Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

<a href="https://www.smartkarma.com/entities/jpmorgan-chase-co" target="_blank" data-smartkarma-citation="entities:277:1" rel="noopener">JPMorgan Chase &amp; Co's (JPM US)</a> fortress foundation needs repair. Rather than a rock-solid balance sheet, JPM’s capital foundation needs to be strengthened to handle the leverage load. It has the lowest Supplementary Leverage Ratio (SLR) amongst the largest US banks and its Tier 1 securities suffer, in part, due to this. It is time to lighten the leverage exposure and add a layer of capital. This creates an investment opportunity.As the pandemic-induced economic crisis unfolded last year, we noted that JPM Tier 1 securities were over-bought relative to the leverage exposure risk at the institution. Please see: <a href="https://www.smartkarma.com/compose/insight/49670/Bank%20Credit%20Weekly:%20US%20Capital%20Buffer%20Risk%20&amp;%20Q1%20Earnings%20Reports-%20JPMorgan%20Looks%20Slightly%20Overbought.%20Read%20more:%20https:/skr.ma/uQHaQ" target="_blank" rel="noopener">Bank Credit Weekly: US Capital Buffer Risk &amp; Q1 Earnings Reports- JPMorgan Looks Slightly Overbought.</a>The Fed exemption of Treasury securities and deposits with the central bank from the SLR bought JPM time. Fast forward one year later to the expiration of these exemptions and, despite ample opportunity, JPMorgan did not issue Tier 1 securities until only two weeks ago when it brought a $25 par security. In additional to raising needed capital, the firm recently threatened to stop taking deposits. It may price itself out of the deposit market, temporarily, but this is not a long-term strategy. The SLR is the binding capital constrain on the firm’s asset growth. JPM needs to obtain or retain more Tier 1 capital. We quantify this within.We believe that JPM could easily bring a 10-year Tier 1 bond to the market and find between US$2 to US$3bn in demand, thereby taking the total Tier 1 financing needs, or balance sheet optimization equivalent, down materially for the remainder of the year. Based on its recently issued Preferred, we believe JPM could achieve a price of Treasuries plus circa 300bps in a 10-year Tier 1 note.Aside from its SLR level, JPMorgan’s credit metrics are on-par with, if not superior to, most other large systemically important financial institutions. And yet, as we present within, JPM’s Tier 1 bonds trade at a discount to materially weaker banks located outside the US. Furthermore, we find that JPMorgan’s 2025 callable Tier 1 bond is at least 40bps oversold as, in our view, its call option is overvalued by the same amount.JPM faces an inflection point with respect to its capital adequacy. Concurrently, the Fed may re-adjust the SLR requirements before year-end; however, we believe it would be foolish of JPM not to take the opportunity to increase its SLR in an improving economic environment. It should re-enforce the foundation of its fortress balance sheet. We believe investors should pre-position for this eventuality. We recommend overweighting JPMorgan’s Tier 1 securities.

JPMorgan Chase &amp; Co's (JPM US) fortress foundation needs repair. Rather than a rock-solid balance sheet, JPM’s capital foundation needs to be strengthened to handle the leverage load. It has the lowest Supplementary Leverage Ratio (SLR) amongst the largest US banks and its Tier 1 securities suffer, in part, due to this. It is time to lighten the leverage exposure and add a layer of capital. This creates an investment opportunity.As the pandemic-induced economic crisis unfolded last year, we noted that JPM Tier 1 securities were over-bought relative to the leverage exposure risk at the institution. Please see: Bank Credit Weekly: US Capital Buffer Risk &amp; Q1 Earnings Reports- JPMorgan Looks Slightly Overbought.The Fed exemption of Treasury securities and deposits with the central bank from the SLR bought JPM time. Fast forward one year later to the expiration of these exemptions and, despite ample opportunity, JPMorgan did not issue Tier 1 securities until only two weeks ago when it brought a $25 par security. In additional to raising needed capital, the firm recently threatened to stop taking deposits. It may price itself out of the deposit market, temporarily, but this is not a long-term strategy. The SLR is the binding capital constrain on the firm’s asset growth. JPM needs to obtain or retain more Tier 1 capital. We quantify this within.We believe that JPM could easily bring a 10-year Tier 1 bond to the market and find between US$2 to US$3bn in demand, thereby taking the total Tier 1 financing needs, or balance sheet optimization equivalent, down materially for the remainder of the year. Based on its recently issued Preferred, we believe JPM could achieve a price of Treasuries plus circa 300bps in a 10-year Tier 1 note.Aside from its SLR level, JPMorgan’s credit metrics are on-par with, if not superior to, most other large systemically important financial institutions. And yet, as we present within, JPM’s Tier 1 bonds trade at a discount to materially weaker banks located outside the US. Furthermore, we find that JPMorgan’s 2025 callable Tier 1 bond is at least 40bps oversold as, in our view, its call option is overvalued by the same amount.JPM faces an inflection point with respect to its capital adequacy. Concurrently, the Fed may re-adjust the SLR requirements before year-end; however, we believe it would be foolish of JPM not to take the opportunity to increase its SLR in an improving economic environment. It should re-enforce the foundation of its fortress balance sheet. We believe investors should pre-position for this eventuality. We recommend overweighting JPMorgan’s Tier 1 securities.

