Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Executive Summary: European bank AT1 significantly outperformed Asia as each EU benchmark Basel III bond tightened during the week. Concurrently, increased risk appetite resulted in performance across the credit continuum in Asia bank bonds. A steepening US Treasury yield curve and risk-on market sentiment drove bank credit spreads tighter, globally. Please see our <a href="https://www.smartkarma.com/insights/bank-macro-manifest-risk-rally-gathers-steam-as-bad-news-more-stimulus" target="_blank" data-smartkarma-citation="insights:47886" rel="noopener">Bank Macro Manifest: Risk Rally Gathers Steam as Bad News = More Stimulus</a> for more details.Europe’s AT1 performance further compressed option adjusted spreads between European AT1 and Asia financial institutions to 50bps inside 2019 levels. This begs the question of how much more spread compression is possible.Globally, <a href="https://www.smartkarma.com/entities/unicredit-spa" target="_blank" data-smartkarma-citation="entities:21234:1" rel="noopener">UniCredit's (UCG IM)</a> 8% coupon 2024 callable note led AT1 and broader bank bond performance, tightening 102bps over the week. This outperformance coincided with positive risk asset sentiment following the announcement that former ECB President Mario Draghi was asked to form Italy’s next government. Investors may wish to consider what additional catalyst could drive spreads tighter. UniCredit is expected to report earnings on Thursday, 11 February.In Asia, Nanyang Commercial Bank led AT1 bond performance by tightening another 54bps on the week. Relative to <a href="https://www.smartkarma.com/entities/bank-of-east-asia-ltd" target="_blank" data-smartkarma-citation="entities:341:1" rel="noopener">Bank of East Asia's (23 HK)</a> 5 5/8% coupon 2022 callable note, the Nanyang outperformance is beginning to look overdone. Please see <a href="https://www.smartkarma.com/insights/bank-credit-compass-credit-tourist-may-vacate-if-real-fundamentals-do-not-catch-up" target="_blank" rel="noopener">Bank Credit Compass: Credit Tourist May Vacate if Real Fundamentals Do Not Catch-Up</a> for more details.<a href="https://www.smartkarma.com/entities/state-bank-of-india" target="_blank" rel="noopener">State Bank of India's (SBIIN)</a> prediction of double-digit returns following results that were better than expectations, drove its shares to a 40% gain during the week. SBIIN’s credit was already there, in our view, but other India-headquartered bank credits may benefit.Meanwhile, in the broader Emerging Market (EM) Senior Unsecured HY area, Turkish bank bonds continued to catch-up with their higher rated EM peers with several notes tightening by +60bps over the week. Given the positive developments in Turkey over the last few weeks and the global risk-on environment, several of these banks continue to trade wide relative to most other EM banks.Market Outlook: Investors remain susceptible to management’s prophecies. Asset quality indicators may greatly underestimate the level of troubled debt due to continued forbearance, restructuring efforts and early-stage aging. This is driving provisioning costs lower than would be expected in a more normal operating environment. The value of these reports is significantly diminished for credit investors. Financial repression creates a market, which in its nature, is always a one-sided bet with the Fed / ECB/ BOJ. There is limited price discovery.  As such, credit value should remain driven by larger market forces.

Executive Summary: European bank AT1 significantly outperformed Asia as each EU benchmark Basel III bond tightened during the week. Concurrently, increased risk appetite resulted in performance across the credit continuum in Asia bank bonds. A steepening US Treasury yield curve and risk-on market sentiment drove bank credit spreads tighter, globally. Please see our Bank Macro Manifest: Risk Rally Gathers Steam as Bad News = More Stimulus for more details.Europe’s AT1 performance further compressed option adjusted spreads between European AT1 and Asia financial institutions to 50bps inside 2019 levels. This begs the question of how much more spread compression is possible.Globally, UniCredit's (UCG IM) 8% coupon 2024 callable note led AT1 and broader bank bond performance, tightening 102bps over the week. This outperformance coincided with positive risk asset sentiment following the announcement that former ECB President Mario Draghi was asked to form Italy’s next government. Investors may wish to consider what additional catalyst could drive spreads tighter. UniCredit is expected to report earnings on Thursday, 11 February.In Asia, Nanyang Commercial Bank led AT1 bond performance by tightening another 54bps on the week. Relative to Bank of East Asia's (23 HK) 5 5/8% coupon 2022 callable note, the Nanyang outperformance is beginning to look overdone. Please see Bank Credit Compass: Credit Tourist May Vacate if Real Fundamentals Do Not Catch-Up for more details.State Bank of India's (SBIIN) prediction of double-digit returns following results that were better than expectations, drove its shares to a 40% gain during the week. SBIIN’s credit was already there, in our view, but other India-headquartered bank credits may benefit.Meanwhile, in the broader Emerging Market (EM) Senior Unsecured HY area, Turkish bank bonds continued to catch-up with their higher rated EM peers with several notes tightening by +60bps over the week. Given the positive developments in Turkey over the last few weeks and the global risk-on environment, several of these banks continue to trade wide relative to most other EM banks.Market Outlook: Investors remain susceptible to management’s prophecies. Asset quality indicators may greatly underestimate the level of troubled debt due to continued forbearance, restructuring efforts and early-stage aging. This is driving provisioning costs lower than would be expected in a more normal operating environment. The value of these reports is significantly diminished for credit investors. Financial repression creates a market, which in its nature, is always a one-sided bet with the Fed / ECB/ BOJ. There is limited price discovery.  As such, credit value should remain driven by larger market forces.

