Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Executive Summary: Momentum behind the recent Treasury market rally may be starting to slow. Greater conviction is likely to build over the weeks which follow as economic data is published, rather than result from this week’s FOMC meeting.It is unlikely that the Fed will signal that it is ready to start tapering its asset purchase program this week. We are yet to see the whites of wage-growth eyes. Meanwhile, Canada became the first major economy to signal an exit from asset purchases. Canada’s central bank also indicated that a rate rise is now expected in the second half of 2022. Global interest rates did not react.  However, we may be tricked into seeing things which not there as upcoming wage data may point to rapidly falling wages.As such, the narrative remains left to be taken in the fixed income markets.  We may have reached a peak in short positioning unwinding and the re-entry of Japanese investors in the market is also taken as a given. Unexpectedly good economic data over the next few weeks could be bad for Treasury yields.  This could re-ignite the reflation and carry-trade rallies.While Treasuries continue to tread water, spreads on US CCC rated notes continued to trade at levels not seen since prior to the Global Financial Crisis in 2007. Investors are becoming concerned that the stretch for yield may be overdone. Excess US spread compression could benefit Asia HY as investors move offshore to grab better yields and excess spreads.In the bank credit markets, Asia-headquartered institution performed across the credit continuum while European bank bond remained stuck with carry-trade unwind performance. The combination of spread tightening and Treasury bond curve flattening generated positive total returns amongst Asia banks.We will hit the peak in bank earnings reports in the upcoming week. US banks set a high bar for performance by generating stellar investment banking and progressively improving core banking results over the last two weeks. They then signaled that they anticipate significantly higher interest rates later this year by raising record breaking amounts in the debt capital markets. Other banks may follow with material debt issuance over the next few weeks after reporting earnings this week.  We explore these market themes within.Market Outlook: Already looking past upcoming spikes in inflation and job creation, the Treasury market is repricing for lower growth and lower rates over a longer time-period. This should be risk asset supportive as the US dollar finally weakens. The risk is that of impotent monetary policy and a constrained fiscal response in a shorter than expected business cycle.

Executive Summary: Momentum behind the recent Treasury market rally may be starting to slow. Greater conviction is likely to build over the weeks which follow as economic data is published, rather than result from this week’s FOMC meeting.It is unlikely that the Fed will signal that it is ready to start tapering its asset purchase program this week. We are yet to see the whites of wage-growth eyes. Meanwhile, Canada became the first major economy to signal an exit from asset purchases. Canada’s central bank also indicated that a rate rise is now expected in the second half of 2022. Global interest rates did not react.  However, we may be tricked into seeing things which not there as upcoming wage data may point to rapidly falling wages.As such, the narrative remains left to be taken in the fixed income markets.  We may have reached a peak in short positioning unwinding and the re-entry of Japanese investors in the market is also taken as a given. Unexpectedly good economic data over the next few weeks could be bad for Treasury yields.  This could re-ignite the reflation and carry-trade rallies.While Treasuries continue to tread water, spreads on US CCC rated notes continued to trade at levels not seen since prior to the Global Financial Crisis in 2007. Investors are becoming concerned that the stretch for yield may be overdone. Excess US spread compression could benefit Asia HY as investors move offshore to grab better yields and excess spreads.In the bank credit markets, Asia-headquartered institution performed across the credit continuum while European bank bond remained stuck with carry-trade unwind performance. The combination of spread tightening and Treasury bond curve flattening generated positive total returns amongst Asia banks.We will hit the peak in bank earnings reports in the upcoming week. US banks set a high bar for performance by generating stellar investment banking and progressively improving core banking results over the last two weeks. They then signaled that they anticipate significantly higher interest rates later this year by raising record breaking amounts in the debt capital markets. Other banks may follow with material debt issuance over the next few weeks after reporting earnings this week.  We explore these market themes within.Market Outlook: Already looking past upcoming spikes in inflation and job creation, the Treasury market is repricing for lower growth and lower rates over a longer time-period. This should be risk asset supportive as the US dollar finally weakens. The risk is that of impotent monetary policy and a constrained fiscal response in a shorter than expected business cycle.  

