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> capital ratios remain above regulatory minimums, even after adjusting COVID-19 forbearance loans at Stage 3 provisioning levels. However, the resulting theoretically slim real economic capital buffer would leave the bank sensitive to another downturn. The risk for AT1 and other credit investors is that HSBC's board misinterprets the “surplus” capital of the firm as being something manufactured by management, rather than artificially engineered by regulators.Having recently raised AT1 capital, HSBC will, undoubtedly, restart equity buy-backs as a show of strength. AT1 investors should be concerned by a large return of capital at this point in the economic. In fact, given the relief cohort composition from a product and geographic perspective, combined with limited personal loan reserve coverage, credit investors should prefer continued capital accretion rather than large “surplus” capital outflows.  Like most banks globally, HSBC’s credit costs were artificially engineered lower during 2020 via regulatory forbearance combined with legislated and bank provided Covid-19 relief. This helped the bank report better results and inflated HSBC’s capital ratios despite the ongoing health crisis. Zero-recovery rates on both the unprovided level of current non-performing assets and the Covid-19 relief portfolio would take HSBC’s CET1 capital buffer into uncomfortable territory. However, annual, normalized, pre-provision income is around 63% the capital buffer at risk from Covid-19 relief granted. This equates to an earn-out period of 1.6 years. This 18-month time-period should be sufficient for the Covid-19 relief portfolio to mature.We caution that it is premature to calculate real economic performance by the Covid-19 relief cohort. As of 30 June, HSBC estimated that over 96% of its Covid-19 relief measures were due to expire by year-end. However, since then, several countries where HSBC operates have extended the duration of legislated relief and others are experiencing another wave of Covid-19 lockdowns. In fact, the 50% reduction in relief that HSBC had forecast to expire by the end of September did not materialize. The question is where are the stress points in the relief cohort?Covid-19 relief was largest against corporate and commercial wholesale borrowers both in terms of the amount of relief provided and relative to the total amount of wholesale loans outstanding. At the same time, Covid-19 relief assistance to unsecured personal loan customers was materially lower despite higher default rates in personal loans. This is not to say that personal lending may not become problematic going forward as that is dependent on the speed, strength, and sustainability of the on-going economic recovery, particularly as it applies to employment levels. The limited assistance provided against personal lending may result in higher delinquencies within this portfolio over time.  In geographic terms, Covid-19 relief granted was largest in Hong Kong. In fact, Hong Kong exposure may be problematic for the firm, given the higher percentage of wholesale relief granted  combined with generally higher expected loss-given-defaults within this type of lending.Meanwhile, with one-month Hibor trading flat to one-month Libor, the easy money to be made from borrowing in USD and lending in HKD is over. The exceedingly low rate may be beneficial to Hong Kong based corporate borrowers, but it may not be so beneficial to HSBC’s net interest margin. Nonetheless, some margin pain may be the price to pay for lower Covid-19 related delinquencies amongst Hong Kong corporate borrowers. Another round of Coronavirus lockdowns, further unrest or another economic shock in Hong Kong, could result in rising non-performing loans.