Bank Credit Weekly: AT1 Outperformance in Risk-On Environment

<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> recently issued 4.6% coupon 2030 first call note is beginning to look overbought relative to other banks and relative to its own credit curve. At the same time, returns are likely to be negatively impacted by rising interest rates as the year progresses. As such, we screen for value in HSBC’s Additional Tier 1 (AT1) curve for alternate investment options to achieve greater total returns this year.This is the second insight in a series on HSBC. In the first note, we considered the bank's ability to withstand a material increase in its credit costs and identified potential Covid-19 asset quality sensitivity. Please see <a href="https://www.smartkarma.com/insights/hsbc-capital-forbearance-and-covid-19-sensitivity" target="_blank" data-smartkarma-citation="insights:47598" rel="noopener">HSBC: Capital, Forbearance and Covid-19 Sensitivity</a> for more details.In this insight, we determine where the market may be mispricing the bank's credit risk and screen for potential extension risk while considering the liquidity of HSBC's AT1 instruments denominated in US$, Singapore-dollars and Euros.The longer the duration of the bond, the greater the price impact from a parallel shift in the yield curve. In theory, credit spreads should remain unchanged, to strengthen, as the economy recovers, and rates rise. In practice, this depends on the spread level per unit of duration along the credit curve. This accounts for the forward-looking nature of the market with respect to perceived credit risk. With an effective duration of 7.85 years and a relatively low credit risk premium, the 2030 callable AT1 note could suffer a lower total return than all other HSBC AT1s, as the yield curve steepens.Concurrently, given HSBC's Common Equity Tier 1 (CET1) capital buffer of approximately 370 basis points, the 10-year note trades tight relative to banks with higher CET1 buffers. In fact, <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> recently issued 4 3/8% coupon 2031 callable bond currently looks better value relative to each bank’s respective capital buffers.Taken together, we find better value elsewhere along HSBC’s AT1 curve.

HSBC Holdings' (HSBA LN) recently issued 4.6% coupon 2030 first call note is beginning to look overbought relative to other banks and relative to its own credit curve. At the same time, returns are likely to be negatively impacted by rising interest rates as the year progresses. As such, we screen for value in HSBC’s Additional Tier 1 (AT1) curve for alternate investment options to achieve greater total returns this year.This is the second insight in a series on HSBC. In the first note, we considered the bank's ability to withstand a material increase in its credit costs and identified potential Covid-19 asset quality sensitivity. Please see HSBC: Capital, Forbearance and Covid-19 Sensitivity for more details.In this insight, we determine where the market may be mispricing the bank's credit risk and screen for potential extension risk while considering the liquidity of HSBC's AT1 instruments denominated in US$, Singapore-dollars and Euros.The longer the duration of the bond, the greater the price impact from a parallel shift in the yield curve. In theory, credit spreads should remain unchanged, to strengthen, as the economy recovers, and rates rise. In practice, this depends on the spread level per unit of duration along the credit curve. This accounts for the forward-looking nature of the market with respect to perceived credit risk. With an effective duration of 7.85 years and a relatively low credit risk premium, the 2030 callable AT1 note could suffer a lower total return than all other HSBC AT1s, as the yield curve steepens.Concurrently, given HSBC's Common Equity Tier 1 (CET1) capital buffer of approximately 370 basis points, the 10-year note trades tight relative to banks with higher CET1 buffers. In fact, UBS Group's (UBSG VX) recently issued 4 3/8% coupon 2031 callable bond currently looks better value relative to each bank’s respective capital buffers.Taken together, we find better value elsewhere along HSBC’s AT1 curve.

