Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

<p><strong>Executive Summary:</strong> A liquidity driven melt-up combined with month-end rebalancing to drive bank credit spread performance over the last week. Remove the month-end rebalancing and short duration positioning may remain the best strategy over the next few weeks, absent a material inflection point in the upcoming non-farm payroll numbers. </p><p>The short end of the rates market continued to push investors up the curve to generate returns. Awash with still rising liquidity, this melt-up was the key driver of credit spread outperformance.</p><p>Risk asset volatility and talking about, talking about, talking about tapering had little lasting impact on US interest rates over the last few weeks. In fact, rate curve flattening, and falling forward breakeven rates, suggest that the interest rate market may buy the Fed’s assessment of inflation as being transitory.</p><p>While the transitory mantra is believed, whispers of supply driven growth constraints are being mentioned. This would be interest rate and credit spread positive as it would extend the duration of the recovery and thereby delay late-stage economic cycle repositioning. Although not consensus, this thought is disconcerting, as it suggests the rising rates consensus is very wrong.</p><p>Therefore, the risk is clearly that the rates market is underpricing the potential for an extended period of higher than anticipated inflation. However, holding cash is expensive. Moving too early to position for higher or longer than anticipated inflation may be career ending. Extending duration to take advantage of declining rates is considered insane. Carry trades remain unloved. Ergo, the silent self-doubtful suffering of the rate and credit markets. Security selection based on fundamental analysis, in so much as one avoids unexpected spread widening, may be the differentiator for outsized total returns over the next few weeks.  </p><p>We elaborate on these themes within.</p><p><strong>Market Outlook:</strong> The question is whether the over-heating narrative will make a comeback and bring rate and tapering expectations closer. Financial stability risks appear binary from here. Either the Fed is over-accommodative, and it sits on its hands too long while asset bubbles over-inflate so that it gets nasty when it moves, or the Fed gets impatient, and it lowers accommodation unexpectedly which creates a risk off reaction. In both cases, curves flatten in a risk-off environment. We suspect the former is more likely, and for now, the Fed remains the bartender rather than the bouncer.</p>

Executive Summary: A liquidity driven melt-up combined with month-end rebalancing to drive bank credit spread performance over the last week. Remove the month-end rebalancing and short duration positioning may remain the best strategy over the next few weeks, absent a material inflection point in the upcoming non-farm payroll numbers. The short end of the rates market continued to push investors up the curve to generate returns. Awash with still rising liquidity, this melt-up was the key driver of credit spread outperformance.Risk asset volatility and talking about, talking about, talking about tapering had little lasting impact on US interest rates over the last few weeks. In fact, rate curve flattening, and falling forward breakeven rates, suggest that the interest rate market may buy the Fed’s assessment of inflation as being transitory.While the transitory mantra is believed, whispers of supply driven growth constraints are being mentioned. This would be interest rate and credit spread positive as it would extend the duration of the recovery and thereby delay late-stage economic cycle repositioning. Although not consensus, this thought is disconcerting, as it suggests the rising rates consensus is very wrong.Therefore, the risk is clearly that the rates market is underpricing the potential for an extended period of higher than anticipated inflation. However, holding cash is expensive. Moving too early to position for higher or longer than anticipated inflation may be career ending. Extending duration to take advantage of declining rates is considered insane. Carry trades remain unloved. Ergo, the silent self-doubtful suffering of the rate and credit markets. Security selection based on fundamental analysis, in so much as one avoids unexpected spread widening, may be the differentiator for outsized total returns over the next few weeks.  We elaborate on these themes within.Market Outlook: The question is whether the over-heating narrative will make a comeback and bring rate and tapering expectations closer. Financial stability risks appear binary from here. Either the Fed is over-accommodative, and it sits on its hands too long while asset bubbles over-inflate so that it gets nasty when it moves, or the Fed gets impatient, and it lowers accommodation unexpectedly which creates a risk off reaction. In both cases, curves flatten in a risk-off environment. We suspect the former is more likely, and for now, the Fed remains the bartender rather than the bouncer.

Bank Credit Weekly: Month-End Rebalancing Takes Risk-Off Before Take-Off

Financials & FinTech research, Galliano’s Financials Research

Victor Galliano

Financials & FinTech research

Financials & FinTech, EM & Developed Markets

Galliano’s Financials Research

Galliano's Financials Research provides fundamental research in Emerging Markets financials, including FinTech, as well as financials in select Developed Markets.

The investment style applied is generally value oriented, although Growth At Reasonable Price (GARP) strategies can also be used where appropriate. 

Our investment research approach aim is often contrarian, looking to capitalise on overly sceptical or optimistic consensus views. In terms of valuation techniques, the focus is on PBV ratio to ROE, PE multiples and dividend yield, as well as the application of PEG ratios and, where appropriate, Sum of the Parts (SOTP) valuations.

