Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Real credit fundamentals have yet to catch-up with spreads in bonds which continue to outperform. True fundamentals have a considerable gap to close relative to spread compression. Global monetary accommodation is in large part responsible for recent outperformance. However, credit tourists may have booked too early.Deeply subordinated Additional Tier 1 (AT1) bonds led in terms of spread tightening during January in Asia. Increased risk tolerance and a reach for yield, possibly by credit tourists, drove results as global vaccination efforts raised economic growth expectations. As such, Hong Kong and Thai- based bank securities outperformed, albeit for differing reasons.As Asia-headquartered banks report earnings, the quality of disclosure varies considerably from bank-to-bank. Even where disclosure is adequate, 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.In terms of economic growth, the IMF projects 11.5% and 8.1% GDP growth this year for India and China, respectively. The near-term future is South Asian, but this may not apply to all. Most India-headquartered banks already price-in considerable recovery prospects. However, significant bank recapitalized in needed for the economic forecasts to materialize and for these banks spreads to be maintained.Eventually, it will be time to deliver real fundamental performance. In the meantime, monetary accommodation should remain the main driver of credit spreads while economic growth plays catch-up. Credit tourists are fickle and may vacate if either are delayed.

Real credit fundamentals have yet to catch-up with spreads in bonds which continue to outperform. True fundamentals have a considerable gap to close relative to spread compression. Global monetary accommodation is in large part responsible for recent outperformance. However, credit tourists may have booked too early.Deeply subordinated Additional Tier 1 (AT1) bonds led in terms of spread tightening during January in Asia. Increased risk tolerance and a reach for yield, possibly by credit tourists, drove results as global vaccination efforts raised economic growth expectations. As such, Hong Kong and Thai- based bank securities outperformed, albeit for differing reasons.As Asia-headquartered banks report earnings, the quality of disclosure varies considerably from bank-to-bank. Even where disclosure is adequate, 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.In terms of economic growth, the IMF projects 11.5% and 8.1% GDP growth this year for India and China, respectively. The near-term future is South Asian, but this may not apply to all. Most India-headquartered banks already price-in considerable recovery prospects. However, significant bank recapitalized in needed for the economic forecasts to materialize and for these banks spreads to be maintained.Eventually, it will be time to deliver real fundamental performance. In the meantime, monetary accommodation should remain the main driver of credit spreads while economic growth plays catch-up. Credit tourists are fickle and may vacate if either are delayed.

Bank Credit Compass: Credit Tourist May Vacate if Real Fundamentals Do Not Catch-Up

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

Specialist in Indian Banking and Economic Research

Hemindra Hazari

Despite reporting a 36% yoy fall in 3QFY2021 net profits and being <a href="https://www.bloombergquint.com/quarterly-earnings/axis-bank-q3-results-net-profit-falls-36-on-higher-provisions" target="_blank" rel="noopener">below</a> consensus estimates, <a href="https://www.smartkarma.com/entities/axis-bank-ltd" target="_blank" data-smartkarma-citation="entities:768:1" rel="noopener">Axis Bank Ltd (AXSB IN)</a> 's share price on January 28, 2021 closed 6% up, while the Nifty-50 declined by 1%. The strong and positive response to the bank’s results was surprising, as Axis Bank declined to voluntarily disclose its 30+ days past due loans, a critical indicator which the bank had disclosed in its 2QFY2021 results conference <a href="https://www.axisbank.com/docs/default-source/call-transcript/q2fy21-earnings-call-transcript.pdf" target="_blank" rel="noopener">call</a>. The 30+ days past due loans serves as a benchmark to analysts to estimate future non-performing loans and incremental credit costs, especially at a time when past trends for credit costs may not hold on account of the unprecedented Covid-19 related lockdown, which severely curtailed economic activity. Even though 30+ day past loans is not a mandatory disclosure, once the senior management of a bank takes a decision to voluntarily disclose the indicator in a certain quarter, thereafter, from a transparency perspective, the bank would be well advised to continue to disclose the number. By failing to voluntarily disclose the 30+ day past due loans in the 3QFY2021, there would be a valid apprehension that the lack of disclosure is because of a sharp deterioration in the indicator, which the bank was uncomfortable in revealing to the market.It is commendable that banks like <a href="https://www.smartkarma.com/entities/yes-bank-ltd" target="_blank" data-smartkarma-citation="entities:767:1" rel="noopener">Yes Bank (YES IN)</a> and <a href="https://www.smartkarma.com/entities/bank-of-baroda" target="_blank" data-smartkarma-citation="entities:545:1" rel="noopener">Bank Of Baroda (BOB IN)</a> (BOB), which reported 3QFY2021 results on January 27, voluntarily disclosed the 30+ days past due loans in their analyst presentation, despite the number revealing a significant deterioration in asset quality as compared with 2QFY2021. The equity market severely punished their share prices on January 28, with Yes Bank falling by 4% and BOB by 10% on January 28.Participants in the capital market such as shareholders, business media and analysts need to publicly call out companies (in this case banks) which cease to voluntarily disclose critical data points that were earlier disclosed, as its sudden absence in all likelihood indicates a negative development which the company does not want to share with stakeholders.