HSBC: AT1 Positioning for Greater Total Returns

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

*Costs Now An Issue: Ping An Bank (000001.CH) [PAB], the Ping An Insurance (2318.HK) [Ping An] banking subsidiary, reported CNY 6.5 bn – declining CNY 2.2 bn (25.1%) on a linked quarter basis. In this environment, credit troubles no doubt are a foregone conclusion. However, this was not necessarily PAB’s biggest issue in its most results announcement, where the bulk of the earnings decline was attributed to a CNY 1.9 bn (17.1%) linked quarter increase in costs;*Credit Is WEAKER Still:  We find that credit weakness is actually deteriorating at an even more accelerated pace than in 3Q20, as net new NPLs have increased CNY 20.5 bn or a massive 241% (223% in 3Q20) on an annualized basis. We also find that PAB’s reserves still remain quite light by CNY 152 bn if we assume a 2x NPL ratio. This shortfall represents 60% of stated equity; and*Fundamentally Challenged Still: Despite the Investor Day cheerleading session, Ping An P&amp;C operating profits declined CNY 2.6 bn (29.2%) HOH in 1H20, as the overall combined ratio eroded 1.5% to 98.1% due primarily to continued weakness within the credit insurance unit where the combined ratio came in at 125.6% (up 32.4%). The credit insurance segment reported a CNY 3.5 bn underwriting loss, due to defaults on underlying loans.

*Costs Now An Issue: Ping An Bank (000001.CH) [PAB], the Ping An Insurance (2318.HK) [Ping An] banking subsidiary, reported CNY 6.5 bn – declining CNY 2.2 bn (25.1%) on a linked quarter basis. In this environment, credit troubles no doubt are a foregone conclusion. However, this was not necessarily PAB’s biggest issue in its most results announcement, where the bulk of the earnings decline was attributed to a CNY 1.9 bn (17.1%) linked quarter increase in costs;*Credit Is WEAKER Still:  We find that credit weakness is actually deteriorating at an even more accelerated pace than in 3Q20, as net new NPLs have increased CNY 20.5 bn or a massive 241% (223% in 3Q20) on an annualized basis. We also find that PAB’s reserves still remain quite light by CNY 152 bn if we assume a 2x NPL ratio. This shortfall represents 60% of stated equity; and*Fundamentally Challenged Still: Despite the Investor Day cheerleading session, Ping An P&amp;C operating profits declined CNY 2.6 bn (29.2%) HOH in 1H20, as the overall combined ratio eroded 1.5% to 98.1% due primarily to continued weakness within the credit insurance unit where the combined ratio came in at 125.6% (up 32.4%). The credit insurance segment reported a CNY 3.5 bn underwriting loss, due to defaults on underlying loans. 

A pack of small, but smart, investors in a free and open market caught hedge funds off guard this week. The hunter was hunted, and the resulting equity market volatility drove financial concerns more than financial conditions. The GameStop situation is noise and not a signal for risk assets. For a nasty global risk asset unwind, there needs to be a catalyst in the form of either an economic downturn or a material tightening in Fed policy. Neither is in play. Weakness in Asia High Yield this week may create opportunities.More importantly, for credit investors, short-term Libor levels hit record lows on Friday. This matters as investors that focus on high-quality short-term securities may be pushed into commercial paper or other very short-duration paper. The rate curve should bull steepening from the excess amount of cash in the market. The flood of cash could drive credit yields even lower.In this environment, U.S. CCC-rated and Asia High Yield index spreads widened.  More and more brokerage houses are recommending Asia High Yield as the place to be in 2021, despite property developer concerns in China. Our take is that fundamentals have yet to catch-up with spreads in the US CCC-rated area although we suspect that they may. However, US High Yield has a higher effective duration now, versus pre-Covid, and versus Asia High Yield. As such US High Yield credits have more limited upside in the reflation scenario. A delay in the reflation scenario should benefit Asia-headquartered risk assets.At the same time, ivory-tower syndrome has taken over the Fed. Chairman Powell’s comments this week that what is really driving asset prices is not monetary policy, suggests that the disconcerting disconnect between financial and economic conditions is not understood by senior policymakers. If the Chairman’s comments were true, then there would be no need to signal a tapering of asset purchases well in advance. Whether you call it price fixing or price guidance by the Fed and ECB policymakers, it does not matter as you cannot fight it. The Fear of Missing Out (FOMO) is real in the credit markets.Despite these challenges, Asia’s bank spreads continued to tighten during the week. Officials in India anticipate 11% GDP growth in ’21-’22 from April, following vaccination, in-line with the 11.5% and 8.1% projected for India and China, respectively, by the IMF. The near-term future is in South Asian, but this may not apply to all India-headquartered banks. We also note that significant bank recapitalized in needed for these forecasts to materialize. Please see <a href="https://www.smartkarma.com/insights/yes-bank-solvency-simulation-with-covid-19-coverage-scenarios" target="_blank" data-smartkarma-citation="insights:47523" rel="noopener">YES Bank Solvency Simulation with Covid-19 Coverage Scenarios</a> for an example of the difficulties facing India-headquartered banks.Market Outlook: GameStop is noise and not a signal. Although weakening in some markets, economic growth and continued monetary accommodation remain the main drivers for credit markets. Credit fundamentals should catch-up with repressed credit spreads. Therefore, credit has limited upside in a fast reflation scenario. Reconciliation or negotiation may deliver the same stimulus result over the near term.  As such, a slower, more contained, reflation environment could be Emerging Market credit supportive.

