Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

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 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

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

*Not Again…:  HSBC Holdings plc (5.HK/HSBA.LN) [HSBC] may have to revisit and re-atone for their anti-money laundering (AML) sins after the International Consortium of Investigative Journalists (ICIJ) reviewed over 2,100 suspicious activity reports (SARs) from over 90 financial institutions. More worrisome, any bank with a Deferred Prosecution Agreement (DPA) which extends beyond 2020 is at heightened risk. The DPA stipulates that a bank may do no wrong during the DPA period – which, in our view, is nearly an impossible task. Challenges such as HSBC North America’s incredibly poor fundamentals place the US operation squarely in the sites of regulators – even without considering the potential for AML problems; and     * China – Our Way Or The Highway: Mainland China stated that it would “take necessary measures to resolutely safeguard the legitimate rights and interests of Chinese companies,” and signaled that HSBC may be on the unreliable entity list – signaling that the bank is squeezed between the legal and political dictates of the US and its Western allies on the one hand and Beijing on the other. If true, HSBC is going to be forced to thread a needle or will be forced to pick a side.

*Not Again…:  HSBC Holdings plc (5.HK/HSBA.LN) [HSBC] may have to revisit and re-atone for their anti-money laundering (AML) sins after the International Consortium of Investigative Journalists (ICIJ) reviewed over 2,100 suspicious activity reports (SARs) from over 90 financial institutions. More worrisome, any bank with a Deferred Prosecution Agreement (DPA) which extends beyond 2020 is at heightened risk. The DPA stipulates that a bank may do no wrong during the DPA period – which, in our view, is nearly an impossible task. Challenges such as HSBC North America’s incredibly poor fundamentals place the US operation squarely in the sites of regulators – even without considering the potential for AML problems; and     * China – Our Way Or The Highway: Mainland China stated that it would “take necessary measures to resolutely safeguard the legitimate rights and interests of Chinese companies,” and signaled that HSBC may be on the unreliable entity list – signaling that the bank is squeezed between the legal and political dictates of the US and its Western allies on the one hand and Beijing on the other. If true, HSBC is going to be forced to thread a needle or will be forced to pick a side. 

HSBC Holdings Plc – Two Birds Hitting One Stone

Thematic (Sector/Industry)

* ICIJ Points Fingers Post-Swedbank Fiasco: The International Consortium of Investigative Journalists (ICIJ) reviewed over 2,100 suspicious activity reports (SARs), which were filed with the US Treasury’s Financial Crimes Enforcement Network (FINCEN). The report suggests that there was about USD 2 tn in questionable transactions between 1999-2017, which were flagged by the sector’s internal compliance officers from over 90 financial institutions;  and*Expect An Active DOJ Under Biden/Harris: If Biden/Harris win, Deutsche and Turkey’s Halkbank (HALKB.TI) would appear to be most as risk with a more proactive Department of Justice (DOJ). However, not far behind are others including: HSBC Holdings (5.HK/HSBA/LN) and Standard Chartered (2888.HK/STAN.LN). In addition, when mainland Chinese-US relations materially deteriorate under a Biden administration, we would fully anticipate the entire mainland Chinese financial system to be under a magnifying glass.

* ICIJ Points Fingers Post-Swedbank Fiasco: The International Consortium of Investigative Journalists (ICIJ) reviewed over 2,100 suspicious activity reports (SARs), which were filed with the US Treasury’s Financial Crimes Enforcement Network (FINCEN). The report suggests that there was about USD 2 tn in questionable transactions between 1999-2017, which were flagged by the sector’s internal compliance officers from over 90 financial institutions;  and*Expect An Active DOJ Under Biden/Harris: If Biden/Harris win, Deutsche and Turkey’s Halkbank (HALKB.TI) would appear to be most as risk with a more proactive Department of Justice (DOJ). However, not far behind are others including: HSBC Holdings (5.HK/HSBA/LN) and Standard Chartered (2888.HK/STAN.LN). In addition, when mainland Chinese-US relations materially deteriorate under a Biden administration, we would fully anticipate the entire mainland Chinese financial system to be under a magnifying glass.