US Banks and the SLR Situation: Overweight JPM Tier 1 Securities

Chief Economist & Political Strategist, CrossASEAN Research

Prasenjit K. Basu

Chief Economist & Political Strategist

CrossASEAN Research

At CrossASEAN Research we strive to produce unbiased and differentiated on the ground insights on companies across South East Asia. Our Research is produced for the most part after face to face meetings and conversations with company management to dig deep into the long term vision and strategy of the companies we cover. We seek to deliver investable and actionable themes on sectors and markets across SE Asia, often in collaboration with other Insight Providers across the region, pooling the vast experience of the analysts within the Smartkarma Ecosystem. We also offer bespoke work and tailor made trips for our clients. 

Insights across South East Asia

Cross Asset Strategy

Dividend yields for the S&amp;P 500 are 1.5%; the only time they were lower in the past 150 years was in 2000 (1% before the "dot-com crash" of 2000). We expect the S&amp;P 500 earnings yield to rebound from its low of 2.5% through a combination of stronger EPS growth and falling stock prices. The 14% of GDP fiscal stimulus will strengthen the recovery; already the end of the SLR-relaxation amounts to a slight tightening of monetary conditions from April 2021. The pledge of US$120 billion of monthly bond purchases will need to be relaxed after May 2021, and further tightening is likely at the FOMC meeting at the end of June, via either a 12.5bp rise in Fed Funds rate or an increase in the 0.1% interest rate paid on banks' reserves. The US$ will strengthen.Over the past 3 months (starting 27 December 2020), the US has legislated an aggregate fiscal stimulus of US$2.8 trillion (14% of GDP), of which the first part (US$0.9 trillion) has been almost entirely disbursed in the current quarter. Unsurprisingly, FOMC members expect US real GDP to rebound to a spectacular 6.5% growth in 2021. The unemployment rate has already declined to 6.2% in February 2021 (from 6.7% in Nov-Dec 2020, and 10.2% in July 2020); although much higher than February 2020 (3.5%), the current unemployment rate is not far above the traditional 5-6% rate considered the non-accelerating-inflation rate of unemployment (NAIRU), which is estimated to have fallen to 4-5% for the 2005-30 period. Given that jobs in the pandemic-hit hospitality sector are unlikely to come back for awhile, we estimate that NAIRU this year is close to 5%, a level of unemployment that is likely to be reached before 4Q 2021. Manufacturing is leading the US recovery: the ISM's manufacturing PMI was equal to a 3-year high (last exceeded 17 years ago) in February 2021 despite inclement weather. The Philadelphia Fed's manufacturing outlook reached a 48-year high this month. Inflation is likely to edge up as unemployment declines toward the NAIRU, making it untenable for the Fed to keep to its pledge of buying US$120 billion of bonds monthly without countervailing actions to reduce the money-multiplier. The first such step removes the SLR relaxations from the beginning of next month. The second is likely to be an increase in the interest rate paid on banks' reserves (from their 0.1% current level) or an outright increase in the Fed Funds rate (to 0.25%) at the June FOMC meeting. We are bearish on risk assets (equities and EMs) over the next half year, and would recommend continuing to rotate away from technology stocks to cyclicals, consumer cyclicals and banks.