Equity Bottom-Up

<ul>
<li>Brazil’s credit quality trends to April seem positive, on balance</li>
<li>Compared to March, there appear to be less concerning consumer credit quality and arrears (15-90 days delay) data</li>
<li>Credit quality to corporates shows that  even though credit risks are rising, the rate of growth is “shallow” in both large corporates as well as micro-enterprises and SMEs</li>
<li>In essence, we believe that credit quality risks may be moderating going forward, especially in higher risk consumer and in micro-enterprise and SME categories</li>
<li>In addition, the bank system’s generally high provisioning levels relative to delinquency provides a healthy buffer, in our view</li>
<li>Credit spreads ticked lower in April, and are still well below their recent highs of early 2020</li>
<li>We continue to see value in the sector and find <a href="https://www.smartkarma.com/entities/banco-do-brasil-sa" target="_blank" data-smartkarma-citation="entities:24564:1" rel="noopener">Banco Do Brasil Sa (BBAS3 BZ)</a> and <a href="https://www.smartkarma.com/entities/banco-bradesco-sa" target="_blank" data-smartkarma-citation="entities:24569:1" rel="noopener">Banco Bradesco Sa (BBDC4 BZ)</a> attractive</li>
<li>Risks to positive view on these big cap Brazil banks include worse than expected credit quality, weak opex control and erosion of credit spreads</li>
</ul>


Brazil’s credit quality trends to April seem positive, on balance
Compared to March, there appear to be less concerning consumer credit quality and arrears (15-90 days delay) data
Credit quality to corporates shows that  even though credit risks are rising, the rate of growth is “shallow” in both large corporates as well as micro-enterprises and SMEs
In essence, we believe that credit quality risks may be moderating going forward, especially in higher risk consumer and in micro-enterprise and SME categories
In addition, the bank system’s generally high provisioning levels relative to delinquency provides a healthy buffer, in our view
Credit spreads ticked lower in April, and are still well below their recent highs of early 2020
We continue to see value in the sector and find Banco Do Brasil Sa (BBAS3 BZ) and Banco Bradesco Sa (BBDC4 BZ) attractive
Risks to positive view on these big cap Brazil banks include worse than expected credit quality, weak opex control and erosion of credit spreads


Brazil Bank Sector Trends to April in Ten Charts

<ul>
<li>
<a href="https://www.smartkarma.com/entities/banco-inter-sa" target="_blank" data-smartkarma-citation="entities:28162:1" rel="noopener">Banco Inter SA (BIDI11 BZ)</a> is a leading digital bank in Brazil, only second to Nubank in scale and scope, with over 10m clients at the end of March 2021</li>
<li>It is also seeing accelerating loan growth to 1Q21 and broadening its service base deriving fees from its services and shopping platform</li>
<li>Yet, even on comparable FinTech valuations, as well as on the PEG ratio metric, Banco Inter’s market value seems stretched</li>
<li>In addition, given the acceleration in loan growth and the resultant absorption in capital, we see a real risk of a further equity cash call in coming quarters</li>
<li>We explore three scenarios for Banco Inter in this report; in our view, none of these scenarios’ implied returns make Banco Inter stock compelling at current valuations</li>
<li>Banco Inter’s upside risks include better than expected opex control especially on new customer acquisition driving better than expected returns</li>
</ul>



Banco Inter SA (BIDI11 BZ) is a leading digital bank in Brazil, only second to Nubank in scale and scope, with over 10m clients at the end of March 2021
It is also seeing accelerating loan growth to 1Q21 and broadening its service base deriving fees from its services and shopping platform
Yet, even on comparable FinTech valuations, as well as on the PEG ratio metric, Banco Inter’s market value seems stretched
In addition, given the acceleration in loan growth and the resultant absorption in capital, we see a real risk of a further equity cash call in coming quarters
We explore three scenarios for Banco Inter in this report; in our view, none of these scenarios’ implied returns make Banco Inter stock compelling at current valuations
Banco Inter’s upside risks include better than expected opex control especially on new customer acquisition driving better than expected returns


Banco Inter (BIDI11 BZ): Too Much Optimism Built into Valuations

<ul>
<li>
<a href="https://www.smartkarma.com/entities/banco-do-brasil-sa" target="_blank" data-smartkarma-citation="entities:24564:1" rel="noopener">Banco Do Brasil Sa (BBAS3 BZ)</a>’s 1Q21 results reflect its sound credit quality and coverage, as well as its healthy capital adequacy</li>
<li>Banco do Brasil’s NPL ratio is the best of the big four Brazil banks, and it also registers the lowest ratio of renegotiated loans to total loans</li>
<li>Its core capital adequacy is also the best of the big four at 1Q21, and this is despite a mark to market hit in the quarter</li>
<li>The new CEO Is committed to reduce the cost base, and enhance returns; administrative expenses declined QoQ and YoY</li>
<li>We believe that these 1Q21 results reinforce our positive view on Banco do Brasil shares and their potential to narrow the PBV ratio discount</li>
<li>Risks to our view include heightened corporate governance risks, as well as worsening credit quality in the forbearance portfolio</li>
</ul>