Asia Banks – Watch Your Anti-Money Laundering Risk Again

The lack of shock and awe from this week’s FOMC meeting did not derail market sentiment as risk tolerance returned to the fixed income markets, albeit without strong conviction. Supply, the US election and vaccine progress are back to the forefront of risk sentiment drivers over the near term while the degree of additional monetary policy stimulus that can be affected remains open to debate. Against this backdrop, Asia and the US high yield markets tightened by similar amounts.   
In rate markets, US Treasury curve steepening returned after two weeks of clear flattening following the Fed Chairman’s Jackson Hole speech. Curve steepening is generally associated with increased bank net interest income from maturity transformation. The return of the reflation trade, along with slightly higher oil prices, suggests that investor’s economic demand expectations rose slightly during the week, despite the lackluster FOMC result. Next week’s record supply of 2-year, 5-year and 7-year Treasury notes should weigh on the rates market, particularly with Japan on holiday on Monday and Tuesday. 
At the shorter end of the interest rate curve, Eurodollar futures rates ticked-up in the +4-year area to suggest one interest rate increase in 2024 and another in 2025. This is hardly consistent with a meaningful attempt to overshoot a 2% inflation target and begs the question of how the Fed can achieve this target with its current policy toolkit. It appears as if lower-for-longer is a five- to seven-year look forward.   
In-line with steepening of the US Treasury yield curve and a return of risk sentiment in Asia, ten bond spreads tightened for every one that widened during the week. The tightening to widening ratio was more than three times the prior week. Almost every bond in our +100-universe tightened. Bank of China’s 2025 callable AT1 bond outperformed all others, tightening by 17bps. <a href="https://www.smartkarma.com/entities/bank-of-china-ltd" target="_blank" data-smartkarma-citation="entities:24574:1" rel="noopener">Bank Of China (BCHINA)</a>AT1 bond has become somewhat of a bellwether of Asia bank risk sentiment over the last few weeks.
In bank debt capital markets, over US$15 billion of securities were issued as banks continued to take advantage of low rates and sustained demand. Amongst Asia-centric banks, Bangkok Bank, Bank of China, HSBC Holdings, ICBC and Sumitomo Mitsui Financial Group brought US$ bonds during the week. We expect <a href="https://www.smartkarma.com/entities/ind-comm-bk-of-china-h" target="_blank" data-smartkarma-citation="entities:1119:1" rel="noopener">ICBC's (H) (1398 HK)</a> new AT1 note to trade in-line with BCHINA’s AT1 over the near term. HSBC’s new note came at a meaningful 20bps new issue concession relative to its holding company Senior Unsecured curve. We suspect that <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> new issue bond will tighten by at least 10bps relatively quickly. Please see <a href="https://www.smartkarma.com/insights/bangkok-bank-s-new-at1-overweight-on-relative-value" target="_blank" data-smartkarma-citation="insights:43402" rel="noopener">Bangkok Bank’s New AT1 – Overweight on Relative Value</a> for our views on this debt issuer and its new security.
Market Outlook The current issue is that Fed policy is now more unpredictable, absent greater guidance on how its new longer-run strategy will influence near-term policy decisions. This past week’s FOMC meeting disappointed by not adding depth to the monetary policy canvas. As such, risks may now be materially higher for EM credit. 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. Following Fed Chairman Powell’s speech, if the Fed permits long bond yields to rise, then marginal flows into emerging market credit may slow on increasing dollar strength.
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.

The lack of shock and awe from this week’s FOMC meeting did not derail market sentiment as risk tolerance returned to the fixed income markets, albeit without strong conviction. Supply, the US election and vaccine progress are back to the forefront of risk sentiment drivers over the near term while the degree of additional monetary policy stimulus that can be affected remains open to debate. Against this backdrop, Asia and the US high yield markets tightened by similar amounts.   
In rate markets, US Treasury curve steepening returned after two weeks of clear flattening following the Fed Chairman’s Jackson Hole speech. Curve steepening is generally associated with increased bank net interest income from maturity transformation. The return of the reflation trade, along with slightly higher oil prices, suggests that investor’s economic demand expectations rose slightly during the week, despite the lackluster FOMC result. Next week’s record supply of 2-year, 5-year and 7-year Treasury notes should weigh on the rates market, particularly with Japan on holiday on Monday and Tuesday. 
At the shorter end of the interest rate curve, Eurodollar futures rates ticked-up in the +4-year area to suggest one interest rate increase in 2024 and another in 2025. This is hardly consistent with a meaningful attempt to overshoot a 2% inflation target and begs the question of how the Fed can achieve this target with its current policy toolkit. It appears as if lower-for-longer is a five- to seven-year look forward.   
In-line with steepening of the US Treasury yield curve and a return of risk sentiment in Asia, ten bond spreads tightened for every one that widened during the week. The tightening to widening ratio was more than three times the prior week. Almost every bond in our +100-universe tightened. Bank of China’s 2025 callable AT1 bond outperformed all others, tightening by 17bps. Bank Of China (BCHINA)AT1 bond has become somewhat of a bellwether of Asia bank risk sentiment over the last few weeks.
In bank debt capital markets, over US$15 billion of securities were issued as banks continued to take advantage of low rates and sustained demand. Amongst Asia-centric banks, Bangkok Bank, Bank of China, HSBC Holdings, ICBC and Sumitomo Mitsui Financial Group brought US$ bonds during the week. We expect ICBC's (H) (1398 HK) new AT1 note to trade in-line with BCHINA’s AT1 over the near term. HSBC’s new note came at a meaningful 20bps new issue concession relative to its holding company Senior Unsecured curve. We suspect that HSBC Holdings' (HSBA LN) new issue bond will tighten by at least 10bps relatively quickly. Please see Bangkok Bank’s New AT1 – Overweight on Relative Value for our views on this debt issuer and its new security.
Market Outlook The current issue is that Fed policy is now more unpredictable, absent greater guidance on how its new longer-run strategy will influence near-term policy decisions. This past week’s FOMC meeting disappointed by not adding depth to the monetary policy canvas. As such, risks may now be materially higher for EM credit. 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. Following Fed Chairman Powell’s speech, if the Fed permits long bond yields to rise, then marginal flows into emerging market credit may slow on increasing dollar strength.
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: Risk Sentiment Returns as Markets Ignore FOMC Disappointment