A pack of small, but smart, investors in a free and open market caught hedge funds off guard this week. The hunter was hunted, and the resulting equity market volatility drove financial concerns more than financial conditions. The GameStop situation is noise and not a signal for risk assets. For a nasty global risk asset unwind, there needs to be a catalyst in the form of either an economic downturn or a material tightening in Fed policy. Neither is in play. Weakness in Asia High Yield this week may create opportunities.More importantly, for credit investors, short-term Libor levels hit record lows on Friday. This matters as investors that focus on high-quality short-term securities may be pushed into commercial paper or other very short-duration paper. The rate curve should bull steepening from the excess amount of cash in the market. The flood of cash could drive credit yields even lower.In this environment, U.S. CCC-rated and Asia High Yield index spreads widened.  More and more brokerage houses are recommending Asia High Yield as the place to be in 2021, despite property developer concerns in China. Our take is that fundamentals have yet to catch-up with spreads in the US CCC-rated area although we suspect that they may. However, US High Yield has a higher effective duration now, versus pre-Covid, and versus Asia High Yield. As such US High Yield credits have more limited upside in the reflation scenario. A delay in the reflation scenario should benefit Asia-headquartered risk assets.At the same time, ivory-tower syndrome has taken over the Fed. Chairman Powell’s comments this week that what is really driving asset prices is not monetary policy, suggests that the disconcerting disconnect between financial and economic conditions is not understood by senior policymakers. If the Chairman’s comments were true, then there would be no need to signal a tapering of asset purchases well in advance. Whether you call it price fixing or price guidance by the Fed and ECB policymakers, it does not matter as you cannot fight it. The Fear of Missing Out (FOMO) is real in the credit markets.Despite these challenges, Asia’s bank spreads continued to tighten during the week. Officials in India anticipate 11% GDP growth in ’21-’22 from April, following vaccination, in-line with the 11.5% and 8.1% projected for India and China, respectively, by the IMF. The near-term future is in South Asian, but this may not apply to all India-headquartered banks. We also note that significant bank recapitalized in needed for these forecasts to materialize. Please see YES Bank Solvency Simulation with Covid-19 Coverage Scenarios for an example of the difficulties facing India-headquartered banks.Market Outlook: GameStop is noise and not a signal. Although weakening in some markets, economic growth and continued monetary accommodation remain the main drivers for credit markets. Credit fundamentals should catch-up with repressed credit spreads. Therefore, credit has limited upside in a fast reflation scenario. Reconciliation or negotiation may deliver the same stimulus result over the near term.  As such, a slower, more contained, reflation environment could be Emerging Market credit supportive.

Bank Credit Weekly: GameStop Is Noise, Not a Signal, for Risk Assets

*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?

United Kingdom

Standard Chartered PLC is an international banking group operating principally in Asia, Africa, and the Middle East. The Company offers its products and services in the personal, consumer, corporate, institutional and treasury areas.

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Standard Chartered (STAN LN)

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European bank AT1 significantly outperformed Asia as each EU Basel III AT1 note tightened. Concurrently, increased risk appetite drove performance...

Hank Calenti, CFA

HSBC: AT1 Positioning for Greater Total Returns

HSBC’s recently issued AT1 is beginning to look overbought. Returns may be negatively impacted by rising interest rates. We screen for better total...

Hank Calenti, CFA

Ping An Insurance - Awful Bank Result

PING AN INSURANCE: PAB reported a 25.1% lower linked quarter result. The bulk of the earnings decline was attributed to a 17.1% increase in costs;...

Thomas J. Monaco

Bank Credit Weekly: GameStop Is Noise, Not a Signal, for Risk Assets

GME is noise, not a signal. Economic growth and monetary policy remain the drivers for credit markets. Reconciliation or negotiation equal the same...

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

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