HSBC Holdings' (HSBA LN) capital ratios remain above regulatory minimums, even after adjusting COVID-19 forbearance loans at Stage 3 provisioning levels. However, the resulting theoretically slim real economic capital buffer would leave the bank sensitive to another downturn. The risk for AT1 and other credit investors is that HSBC's board misinterprets the “surplus” capital of the firm as being something manufactured by management, rather than artificially engineered by regulators.Having recently raised AT1 capital, HSBC will, undoubtedly, restart equity buy-backs as a show of strength. AT1 investors should be concerned by a large return of capital at this point in the economic. In fact, given the relief cohort composition from a product and geographic perspective, combined with limited personal loan reserve coverage, credit investors should prefer continued capital accretion rather than large “surplus” capital outflows.  Like most banks globally, HSBC’s credit costs were artificially engineered lower during 2020 via regulatory forbearance combined with legislated and bank provided Covid-19 relief. This helped the bank report better results and inflated HSBC’s capital ratios despite the ongoing health crisis. Zero-recovery rates on both the unprovided level of current non-performing assets and the Covid-19 relief portfolio would take HSBC’s CET1 capital buffer into uncomfortable territory. However, annual, normalized, pre-provision income is around 63% the capital buffer at risk from Covid-19 relief granted. This equates to an earn-out period of 1.6 years. This 18-month time-period should be sufficient for the Covid-19 relief portfolio to mature.We caution that it is premature to calculate real economic performance by the Covid-19 relief cohort. As of 30 June, HSBC estimated that over 96% of its Covid-19 relief measures were due to expire by year-end. However, since then, several countries where HSBC operates have extended the duration of legislated relief and others are experiencing another wave of Covid-19 lockdowns. In fact, the 50% reduction in relief that HSBC had forecast to expire by the end of September did not materialize. The question is where are the stress points in the relief cohort?Covid-19 relief was largest against corporate and commercial wholesale borrowers both in terms of the amount of relief provided and relative to the total amount of wholesale loans outstanding. At the same time, Covid-19 relief assistance to unsecured personal loan customers was materially lower despite higher default rates in personal loans. This is not to say that personal lending may not become problematic going forward as that is dependent on the speed, strength, and sustainability of the on-going economic recovery, particularly as it applies to employment levels. The limited assistance provided against personal lending may result in higher delinquencies within this portfolio over time.  In geographic terms, Covid-19 relief granted was largest in Hong Kong. In fact, Hong Kong exposure may be problematic for the firm, given the higher percentage of wholesale relief granted  combined with generally higher expected loss-given-defaults within this type of lending.Meanwhile, with one-month Hibor trading flat to one-month Libor, the easy money to be made from borrowing in USD and lending in HKD is over. The exceedingly low rate may be beneficial to Hong Kong based corporate borrowers, but it may not be so beneficial to HSBC’s net interest margin. Nonetheless, some margin pain may be the price to pay for lower Covid-19 related delinquencies amongst Hong Kong corporate borrowers. Another round of Coronavirus lockdowns, further unrest or another economic shock in Hong Kong, could result in rising non-performing loans.

HSBC: Capital, Forbearance and Covid-19 Sensitivity

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

*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?

We screen for value in <a href="https://www.smartkarma.com/entities/standard-chartered-plc" target="_blank" data-smartkarma-citation="entities:193:1" rel="noopener">Standard Chartered' s  (StanLn)</a> Additional Tier 1 (AT1) curve within a post-Covid-19 economic operating environment. This is the final installment of a series of linked insights on Standard Chartered. Please see: <a href="https://www.smartkarma.com/insights/standard-chartered-credit-versus-a-sovereign-cds-portfolio" target="_blank" data-smartkarma-citation="insights:47205" rel="noopener">Standard Chartered Credit versus a Sovereign CDS Portfolio</a> as well as <a href="https://www.smartkarma.com/insights/standard-chartered-capital-forbearance-and-cds" target="_blank" data-smartkarma-citation="insights:47266" rel="noopener">Capital, Forbearance and CDS</a> for background on StanLn.First we assess whether StanLn has the capacity to absorb losses from its Covid-19 relief lending. Then we screen for potential extension risk and determine where the market may be mispricing StanLn’s credit risk while considering the liquidity of its AT1 instruments and other factors that may influence credit spreads.Standard Chartered ’s recently issued 4.75% coupon 2031 first call AT1 bond should be trading tighter given a higher Common Equity Tier 1 capital buffer than other banks which recently issued 10-year AT1 notes. However, the question is whether investors should reach for duration at this point in the Covid-19 economic cycle. Concurrently, Standard Chartered’ s Legacy Tier 1 bonds may be of interest to event-driven investors. Please see: <a href="https://www.smartkarma.com/insights/standard-chartered-legacy-tier-1-is-on-fire" target="_blank" data-smartkarma-citation="insights:45722" rel="noopener">Standard Chartered Legacy Tier 1 is on Fire</a> for more details.Our top pick is the 7.75% coupon 2023 AT1 bond due to superior credit-adjusted returns, moderate duration as well as low extension risk and decent liquidity.  The main risk to this top pick is the tension between assuring sufficient shareholder returns in the near-term versus StanLn’s long-term provisioning needs. The bank is expected to announce full-year results towards the end of February.