Despite reporting a 36% yoy fall in 3QFY2021 net profits and being below consensus estimates, Axis Bank Ltd (AXSB IN) 's share price on January 28, 2021 closed 6% up, while the Nifty-50 declined by 1%. The strong and positive response to the bank’s results was surprising, as Axis Bank declined to voluntarily disclose its 30+ days past due loans, a critical indicator which the bank had disclosed in its 2QFY2021 results conference call. The 30+ days past due loans serves as a benchmark to analysts to estimate future non-performing loans and incremental credit costs, especially at a time when past trends for credit costs may not hold on account of the unprecedented Covid-19 related lockdown, which severely curtailed economic activity. Even though 30+ day past loans is not a mandatory disclosure, once the senior management of a bank takes a decision to voluntarily disclose the indicator in a certain quarter, thereafter, from a transparency perspective, the bank would be well advised to continue to disclose the number. By failing to voluntarily disclose the 30+ day past due loans in the 3QFY2021, there would be a valid apprehension that the lack of disclosure is because of a sharp deterioration in the indicator, which the bank was uncomfortable in revealing to the market.It is commendable that banks like Yes Bank (YES IN) and Bank Of Baroda (BOB IN) (BOB), which reported 3QFY2021 results on January 27, voluntarily disclosed the 30+ days past due loans in their analyst presentation, despite the number revealing a significant deterioration in asset quality as compared with 2QFY2021. The equity market severely punished their share prices on January 28, with Yes Bank falling by 4% and BOB by 10% on January 28.Participants in the capital market such as shareholders, business media and analysts need to publicly call out companies (in this case banks) which cease to voluntarily disclose critical data points that were earlier disclosed, as its sudden absence in all likelihood indicates a negative development which the company does not want to share with stakeholders. 

Axis Bank Stops Sharing 30+ Days Past Due Data: When Sudden Silence Tells a Tale

<a href="https://www.smartkarma.com/entities/yes-bank-ltd" target="_blank" data-smartkarma-citation="entities:767:1" rel="noopener">YES Bank's (YesIn)</a> solvency is set to be tested again by large, and growing Covid-19 related delinquencies. Credit quality looks set to crater unless restructuring efforts are significantly expanded.Loans overdue between 30-to-90 days more than quadrupled between Sept and Dec. following the lifting of the loan repayment moratorium by the Reserve Bank of India in August. Perhaps this was to be expected; however, given this large Covid-19 related delinquency trend, overdue loan growth at a fraction of this rate going forward could seriously compromise the institution.Given that YES Bank has already pierced the point-of-non-viability once in the last 12 months, the question for credit investors is the sufficiency of capital and earnings available to absorb additional losses. To assess this, we stress YES Bank’s solvency buffer via several Covid-19 coverage scenarios. This simulation delivers surprising, yet very preliminary results. To undertake this exercise, we answer three questions:<ol>
<li>How much of YesIn’s credit portfolio is at risk from Coronavirus contagion?</li>
<li>What is a sufficient coverage level for YesIn’s Covid-19 related delinquencies over time?</li>
<li>What is the sufficiency of YES Bank’s real recurrent earnings power?</li>
</ol>Please see our companion report, <a href="https://www.smartkarma.com/insights/yes-bank-q3-results-recurrent-earnings-power-at-one-third-pre-provision-income" target="_blank" data-smartkarma-citation="insights:47484" rel="noopener">YES Bank Q3 Results: Recurrent Earnings Power at One-Third Pre-Provision Income</a>, for how we derive the bank’s real recurrent earnings power.Despite the recent sell-off which offers greater credit spread opportunity, we remain comfortable with our Underweight recommendation on YES Bank’s 3.75% 2023 Senior Unsecured bond. The bond is now two price points lower than when we recommended an Underweight position. Since we are yet to see the depth of distress within YES Bank’s rapidly expanded overdue loan category, now is not the time to overweight YES Bank risk.

