Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Executive Summary: It may be time to take duration, at least through the summer. Swap spread trends suggest to us that interest rates may have peaked over the near term, or at least until the Fed decides to talk about talking about tapering its asset purchases. We do not anticipate this discussion before next year.US inflation hit its highest annualized rate since 1995 and, after a brief spike upwards, interest rates were no more volatile than in prior weeks without significant data announcements. In fact, the Treasury curve barely moved week-on-week while Fed Fund rate expectations rose slightly.Credit spreads continue to track interest rates with shorter-end securities outperforming on a total return basis, while intermediate four-to-five-year spreads outperformed on pure credit terms. There was consistent performance across geographies, across the curve and across bank bond asset classes. European bank credit continues to slightly outperform Asia, although this may be tempered as Bund rates rise.Spread compression is likely to remain driven by economic growth expectations with lower rated high yield securities having a higher beta to the economic recovery. Higher grade securities remain defensive and expensive from a total return perspective.In the primary market, a jumbo-sized bond by <a href="https://www.smartkarma.com/entities/credit-suisse-group-ag" target="_blank" data-smartkarma-citation="entities:22253:1" rel="noopener">Credit Suisse (CSGN VX)</a> took issuance to almost US$11 billion for a second week in a row. Credit Suisse Group’s Senior Unsecured note priced in-line with its curve. <a href="https://www.smartkarma.com/entities/danske-bank-a-s" target="_blank" data-smartkarma-citation="entities:22336:1" rel="noopener">Danske Bank's (DANSKE DC)</a> Additional Tier 1 may be more interesting for investors.Market Outlook: The question is whether the over-heating narrative will make a comeback and bring rate and tapering expectations closer. Financial stability risks appear binary from here. Either the Fed is over-accommodative, and it sits on its hands too long while asset bubbles over-inflate so that it gets nasty when it moves, or the Fed gets impatient, and it lowers accommodation unexpectedly which creates a risk off reaction. In both cases, curves flatten in a risk-off environment. We suspect the former is more likely, and for now, the Fed remains the bartender.

Executive Summary: It may be time to take duration, at least through the summer. Swap spread trends suggest to us that interest rates may have peaked over the near term, or at least until the Fed decides to talk about talking about tapering its asset purchases. We do not anticipate this discussion before next year.US inflation hit its highest annualized rate since 1995 and, after a brief spike upwards, interest rates were no more volatile than in prior weeks without significant data announcements. In fact, the Treasury curve barely moved week-on-week while Fed Fund rate expectations rose slightly.Credit spreads continue to track interest rates with shorter-end securities outperforming on a total return basis, while intermediate four-to-five-year spreads outperformed on pure credit terms. There was consistent performance across geographies, across the curve and across bank bond asset classes. European bank credit continues to slightly outperform Asia, although this may be tempered as Bund rates rise.Spread compression is likely to remain driven by economic growth expectations with lower rated high yield securities having a higher beta to the economic recovery. Higher grade securities remain defensive and expensive from a total return perspective.In the primary market, a jumbo-sized bond by Credit Suisse (CSGN VX) took issuance to almost US$11 billion for a second week in a row. Credit Suisse Group’s Senior Unsecured note priced in-line with its curve. Danske Bank's (DANSKE DC) Additional Tier 1 may be more interesting for investors.Market Outlook: The question is whether the over-heating narrative will make a comeback and bring rate and tapering expectations closer. Financial stability risks appear binary from here. Either the Fed is over-accommodative, and it sits on its hands too long while asset bubbles over-inflate so that it gets nasty when it moves, or the Fed gets impatient, and it lowers accommodation unexpectedly which creates a risk off reaction. In both cases, curves flatten in a risk-off environment. We suspect the former is more likely, and for now, the Fed remains the bartender.

Bank Credit Weekly: Inflation Non-Event Suggests Time to Take Duration?