Dividend yields for the S&amp;P 500 are 1.5%; the only time they were lower in the past 150 years was in 2000 (1% before the "dot-com crash" of 2000). We expect the S&amp;P 500 earnings yield to rebound from its low of 2.5% through a combination of stronger EPS growth and falling stock prices. The 14% of GDP fiscal stimulus will strengthen the recovery; already the end of the SLR-relaxation amounts to a slight tightening of monetary conditions from April 2021. The pledge of US$120 billion of monthly bond purchases will need to be relaxed after May 2021, and further tightening is likely at the FOMC meeting at the end of June, via either a 12.5bp rise in Fed Funds rate or an increase in the 0.1% interest rate paid on banks' reserves. The US$ will strengthen.Over the past 3 months (starting 27 December 2020), the US has legislated an aggregate fiscal stimulus of US$2.8 trillion (14% of GDP), of which the first part (US$0.9 trillion) has been almost entirely disbursed in the current quarter. Unsurprisingly, FOMC members expect US real GDP to rebound to a spectacular 6.5% growth in 2021. The unemployment rate has already declined to 6.2% in February 2021 (from 6.7% in Nov-Dec 2020, and 10.2% in July 2020); although much higher than February 2020 (3.5%), the current unemployment rate is not far above the traditional 5-6% rate considered the non-accelerating-inflation rate of unemployment (NAIRU), which is estimated to have fallen to 4-5% for the 2005-30 period. Given that jobs in the pandemic-hit hospitality sector are unlikely to come back for awhile, we estimate that NAIRU this year is close to 5%, a level of unemployment that is likely to be reached before 4Q 2021. Manufacturing is leading the US recovery: the ISM's manufacturing PMI was equal to a 3-year high (last exceeded 17 years ago) in February 2021 despite inclement weather. The Philadelphia Fed's manufacturing outlook reached a 48-year high this month. Inflation is likely to edge up as unemployment declines toward the NAIRU, making it untenable for the Fed to keep to its pledge of buying US$120 billion of bonds monthly without countervailing actions to reduce the money-multiplier. The first such step removes the SLR relaxations from the beginning of next month. The second is likely to be an increase in the interest rate paid on banks' reserves (from their 0.1% current level) or an outright increase in the Fed Funds rate (to 0.25%) at the June FOMC meeting. We are bearish on risk assets (equities and EMs) over the next half year, and would recommend continuing to rotate away from technology stocks to cyclicals, consumer cyclicals and banks. 

Biden's Huge Stimulus Is Obliging the Fed to Edge Away from Unlimited QE

Asset Allocation & Fund Positioning, Copley Fund Research

Steven Holden

Asset Allocation & Fund Positioning

Copley Fund Research

Copley Fund Research provide research and data on asset allocation among Global and Emerging Market equity funds.  The analysis details absolute and relative positioning across countries, sectors and industries together with highly granular data on single stock and single fund allocations.  The data is updated monthly with time series going back to January 2011.

Global Research - Analysis of 165 prominent Global equity funds, combined AUM $335bn
GEM Research - Analysis of 127 prominent global EM equity funds, combined AUM $250bn

Asset Allocation - Global and GEM Equity

Thematic (Sector/Industry)

US Financial stocks are a key holding for Global active managers.  Average weights stand at 6.38% among the 383 Global funds in our analysis, the 3rd largest global country/sector allocation.After a heavy sell of during the first few months of COVID-19, allocations bottomed out in August 2020 and turned sharply to the upside.  US Financials captured some of the largest ownership increases among global country/sector peers, moving from underweight to overweight in the process.<a href="https://www.smartkarma.com/entities/morgan-stanley" target="_blank" data-smartkarma-citation="entities:1122:1" rel="noopener">Morgan Stanley (MS US)</a> has broken out to new highs in active fund ownership, <a href="https://www.smartkarma.com/entities/jpmorgan-chase-co" target="_blank" data-smartkarma-citation="entities:277:1" rel="noopener">JPMorgan Chase &amp; Co (JPM US)</a> is the most widely held Financial stock, whilst <a href="https://www.smartkarma.com/entities/citigroup-inc" target="_blank" data-smartkarma-citation="entities:279:1" rel="noopener">Citigroup Inc (C US)</a> exposure remains subdued.There are few signs of confidence levels abating or that managers are overly exposed to the sector, either on an absolute basis or relative to benchmark.  Therefore, we see it as low risk that managers will look to scale back exposure at this juncture.

US Financial stocks are a key holding for Global active managers.  Average weights stand at 6.38% among the 383 Global funds in our analysis, the 3rd largest global country/sector allocation.After a heavy sell of during the first few months of COVID-19, allocations bottomed out in August 2020 and turned sharply to the upside.  US Financials captured some of the largest ownership increases among global country/sector peers, moving from underweight to overweight in the process.Morgan Stanley (MS US) has broken out to new highs in active fund ownership, JPMorgan Chase &amp; Co (JPM US) is the most widely held Financial stock, whilst Citigroup Inc (C US) exposure remains subdued.There are few signs of confidence levels abating or that managers are overly exposed to the sector, either on an absolute basis or relative to benchmark.  Therefore, we see it as low risk that managers will look to scale back exposure at this juncture.

Silver Point

Thomas J. Monaco

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

*DOJ Going Overboard:The US Department of Justice (DOJ) has begun investigating Visa (V.US) [Visa] over anticompetitive practices again. This time for alleged restrictions of merchants from routing in-store and online debit-card transactions through less expensive card networks, which is in contravention to the 2010 Durbin Amendment; and*Here Is Where We Think The DOJ Is Wrong: With Visa’s termination of its upstart Plaid acquisition, Visa’s alleged attempt to monopolize the online debit business has already been thwarted. Further, the combination of mix shift toward covered transactions coupled with declining yields has acted as a headwind for Visa's debit interchange fees. That Mastercard (MA.US) has convinced numerous US banks to switch their debit-card portfolios away from Visa evidences competitive pricing pressures. Lastly, there may actually be precedence for Visa’s stance given the recent outcome of the Federal Trade Commission (FTC) v. Qualcomm (QCOM.US) case.