We screen for value in Standard Chartered' s  (StanLn) Additional Tier 1 (AT1) curve within a post-Covid-19 economic operating environment. This is the final installment of a series of linked insights on Standard Chartered. Please see: Standard Chartered Credit versus a Sovereign CDS Portfolio as well as Capital, Forbearance and CDS for background on StanLn.First we assess whether StanLn has the capacity to absorb losses from its Covid-19 relief lending. Then we screen for potential extension risk and determine where the market may be mispricing StanLn’s credit risk while considering the liquidity of its AT1 instruments and other factors that may influence credit spreads.Standard Chartered ’s recently issued 4.75% coupon 2031 first call AT1 bond should be trading tighter given a higher Common Equity Tier 1 capital buffer than other banks which recently issued 10-year AT1 notes. However, the question is whether investors should reach for duration at this point in the Covid-19 economic cycle. Concurrently, Standard Chartered’ s Legacy Tier 1 bonds may be of interest to event-driven investors. Please see: Standard Chartered Legacy Tier 1 is on Fire for more details.Our top pick is the 7.75% coupon 2023 AT1 bond due to superior credit-adjusted returns, moderate duration as well as low extension risk and decent liquidity.  The main risk to this top pick is the tension between assuring sufficient shareholder returns in the near-term versus StanLn’s long-term provisioning needs. The bank is expected to announce full-year results towards the end of February.

Standard Chartered: Screening for AT1 Value, Post-Covid-19

<a href="https://www.smartkarma.com/entities/standard-chartered-plc" target="_blank" data-smartkarma-citation="entities:193:1" rel="noopener">Standard Chartered' s (StanLn)</a> capital ratios remain above regulatory minimums, even after adjusting for Covid-19 forbearance amounts. While stronger than peers from a capital perspective, the slim real economic capital buffer could leave the bank sensitive to another downturn. In fact, given the relief cohort composition from a product perspective, combined with StanLn's optimistic macroeconomic assumptions, we anticipate higher credit costs over time.Like most banks globally, Standard Chartered’ s credit costs that were artificially engineered lower during 2020 via regulatory forbearance combined with legislated and bank provided Covid-19 relief. This helped StanLn report better results despite the ongoing health crisis. Lack of Covid-19 coverage also inflated StanLn’s capital ratios. The question is where are the stress points in the relief cohort?Covid-19 relief granted was largest against home mortgage borrowers. A higher level of real estate as security in the Covid-19 relief program should keep overall losses lower within this cohort. However, despite higher default rates in commercial real estate and amongst small and medium sized enterprises, Covid-19 relief assistance was materially lower in each of these areas. The limited assistance provided to SMEs may result in higher delinquencies within this portfolio over time.  Furthermore, StanLn’s 2021 economic projections, which feed into its provisioning models, may be overly optimistic. GDP expectations for Singapore, Hong Kong and India are higher than Bloomberg consensus estimates. These countries combined account for 33% of Standard Chartered’s credit risk. Please see <a href="https://www.smartkarma.com/insights/standard-chartered-credit-versus-a-sovereign-cds-portfolio" target="_blank" data-smartkarma-citation="insights:47205" rel="noopener">Standard Chartered Credit Versus a Sovereign CDS Portfolio</a> for more on StanLn’s country exposure.Against this artificially engineered credit cost background, StanLn’s Sub / Senior Credit Default Swap (CDS) curve appears to be pricing in a weaker fundamental credit profile over the next two years. StanLn’s Sub/ Snr CDS is materially higher than <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>.