Bank Credit Weekly: Momentum Slows as Conviction Is Lacking

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

Postal Savings Bank of China C / Equity Bottom-Up

<ul>
<li>We screen the 4Q20 results for credit quality and value of thirty five GEM banks</li>
<li>We add a new screen showing tangible book value per share growth from 2016 to 2020, and compare this to 2020 PTBV ratio</li>
<li>Specifically we identify six banks that screen well on these combined factors; <a href="https://www.smartkarma.com/entities/grupo-financiero-banorte-o" target="_blank" data-smartkarma-citation="entities:24780:1" rel="noopener">Grupo Financiero Banorte-O (GFNORTEO MF)</a>, <a href="https://www.smartkarma.com/entities/credicorp-ltd" target="_blank" data-smartkarma-citation="entities:25963:1" rel="noopener">Credicorp Ltd (BAP US)</a>, <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>, <a href="https://www.smartkarma.com/entities/hana-financial-group" target="_blank" data-smartkarma-citation="entities:12843:1" rel="noopener">Hana Financial (086790 KS)</a>, <a href="https://www.smartkarma.com/entities/postal-savings-bank-of-china" target="_blank" data-smartkarma-citation="entities:22848:1" rel="noopener">Postal Savings Bank of China (1658 HK)</a> and – in the higher risk category – <a href="https://www.smartkarma.com/entities/commercial-international-bank" target="_blank" data-smartkarma-citation="entities:27625:1" rel="noopener">Commercial International Bank (COMI EY)</a> of Egypt</li>
<li>A name to watch, albeit a higher risk GEM bank on attractive valuations, is <a href="https://www.smartkarma.com/entities/turkiye-garanti-bankasi-as" target="_blank" data-smartkarma-citation="entities:25026:1" rel="noopener">Turkiye Garanti Bankasi As (GARAN TI)</a> in Turkey; nevertheless, the unpredictable Erdogan factor still calls for near term caution</li>
<li>Private sector Indian banks trade on demanding valuations, in our view; public sector bank SBI is the deep value, but relatively high risk, name in India with its relatively low NPL coverage levels</li>
<li>Risks to our positive view on these six GEM banks generally include increased political and geo-political tensions, as well as a weaker than expected GDP growth recovery leading to worsen than expected credit quality  and weak loan growth</li>
</ul>


We screen the 4Q20 results for credit quality and value of thirty five GEM banks
We add a new screen showing tangible book value per share growth from 2016 to 2020, and compare this to 2020 PTBV ratio
Specifically we identify six banks that screen well on these combined factors; Grupo Financiero Banorte-O (GFNORTEO MF), Credicorp Ltd (BAP US), Banco Do Brasil Sa (BBAS3 BZ), Hana Financial (086790 KS), Postal Savings Bank of China (1658 HK) and – in the higher risk category – Commercial International Bank (COMI EY) of Egypt
A name to watch, albeit a higher risk GEM bank on attractive valuations, is Turkiye Garanti Bankasi As (GARAN TI) in Turkey; nevertheless, the unpredictable Erdogan factor still calls for near term caution
Private sector Indian banks trade on demanding valuations, in our view; public sector bank SBI is the deep value, but relatively high risk, name in India with its relatively low NPL coverage levels
Risks to our positive view on these six GEM banks generally include increased political and geo-political tensions, as well as a weaker than expected GDP growth recovery leading to worsen than expected credit quality  and weak loan growth


<ul>
<li>The double digit system YoY loan growth to February is deceptive, and largely a product of government sponsored relief lending especially ex-corporate</li>
<li>Headline credit quality continues to deteriorate, with the mortgage NPL ratio accelerating in February albeit from a low base</li>
<li>Arrears (15-90 days overdue loans) also showed a deterioration in February, with loans to individuals leading the way</li>
<li>The debt burden of households (latest available data to December) also showed domestic finances under further strain</li>
<li>Despite the sharp increase in benchmark SELIC rate to 2.75% from 2% earlier in March, credit spreads only edged higher in new credit to individuals in February</li>
<li>We expect the picture to become increasingly challenging for Brazilian banks on credit quality in particular going forward; we maintain our positive view on <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>, but would be cautious on the other big-cap bank names in Brazil</li>
<li>Risks to our positive view on Banco do Brasil includes much worse than expected NPLs, higher than expected spread pressure and poor opex control</li>
</ul>


The double digit system YoY loan growth to February is deceptive, and largely a product of government sponsored relief lending especially ex-corporate
Headline credit quality continues to deteriorate, with the mortgage NPL ratio accelerating in February albeit from a low base
Arrears (15-90 days overdue loans) also showed a deterioration in February, with loans to individuals leading the way
The debt burden of households (latest available data to December) also showed domestic finances under further strain
Despite the sharp increase in benchmark SELIC rate to 2.75% from 2% earlier in March, credit spreads only edged higher in new credit to individuals in February
We expect the picture to become increasingly challenging for Brazilian banks on credit quality in particular going forward; we maintain our positive view on Banco Do Brasil Sa (BBAS3 BZ), but would be cautious on the other big-cap bank names in Brazil
Risks to our positive view on Banco do Brasil includes much worse than expected NPLs, higher than expected spread pressure and poor opex control


