, although not incorporated in risk management disclosures, is the reason why UBS’ capital constraint is leverage ratio driven. Third, broader financial market risk exposure may be the biggest risk for credit investors at current trading levels. We elaborate more on each within.UBS’ Additional Tier 1 bonds trade at a material premium to other firms. Considering that UBS is exposed by more than the market expected to idiosyncratic events impacting other banks, juxtaposed with a low capital buffer relative to firms with much less market exposure, and given that financial market conditions are about as good as it can get for investment banking and asset managers, now is the time to lighten exposure to firms like UBS.In light of today’s announcement and the path forward from a financial market perspective, we recommend that investors Underweight exposure to UBS.

UBS: Archegos Surprise; Underweight on Three Lessons Learned

Executive Summary: Momentum behind the recent Treasury market rally may be starting to slow. Greater conviction is likely to build over the weeks which follow as economic data is published, rather than result from this week’s FOMC meeting.It is unlikely that the Fed will signal that it is ready to start tapering its asset purchase program this week. We are yet to see the whites of wage-growth eyes. Meanwhile, Canada became the first major economy to signal an exit from asset purchases. Canada’s central bank also indicated that a rate rise is now expected in the second half of 2022. Global interest rates did not react.  However, we may be tricked into seeing things which not there as upcoming wage data may point to rapidly falling wages.As such, the narrative remains left to be taken in the fixed income markets.  We may have reached a peak in short positioning unwinding and the re-entry of Japanese investors in the market is also taken as a given. Unexpectedly good economic data over the next few weeks could be bad for Treasury yields.  This could re-ignite the reflation and carry-trade rallies.While Treasuries continue to tread water, spreads on US CCC rated notes continued to trade at levels not seen since prior to the Global Financial Crisis in 2007. Investors are becoming concerned that the stretch for yield may be overdone. Excess US spread compression could benefit Asia HY as investors move offshore to grab better yields and excess spreads.In the bank credit markets, Asia-headquartered institution performed across the credit continuum while European bank bond remained stuck with carry-trade unwind performance. The combination of spread tightening and Treasury bond curve flattening generated positive total returns amongst Asia banks.We will hit the peak in bank earnings reports in the upcoming week. US banks set a high bar for performance by generating stellar investment banking and progressively improving core banking results over the last two weeks. They then signaled that they anticipate significantly higher interest rates later this year by raising record breaking amounts in the debt capital markets. Other banks may follow with material debt issuance over the next few weeks after reporting earnings this week.  We explore these market themes within.Market Outlook: Already looking past upcoming spikes in inflation and job creation, the Treasury market is repricing for lower growth and lower rates over a longer time-period. This should be risk asset supportive as the US dollar finally weakens. The risk is that of impotent monetary policy and a constrained fiscal response in a shorter than expected business cycle.

Executive Summary: Momentum behind the recent Treasury market rally may be starting to slow. Greater conviction is likely to build over the weeks which follow as economic data is published, rather than result from this week’s FOMC meeting.It is unlikely that the Fed will signal that it is ready to start tapering its asset purchase program this week. We are yet to see the whites of wage-growth eyes. Meanwhile, Canada became the first major economy to signal an exit from asset purchases. Canada’s central bank also indicated that a rate rise is now expected in the second half of 2022. Global interest rates did not react.  However, we may be tricked into seeing things which not there as upcoming wage data may point to rapidly falling wages.As such, the narrative remains left to be taken in the fixed income markets.  We may have reached a peak in short positioning unwinding and the re-entry of Japanese investors in the market is also taken as a given. Unexpectedly good economic data over the next few weeks could be bad for Treasury yields.  This could re-ignite the reflation and carry-trade rallies.While Treasuries continue to tread water, spreads on US CCC rated notes continued to trade at levels not seen since prior to the Global Financial Crisis in 2007. Investors are becoming concerned that the stretch for yield may be overdone. Excess US spread compression could benefit Asia HY as investors move offshore to grab better yields and excess spreads.In the bank credit markets, Asia-headquartered institution performed across the credit continuum while European bank bond remained stuck with carry-trade unwind performance. The combination of spread tightening and Treasury bond curve flattening generated positive total returns amongst Asia banks.We will hit the peak in bank earnings reports in the upcoming week. US banks set a high bar for performance by generating stellar investment banking and progressively improving core banking results over the last two weeks. They then signaled that they anticipate significantly higher interest rates later this year by raising record breaking amounts in the debt capital markets. Other banks may follow with material debt issuance over the next few weeks after reporting earnings this week.  We explore these market themes within.Market Outlook: Already looking past upcoming spikes in inflation and job creation, the Treasury market is repricing for lower growth and lower rates over a longer time-period. This should be risk asset supportive as the US dollar finally weakens. The risk is that of impotent monetary policy and a constrained fiscal response in a shorter than expected business cycle.  