*Kudos For Better Bottom-line:HSBC North America (5.HK/HSBA.LN) [HSBCNA] HSBCNA deserves some kudos for its positive 2Q20 earnings result of USD 48.7 mn during the height of the pandemic against a 1Q20 loss of USD 1.2 bn. The problem with these results, in our view, is that they appear incredibly managed, as revenues are increasingly reliant on lower quality capital markets revenue sources at 36.0% (27.6% in 1Q20). In other words, we do not believe 2Q20 these results are sustainable;*Hong Kong Tax Rate Continues To Mask Management’s Global Mistakes: When your core subsidiary in Hong Kong has a statutory corporate tax rate of 16.5% and the organization is not subject to global taxation, low taxes can mask the many mistakes that HSBC makes – particularly in the USA; and*HSBCNA Should Be Sold: HSBCNA is a chronic mess, and there is absolutely no need for HSBC to maintain a full commercial/retail banking presence in the US. It cannot earn a positive return under its current structure; credit is again about to fall off a cliff; does not earning; NIMs are among the lowest in the USA; and capital is shortly about to fall below regulatory guidance. Further, the bad acquisitions and regulatory headaches should spur management to cut and run in the US. Knowing HSBC management as we do, they will continue making the same mistakes over and over again.

*Kudos For Better Bottom-line:HSBC North America (5.HK/HSBA.LN) [HSBCNA] HSBCNA deserves some kudos for its positive 2Q20 earnings result of USD 48.7 mn during the height of the pandemic against a 1Q20 loss of USD 1.2 bn. The problem with these results, in our view, is that they appear incredibly managed, as revenues are increasingly reliant on lower quality capital markets revenue sources at 36.0% (27.6% in 1Q20). In other words, we do not believe 2Q20 these results are sustainable;*Hong Kong Tax Rate Continues To Mask Management’s Global Mistakes: When your core subsidiary in Hong Kong has a statutory corporate tax rate of 16.5% and the organization is not subject to global taxation, low taxes can mask the many mistakes that HSBC makes – particularly in the USA; and*HSBCNA Should Be Sold: HSBCNA is a chronic mess, and there is absolutely no need for HSBC to maintain a full commercial/retail banking presence in the US. It cannot earn a positive return under its current structure; credit is again about to fall off a cliff; does not earning; NIMs are among the lowest in the USA; and capital is shortly about to fall below regulatory guidance. Further, the bad acquisitions and regulatory headaches should spur management to cut and run in the US. Knowing HSBC management as we do, they will continue making the same mistakes over and over again.   

United Kingdom

HSBC Holdings plc is the holding company for the HSBC Group. The Company provides a variety of international banking and financial services, including retail and corporate banking, trade, trusteeship, securities, custody, capital markets, treasury, private and investment banking, and insurance.  The Group operates worldwide.

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HSBC Holdings (HSBA LN)

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

HSBC Holdings Plc – Two Birds Hitting One Stone

*Not Again…: HSBC Holdings plc (5.HK/HSBA.LN) [HSBC] may have to revisit and re-atone for their anti-money laundering (AML) sins after the...

Thomas J. Monaco

Asia Banks – Watch Your Anti-Money Laundering Risk Again

* ICIJ Points Fingers Post-Swedbank Fiasco: The International Consortium of Investigative Journalists (ICIJ) reviewed over 2,100 suspicious...

Thomas J. Monaco

Bank Credit Weekly: Risk Sentiment Returns as Markets Ignore FOMC Disappointment

The lack of shock and awe outcome from this week’s FOMC meeting did not derail market sentiment as risk tolerance returned to the fixed income...

Hank Calenti, CFA

HSBC Holdings – FSBO

*Kudos For Better Bottom-line: HSBC North America (5.HK/HSBA.LN) [HSBCNA] HSBCNA deserves some kudos for its positive 2Q20 earnings result of USD...

Thomas J. Monaco

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