Executive Summary: Friday’s jobs report shocker capped off a week which included US Treasury Secretary Janet Yellen needing to be Mirandized. This was followed by the Fed stating the obvious in its financial stability report. Unmentioned in this report is that the role of this Fed is no longer to take away the punchbowl, but instead it is the bartender. The week ended with a jobs report that was the biggest miss in nominal terms, ever.The report was at odds with recent PMI surveys in which respondents stated that it was difficult to hire. This may be the result of frictions in hiring as unemployment benefits as well as child-care needs and postponed school re-openings delay employee re-entry. The truth serum for the US economy may occur around September when extended unemployment payments expire.The market impact was an immediate 10 basis point (bp) drop in the 10-year Treasury while the 2-year note even fell 1bp. Prices on the 10-year gave up these gains as the day progressed, but the smart money, that is the bond market, may be correct with the recent dampening of interest rates suggesting a longer time period to a less accommodative Fed.  The US Treasury bond curve ended the week flatter with short-end yields falling by much less than the longer part of the curve.With rates continuing to push credit spreads, Asia- and European-headquartered banks generated negative total returns in all but the lowest duration notes. There was a clear preference for Additional Tier 1 (AT1) bond issuance over the past week while over US$11 billion equivalent was raised by financial institutions globally in USD and Euros. In what may have been the busiest AT1 bond issuance weeks of the year, five institutions brought over US$6.5 billion in six securities.Nonetheless, this is a great credit environment and spreads which could go even tighter into year-end. A single piece of data, such as April’s non-farm payroll figure, is unlikely to change investor positioning. It may be a little too early to fade the market as fundamentals catch-up.Next week we will get a record-matching $126 billion slate of Treasury auctions. We may also see a robust serving of corporate and financials debt issuance. US consumer-price data is set to be published on Tuesday, 12 May. A sharp annual acceleration is forecast, although the market is likely to dismiss the figure as resulting from a comparison to depressed levels of a year earlier.With peak Q1 earnings season now behind us, Japanese banks will deliver their year-end results over the next week while several other stragglers pepper the remainder of the month. US banks signaled that they anticipate significantly higher interest rates by raising record breaking amounts in the debt capital markets following their Q1 earnings announcements. Other banks may follow with material debt issuance over the next few weeks after reporting earnings.Market Outlook: The question is whether the over-heating narrative will make a comeback and bring rate and tapering expectations closer. Financial stability risks appear binary from here. Either the Fed is over-accommodative, and it sits on its hands too long while asset bubbles over-inflate so that it gets nasty when it moves, or the Fed gets impatient, and it lowers accommodation unexpectedly which creates a risk off reaction. In both cases, curves flatten in a risk-off environment. We suspect the former is more likely, and for now, the Fed remains the bartender.

Executive Summary: Friday’s jobs report shocker capped off a week which included US Treasury Secretary Janet Yellen needing to be Mirandized. This was followed by the Fed stating the obvious in its financial stability report. Unmentioned in this report is that the role of this Fed is no longer to take away the punchbowl, but instead it is the bartender. The week ended with a jobs report that was the biggest miss in nominal terms, ever.The report was at odds with recent PMI surveys in which respondents stated that it was difficult to hire. This may be the result of frictions in hiring as unemployment benefits as well as child-care needs and postponed school re-openings delay employee re-entry. The truth serum for the US economy may occur around September when extended unemployment payments expire.The market impact was an immediate 10 basis point (bp) drop in the 10-year Treasury while the 2-year note even fell 1bp. Prices on the 10-year gave up these gains as the day progressed, but the smart money, that is the bond market, may be correct with the recent dampening of interest rates suggesting a longer time period to a less accommodative Fed.  The US Treasury bond curve ended the week flatter with short-end yields falling by much less than the longer part of the curve.With rates continuing to push credit spreads, Asia- and European-headquartered banks generated negative total returns in all but the lowest duration notes. There was a clear preference for Additional Tier 1 (AT1) bond issuance over the past week while over US$11 billion equivalent was raised by financial institutions globally in USD and Euros. In what may have been the busiest AT1 bond issuance weeks of the year, five institutions brought over US$6.5 billion in six securities.Nonetheless, this is a great credit environment and spreads which could go even tighter into year-end. A single piece of data, such as April’s non-farm payroll figure, is unlikely to change investor positioning. It may be a little too early to fade the market as fundamentals catch-up.Next week we will get a record-matching $126 billion slate of Treasury auctions. We may also see a robust serving of corporate and financials debt issuance. US consumer-price data is set to be published on Tuesday, 12 May. A sharp annual acceleration is forecast, although the market is likely to dismiss the figure as resulting from a comparison to depressed levels of a year earlier.With peak Q1 earnings season now behind us, Japanese banks will deliver their year-end results over the next week while several other stragglers pepper the remainder of the month. US banks signaled that they anticipate significantly higher interest rates by raising record breaking amounts in the debt capital markets following their Q1 earnings announcements. Other banks may follow with material debt issuance over the next few weeks after reporting earnings.Market Outlook: The question is whether the over-heating narrative will make a comeback and bring rate and tapering expectations closer. Financial stability risks appear binary from here. Either the Fed is over-accommodative, and it sits on its hands too long while asset bubbles over-inflate so that it gets nasty when it moves, or the Fed gets impatient, and it lowers accommodation unexpectedly which creates a risk off reaction. In both cases, curves flatten in a risk-off environment. We suspect the former is more likely, and for now, the Fed remains the bartender.

Bank Credit Weekly: Jobs Report Shocker Flattens Curves

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

Switzerland

Credit Suisse Group AG is an international financial services group. The Group provides investment banking, private banking, and asset management services to customers located around the world.

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Credit Suisse (CSGN VX)

Bank Credit Weekly: Inflation Non-Event Suggests Time to Take Duration?

Time to take duration? At the same time, high yield securities have a higher beta to the economy. As such, long duration, high yield may offer...

Hank Calenti, CFA

Bank Credit Weekly: Jobs Report Shocker Flattens Curves

Job data raises uncertainty as the Fed continues to act as bartender. Financial stability risks appear binary while rates push credit spreads. Can...

Hank Calenti, CFA

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

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