YES Bank's (YesIn) solvency is set to be tested again by large, and growing Covid-19 related delinquencies. Credit quality looks set to crater unless restructuring efforts are significantly expanded.Loans overdue between 30-to-90 days more than quadrupled between Sept and Dec. following the lifting of the loan repayment moratorium by the Reserve Bank of India in August. Perhaps this was to be expected; however, given this large Covid-19 related delinquency trend, overdue loan growth at a fraction of this rate going forward could seriously compromise the institution.Given that YES Bank has already pierced the point-of-non-viability once in the last 12 months, the question for credit investors is the sufficiency of capital and earnings available to absorb additional losses. To assess this, we stress YES Bank’s solvency buffer via several Covid-19 coverage scenarios. This simulation delivers surprising, yet very preliminary results. To undertake this exercise, we answer three questions:
How much of YesIn’s credit portfolio is at risk from Coronavirus contagion?
What is a sufficient coverage level for YesIn’s Covid-19 related delinquencies over time?
What is the sufficiency of YES Bank’s real recurrent earnings power?
Please see our companion report, YES Bank Q3 Results: Recurrent Earnings Power at One-Third Pre-Provision Income, for how we derive the bank’s real recurrent earnings power.Despite the recent sell-off which offers greater credit spread opportunity, we remain comfortable with our Underweight recommendation on YES Bank’s 3.75% 2023 Senior Unsecured bond. The bond is now two price points lower than when we recommended an Underweight position. Since we are yet to see the depth of distress within YES Bank’s rapidly expanded overdue loan category, now is not the time to overweight YES Bank risk.

YES Bank Solvency Simulation with Covid-19 Coverage Scenarios

The means to an end matters for credit investors. Although net income may remain unchanged, operating pre-provision profits can be inflated by moving income up the P&amp;L statement. Unadjusted, this inflates recurrent earnings power.In our opinion, <a href="https://www.smartkarma.com/entities/yes-bank-ltd" target="_blank" data-smartkarma-citation="entities:767:1" rel="noopener">YES Bank's (</a><a href="https://www.smartkarma.com/entities/yes-bank-ltd" target="_blank" data-smartkarma-citation="entities:767:1" rel="noopener">YES IN</a>)<a href="https://www.smartkarma.com/entities/yes-bank-ltd" target="_blank" data-smartkarma-citation="entities:767:1" rel="noopener"></a> interest and non-interest income are inflated relative to more conservative accounting standards. This overstates operating profits and makes cross-border comparisons difficult.  Recoveries on the principal of loans previously written-down are recognized as non-interest revenues rather than offset against new loss provisions or recognized as non-recurrent earnings. Also, interest recovered appears to be written back immediately within non-interest revenue rather than accreted over the life of the rescheduled loan or booked as a gain from the sale of assets, as the case may be. These actions inflate operating revenues, efficiency ratios, and operating pre-provisions profits. Furthermore, the firm is recognizing interest income on loans overdue more than 90 days and not classified as non-performing as per India’s Supreme Court order of 3 Sept 2020. In addition to inflating pre-provision profits and efficiency ratios, this also materially increases net interest margins. This confluence meaningfully inflates YES Bank’s pre-provision income. Adjusted for these items, recurrent earnings power is one-third reported pre-provision profits. In fact, recoveries and standstill interest represent 41% of YES Bank’s total income, versus only as much as 14% at <a href="https://www.smartkarma.com/entities/axis-bank-ltd" target="_blank" data-smartkarma-citation="entities:768:1" rel="noopener">Axis Bank Ltd (AXSB IN)</a>. YES Bank has a much lower loss absorption ability from continuing operations than meets the eye. This can have negative solvency implications, long-term, if left untreated.