Banco Do Brasil Sa (BBAS3 BZ)’s 1Q21 results reflect its sound credit quality and coverage, as well as its healthy capital adequacy
Banco do Brasil’s NPL ratio is the best of the big four Brazil banks, and it also registers the lowest ratio of renegotiated loans to total loans
Its core capital adequacy is also the best of the big four at 1Q21, and this is despite a mark to market hit in the quarter
The new CEO Is committed to reduce the cost base, and enhance returns; administrative expenses declined QoQ and YoY
We believe that these 1Q21 results reinforce our positive view on Banco do Brasil shares and their potential to narrow the PBV ratio discount
Risks to our view include heightened corporate governance risks, as well as worsening credit quality in the forbearance portfolio


Banco Do Brasil (BBAS3 BZ): Solid 1Q21, with the Prospect of Improving Returns

Smartkarma Research Team, Smartkarma

Smartkarma Research

Smartkarma Research Team

Smartkarma

Smartkarma unites the fragmented investment industry, connecting institutional investors, independent research providers, and corporates within a single network.

Research Reinvented

<p>For our next Webinar, we are excited to welcome Insight Provider <a href="https://www.smartkarma.com/profiles/victor-galliano" target="_blank" data-smartkarma-citation="accounts:3251" rel="noopener">Victor Galliano</a>, who will share his insight into opportunities in Lat-Am financials.</p><h3>The webinar will be hosted on Wednesday, 5 May 2021, 17:00 SGT/HKT.</h3><div class="content-highlight"><h2><a href="https://share.hsforms.com/1H9pFZOB-RF2J00kbvMmxcw2c5gj?zoom_webinar_id=83773021447" target="_blank" rel="noopener">Register for the Webinar here</a></h2></div><p>Victor Galliano is an experienced equity banks analyst, having covered Latin America banks and non-bank financials for over 12 years, as well as more recently covering Italian banks and Fintech. He has worked in sell-side equity research for 30 years in a career spanning Barclays, HSBC, BBVA LatInvest, Barings, and NatWest.</p>

For our next Webinar, we are excited to welcome Insight Provider Victor Galliano, who will share his insight into opportunities in Lat-Am financials.The webinar will be hosted on Wednesday, 5 May 2021, 17:00 SGT/HKT.Register for the Webinar hereVictor Galliano is an experienced equity banks analyst, having covered Latin America banks and non-bank financials for over 12 years, as well as more recently covering Italian banks and Fintech. He has worked in sell-side equity research for 30 years in a career spanning Barclays, HSBC, BBVA LatInvest, Barings, and NatWest.

Smartkarma Webinar | Latin America Financials: Focusing on Value Opportunities

Brazil

Banco do Brasil is a Brazilian financial services company offering a wide range of banking products and services, including retail and corporate banking, investment management, insurance, and agribusiness loans. It serves individuals, companies, and the public sector, with a strong leadership position in retail banking in Brazil. The company is headquartered in Brasília, Brazil, and was founded on October 12, 1808.

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Banco do Brasil (BBAS3 BR)

Bank Credit Weekly: Month-End Rebalancing Takes Risk-Off Before Take-Off

Short duration positioning may remain the best strategy over the next few weeks, absent a material inflection point in the upcoming non-farm...

Hank Calenti, CFA

Brazil Bank Sector Trends to April in Ten Charts

April credit quality data is better than March, the bank system has good NPL coverage & the debt servicing burden is declining with falling lending...

Victor Galliano

Banco Inter (BIDI11 BZ): Too Much Optimism Built into Valuations

Banco Inter, as a leading Brazilian digital challenger bank, is growing fast. Yet our 3 scenarios show that premium growth does not mean premium...

Victor Galliano

Banco Do Brasil (BBAS3 BZ): Solid 1Q21, with the Prospect of Improving Returns

Post 1Q21 result, we believe that Banco do Brasil's PBV ratio discount (c60%) should narrow, supported by its healthy credit quality and capital...

Victor Galliano

Smartkarma Webinar | Latin America Financials: Focusing on Value Opportunities

On 5 May, 5pm SGT, join our next Webinar, where we welcome Insight Provider Victor Galliano, to hear his insights into opportunities in Latin...

Smartkarma Research

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