Standard Chartered' s (StanLn) capital ratios remain above regulatory minimums, even after adjusting for Covid-19 forbearance amounts. While stronger than peers from a capital perspective, the slim real economic capital buffer could leave the bank sensitive to another downturn. In fact, given the relief cohort composition from a product perspective, combined with StanLn's optimistic macroeconomic assumptions, we anticipate higher credit costs over time.Like most banks globally, Standard Chartered’ s credit costs that were artificially engineered lower during 2020 via regulatory forbearance combined with legislated and bank provided Covid-19 relief. This helped StanLn report better results despite the ongoing health crisis. Lack of Covid-19 coverage also inflated StanLn’s capital ratios. The question is where are the stress points in the relief cohort?Covid-19 relief granted was largest against home mortgage borrowers. A higher level of real estate as security in the Covid-19 relief program should keep overall losses lower within this cohort. However, despite higher default rates in commercial real estate and amongst small and medium sized enterprises, Covid-19 relief assistance was materially lower in each of these areas. The limited assistance provided to SMEs may result in higher delinquencies within this portfolio over time.  Furthermore, StanLn’s 2021 economic projections, which feed into its provisioning models, may be overly optimistic. GDP expectations for Singapore, Hong Kong and India are higher than Bloomberg consensus estimates. These countries combined account for 33% of Standard Chartered’s credit risk. Please see Standard Chartered Credit Versus a Sovereign CDS Portfolio for more on StanLn’s country exposure.Against this artificially engineered credit cost background, StanLn’s Sub / Senior Credit Default Swap (CDS) curve appears to be pricing in a weaker fundamental credit profile over the next two years. StanLn’s Sub/ Snr CDS is materially higher than HSBC Holdings' (HSBA LN).

Standard Chartered: Capital, Forbearance and CDS

*Results Ahead Of Consensus: Bank of America (BAC.US) [BAC] reported 4Q20 bottom-line results of USD 5.2 bn, increasing USD 768 mn (17.3%) linked quarter. Results were driven by two factors: a) a USD 1.3 bn reduction in loss provision, tracking the overall improvement in net new NPLs; and b) a USD 474 mn (3.3%) decline in costs attributed to the 55.4% reduction in other operating expenses;*BAC Still Needs To Focus On Credit Quality: BAC’s NPLs increased USD 386 mn (8.2%) linked quarter and represent 55 bp of total loans – up 5 bp linked quarter due to both the NPL increase and the 2.9% contraction in loans outstanding. Although the NPL ratio is generally low, we are concerned with both the 30-89 days past due and commercial receivable criticisms which both increased; and*Buyback Will Be Attempted:BAC’s Standardized CET1 remained roughly unchanged linked quarter at 11.9%, and is 140 bp above BAC's capital requirement target.This should allow BAC to execute a share buyback of USD 3.2 bn in 1Q21 – USD 2.9 bn under the income test plus USD 300 mn to offset employee issuance.

*Results Ahead Of Consensus: Bank of America (BAC.US) [BAC] reported 4Q20 bottom-line results of USD 5.2 bn, increasing USD 768 mn (17.3%) linked quarter. Results were driven by two factors: a) a USD 1.3 bn reduction in loss provision, tracking the overall improvement in net new NPLs; and b) a USD 474 mn (3.3%) decline in costs attributed to the 55.4% reduction in other operating expenses;*BAC Still Needs To Focus On Credit Quality: BAC’s NPLs increased USD 386 mn (8.2%) linked quarter and represent 55 bp of total loans – up 5 bp linked quarter due to both the NPL increase and the 2.9% contraction in loans outstanding. Although the NPL ratio is generally low, we are concerned with both the 30-89 days past due and commercial receivable criticisms which both increased; and*Buyback Will Be Attempted:BAC’s Standardized CET1 remained roughly unchanged linked quarter at 11.9%, and is 140 bp above BAC's capital requirement target.This should allow BAC to execute a share buyback of USD 3.2 bn in 1Q21 – USD 2.9 bn under the income test plus USD 300 mn to offset employee issuance. 

Bank of America – Driven Entirely By Credit

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 (5 HK)

HSBC: Capital, Forbearance and Covid-19 Sensitivity

AT1 holders should be concerned by a large stock buyback at this point in the economic cycle. Hong Kong may be problematic, given higher wholesale...

Hank Calenti, CFA

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

Standard Chartered: Screening for AT1 Value, Post-Covid-19

We screen for value in StanLn’s AT1 curve, including the S$ bond, within a post-Covid-19 economic environment, and we determine StanLn’s capacity...

Hank Calenti, CFA

Standard Chartered: Capital, Forbearance and CDS

Standard Chartered’s capital ratios remain above regulatory minimums even after adjusting for Covid-19 forbearance. Limited aid to SMEs and...

Hank Calenti, CFA

Bank of America – Driven Entirely By Credit

BANK OF AMERICA: BAC's 4Q20 bottom-line of USD 5.2 bn increased 17.3% driven by a USD 1.3 bn reduction in provisions. NPLs increased 8.2%, as did...

Thomas J. Monaco

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