<ul>
<li>The market is likely to fear that <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> CEO Andre Brandao’s resignation threatens the restructuring plan, and other pro-market management initiatives</li>
<li>The replacement candidate for CEO is internal, according to press reports, which could imply lesser potential for restructuring, and limited potential for enhanced returns going forward</li>
<li>Despite these concerns, it is relevant to stress that the bank has a relatively strong balance sheet, with an improved core capital ratio and healthy credit quality metrics; rising benchmark rates in Brazil should also support credit spreads going forward</li>
<li>We expect near term downside to the share price, but given its current 64% and 57% PBV ratio discounts to <a href="https://www.smartkarma.com/entities/itau-unibanco-holding-sa-9d47d196-e503-471b-a84e-ca4401033062" target="_blank" data-smartkarma-citation="entities:24550:1" rel="noopener">Itau Unibanco Holding Sa (ITUB4 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>  respectively, a lot seems priced in; the current PBV ratio discounts are close the maximum discounts of the last five years</li>
<li>The share price downside should be limited, in our view, as the market was already cautious on the Banco do Brasil stock following the Petrobras CEO removal</li>
<li>Risks to our view include a more interventionist and populist approach by government towards the management and the strategic direction of Banco do Brasil, as well as a weaker than expected economic recovery leading to higher than expected delinquencies and cost of risk going forward</li>
</ul>


The market is likely to fear that Banco Do Brasil Sa (BBAS3 BZ) CEO Andre Brandao’s resignation threatens the restructuring plan, and other pro-market management initiatives
The replacement candidate for CEO is internal, according to press reports, which could imply lesser potential for restructuring, and limited potential for enhanced returns going forward
Despite these concerns, it is relevant to stress that the bank has a relatively strong balance sheet, with an improved core capital ratio and healthy credit quality metrics; rising benchmark rates in Brazil should also support credit spreads going forward
We expect near term downside to the share price, but given its current 64% and 57% PBV ratio discounts to Itau Unibanco Holding Sa (ITUB4 BZ) and Banco Bradesco Sa (BBDC4 BZ)  respectively, a lot seems priced in; the current PBV ratio discounts are close the maximum discounts of the last five years
The share price downside should be limited, in our view, as the market was already cautious on the Banco do Brasil stock following the Petrobras CEO removal
Risks to our view include a more interventionist and populist approach by government towards the management and the strategic direction of Banco do Brasil, as well as a weaker than expected economic recovery leading to higher than expected delinquencies and cost of risk going forward


Banco Do Brasil (BBAS3 BZ): CEO Resignation, near Term Downside, but How Much Is Already Discounted?

<ul>
<li>The macro-economic and political backdrop for Brazil is a challenging one, which has driven the poor performance of Brazil assets and the BRL</li>
<li>Governance concerns re <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>, in the wake of the removal of the Petrobras CEO, have added to the negative share price impact, yet we see cause for optimism</li>
<li>Attractive absolute valuations, as well as relatively low PBV ratios, are discounting a lot of the bad news</li>
<li>Banco do Brasil’s balance sheet is much improved at YE 2020, in terms of capital adequacy as well as NPL coverage, and its exposure to higher risk loan segments is limited</li>
<li>The prospect of rising benchmark interest rates is already leading to better new loan pricing sector-wide and the potential of recovering credit spreads contributes to the bull case</li>
<li>Risks to our positive view on Banco do Brasil include the removal of its market oriented CEO, worse than expected credit delinquency going forward as well as a less than expected positive impact from rising spreads</li>
</ul>


The macro-economic and political backdrop for Brazil is a challenging one, which has driven the poor performance of Brazil assets and the BRL
Governance concerns re Banco Do Brasil Sa (BBAS3 BZ), in the wake of the removal of the Petrobras CEO, have added to the negative share price impact, yet we see cause for optimism
Attractive absolute valuations, as well as relatively low PBV ratios, are discounting a lot of the bad news
Banco do Brasil’s balance sheet is much improved at YE 2020, in terms of capital adequacy as well as NPL coverage, and its exposure to higher risk loan segments is limited
The prospect of rising benchmark interest rates is already leading to better new loan pricing sector-wide and the potential of recovering credit spreads contributes to the bull case
Risks to our positive view on Banco do Brasil include the removal of its market oriented CEO, worse than expected credit delinquency going forward as well as a less than expected positive impact from rising spreads


Brazil Banks - Market Concerns Overdone, with the Banco Do Brasil (BBAS3 BZ) Strengths Under-Rated

Brazil

Banco do Brasil S.A. attracts deposits and offers retail and commercial banking services.  The Bank offers consumer, commercial, and agribusiness loans, asset management, foreign exchange, private pension, insurance, lease financing, credit cards, and Internet banking services.

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Banco do Brasil (BBAS3 BZ)

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