Bank Credit Weekly: Momentum Slows as Conviction Is Lacking

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

*Results Materially Supported By Provision Reversals and Principal Transactions: Citigroup (C.US) [Citi] reported 1Q21 bottom-line results of USD 7.6 bn, increasing USD 3.7 bn (89.0%) linked quarter. Citi reversed provisions of USD 2.1 bn - increasing 43.7x versus 4Q20. In addition to the negative provision, Citi’s results were also supported by a USD 2.0 bn (99.7%) increase in principal transaction gains;*Credit Weaker But Coverage Strong: Net new NPLs came in about 1/3 of the previous quarter’s result came in at USD 635 mn or increasing 48.0% on an annualized basis – still far worse than JPM for the last three consecutive quarters. Citi’s loan loss reserve declined to 422% of NPLs and 325 bp of total loans – but still pretty darn good for the known and potential risk in the loan portfolio; and *Puzzling EM Exit: Citi also announced strategic changes in the Global Consumer Bank (GCB), where they are exiting 13 markets, of which ten are in Asia-Pacific. As rationale for the move, new CEO Jane Fraser believe that Citi "does not have the scale" to compete in those markets which account for USD 7 bn in allocated equity and USD 70 bn in loans. We await clarity on the potential restructuring costs and the capital release from these divestitures.

*Results Materially Supported By Provision Reversals and Principal Transactions: Citigroup (C.US) [Citi] reported 1Q21 bottom-line results of USD 7.6 bn, increasing USD 3.7 bn (89.0%) linked quarter. Citi reversed provisions of USD 2.1 bn - increasing 43.7x versus 4Q20. In addition to the negative provision, Citi’s results were also supported by a USD 2.0 bn (99.7%) increase in principal transaction gains;*Credit Weaker But Coverage Strong: Net new NPLs came in about 1/3 of the previous quarter’s result came in at USD 635 mn or increasing 48.0% on an annualized basis – still far worse than JPM for the last three consecutive quarters. Citi’s loan loss reserve declined to 422% of NPLs and 325 bp of total loans – but still pretty darn good for the known and potential risk in the loan portfolio; and *Puzzling EM Exit: Citi also announced strategic changes in the Global Consumer Bank (GCB), where they are exiting 13 markets, of which ten are in Asia-Pacific. As rationale for the move, new CEO Jane Fraser believe that Citi "does not have the scale" to compete in those markets which account for USD 7 bn in allocated equity and USD 70 bn in loans. We await clarity on the potential restructuring costs and the capital release from these divestitures.

Switzerland

Credit Suisse Group AG operates as a wealth management firm. The Company specializes in investment banking and offers wealth management activities aiming to capitalize on both the large pool of wealth within mature markets, as well as the significant growth in wealth in Asia Pacific and other emerging markets. Credit Suisse Group serves customers worldwide.

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Credit Suisse Group (CS US)

Banco Santander: Undervalued AT1

Santander’s AT1 is undervalued. There is considerably more upside from these securities than at other globally diversified, and EM-centric,...

Hank Calenti, CFA

HSBC’s Q1 Results: One Part Theater and One Part Reality as We Move To a Downgrade

HSBC’s earnings release was one part theater, one part reality and in a large part more of the same. This may be a long and slow recovery and...

Hank Calenti, CFA

UBS: Archegos Surprise; Underweight on Three Lessons Learned

The Archegos surprise provides three lessons for credit investors. The net result is that it is time to lighten exposure to UBS.

Hank Calenti, CFA

Bank Credit Weekly: Momentum Slows as Conviction Is Lacking

Momentum behind the Treasury market started to slow. Greater conviction is likely to build over the weeks which follow as economic data is...

Hank Calenti, CFA

Citigroup – Shifting Winds

CITIGROUP: Citi reported a QOQ 1Q21 bottom-line result increase of 89.0% due to provision reversals and principal transactions. Net new NPLs...

Thomas J. Monaco

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