The means to an end matters for credit investors. Although net income may remain unchanged, operating pre-provision profits can be inflated by moving income up the P&amp;L statement. Unadjusted, this inflates recurrent earnings power.In our opinion, YES Bank's (YES IN) interest and non-interest income are inflated relative to more conservative accounting standards. This overstates operating profits and makes cross-border comparisons difficult.  Recoveries on the principal of loans previously written-down are recognized as non-interest revenues rather than offset against new loss provisions or recognized as non-recurrent earnings. Also, interest recovered appears to be written back immediately within non-interest revenue rather than accreted over the life of the rescheduled loan or booked as a gain from the sale of assets, as the case may be. These actions inflate operating revenues, efficiency ratios, and operating pre-provisions profits. Furthermore, the firm is recognizing interest income on loans overdue more than 90 days and not classified as non-performing as per India’s Supreme Court order of 3 Sept 2020. In addition to inflating pre-provision profits and efficiency ratios, this also materially increases net interest margins. This confluence meaningfully inflates YES Bank’s pre-provision income. Adjusted for these items, recurrent earnings power is one-third reported pre-provision profits. In fact, recoveries and standstill interest represent 41% of YES Bank’s total income, versus only as much as 14% at Axis Bank Ltd (AXSB IN). YES Bank has a much lower loss absorption ability from continuing operations than meets the eye. This can have negative solvency implications, long-term, if left untreated.

YES Bank Q3 Results: Recurrent Earnings Power at One-Third Pre-Provision Income

India

YES BANK Limited provides banking services. The Bank offers deposits, personal loans, e-banking, trade finance, corporate, and business banking services. YES BANK serves the food and agribusiness, life sciences, healthcare, biotechnology, telecommunications, media, information technology, and infrastructure development industries in India.

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Yes Bank (YES IN)

Bank Credit Compass: Credit Tourist May Vacate if Real Fundamentals Do Not Catch-Up

Credit tourists may vacate if economic growth and real credit fundaments are not delivered. The gap between credit spreads and fundamentals is...

Hank Calenti, CFA

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

YES Bank Solvency Simulation with Covid-19 Coverage Scenarios

Earnings power is not sufficient to achieve material Covid-19 reserve coverage. Expect material capital erosion. Solvency is delinquency dependent....

Hank Calenti, CFA

YES Bank Q3 Results: Recurrent Earnings Power at One-Third Pre-Provision Income

YES Bank’s recurrent earnings power is 1/3’rd pre-provision income. Loss absorption ability is much lower than meets the eye. Negative solvency...

Hank Calenti, CFA

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Bank Credit Compass: Credit Tourist May Vacate if Real Fundamentals Do Not Catch-Up

Credit tourists may vacate if economic growth and real credit fundaments are not delivered. The gap between credit spreads and fundamentals is...

Hank Calenti, CFA

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

Axis Bank Stops Sharing 30+ Days Past Due Data: When Sudden Silence Tells a Tale

When a bank, after earlier disclosing an indicator, fails to disclose it in future, it alerts stakeholders to the fact that it may be hiding a...

Hemindra Hazari

YES Bank Solvency Simulation with Covid-19 Coverage Scenarios

Earnings power is not sufficient to achieve material Covid-19 reserve coverage. Expect material capital erosion. Solvency is delinquency dependent....

Hank Calenti, CFA

YES Bank Q3 Results: Recurrent Earnings Power at One-Third Pre-Provision Income

YES Bank’s recurrent earnings power is 1/3’rd pre-provision income. Loss absorption ability is much lower than meets the eye. Negative solvency...

Hank Calenti, CFA