*DOJ Going Overboard:The US Department of Justice (DOJ) has begun investigating Visa (V.US) [Visa] over anticompetitive practices again. This time for alleged restrictions of merchants from routing in-store and online debit-card transactions through less expensive card networks, which is in contravention to the 2010 Durbin Amendment; and*Here Is Where We Think The DOJ Is Wrong: With Visa’s termination of its upstart Plaid acquisition, Visa’s alleged attempt to monopolize the online debit business has already been thwarted. Further, the combination of mix shift toward covered transactions coupled with declining yields has acted as a headwind for Visa's debit interchange fees. That Mastercard (MA.US) has convinced numerous US banks to switch their debit-card portfolios away from Visa evidences competitive pricing pressures. Lastly, there may actually be precedence for Visa’s stance given the recent outcome of the Federal Trade Commission (FTC) v. Qualcomm (QCOM.US) case.

Visa Inc – Noise Creates Buying Opportunity

*Gross Operating Revenues Do NOT Cover Recurring Costs At HSBCNA: HSBC Holdings plc’s (HSBC) [5.HK/HSBA.LN] US subsidiary, HSBC North America (US only) [HSBCNA], reported yet another troubling set of results for 4Q20, losing USD 152.6 mn – down USD 312.6 mn (195.4%) on a linked quarter basis. Excluding non-recurring items, core operating income declined USD 313.6 mn (230.1%) for a loss of USD 177.3 mn over the same period. As it stands again, HSBCNA’s operating costs exceed recurring revenues; *HSBCNA Is Evolving Into An Indian State Bank: Given the credit weakness, we find that NPL/TL and problem assets/TL ratios significantly worsened 92 bp and 160 bp linked quarter, respectively, to 2.82% and 5.01%. By our calculation, we note that net new problem loan growth is a scary USD 867.9 mn  - for an annualized rate of growth of 155.4% - in line with the Indian state banks. By our calculation, HSBCNA’s reserves are light by USD 3.8 bn or 17.6% of HSBCNA’s stated equity. We would have compared the reserve shortfall to PBT, but HSBCNA simply loses money on an operating basis; and*HSBCNA Should Be Dumped At Any Price: HSBCNA is a chronic mess, and there is absolutely no need for HSBC to maintain a full commercial/retail banking presence in the US. It cannot earn a positive return under its current structure; credit is again about to fall off a cliff; does not earning; NIMs are among the lowest in the USA; and capital is shortly about to fall below regulatory guidance. Further, the bad acquisitions and regulatory headaches should spur management to cut and run in the US. We look forward to Group results on February 23rd, and the clarity we will receive on its hot mess in the US.

*Gross Operating Revenues Do NOT Cover Recurring Costs At HSBCNA: HSBC Holdings plc’s (HSBC) [5.HK/HSBA.LN] US subsidiary, HSBC North America (US only) [HSBCNA], reported yet another troubling set of results for 4Q20, losing USD 152.6 mn – down USD 312.6 mn (195.4%) on a linked quarter basis. Excluding non-recurring items, core operating income declined USD 313.6 mn (230.1%) for a loss of USD 177.3 mn over the same period. As it stands again, HSBCNA’s operating costs exceed recurring revenues; *HSBCNA Is Evolving Into An Indian State Bank: Given the credit weakness, we find that NPL/TL and problem assets/TL ratios significantly worsened 92 bp and 160 bp linked quarter, respectively, to 2.82% and 5.01%. By our calculation, we note that net new problem loan growth is a scary USD 867.9 mn  - for an annualized rate of growth of 155.4% - in line with the Indian state banks. By our calculation, HSBCNA’s reserves are light by USD 3.8 bn or 17.6% of HSBCNA’s stated equity. We would have compared the reserve shortfall to PBT, but HSBCNA simply loses money on an operating basis; and*HSBCNA Should Be Dumped At Any Price: HSBCNA is a chronic mess, and there is absolutely no need for HSBC to maintain a full commercial/retail banking presence in the US. It cannot earn a positive return under its current structure; credit is again about to fall off a cliff; does not earning; NIMs are among the lowest in the USA; and capital is shortly about to fall below regulatory guidance. Further, the bad acquisitions and regulatory headaches should spur management to cut and run in the US. We look forward to Group results on February 23rd, and the clarity we will receive on its hot mess in the US.     

HSBC Holdings Plc –American Result Intimates Group Miss

United States

Bank of America Corporation accepts deposits and offers banking, investing, asset management, and other financial and risk-management products and services.  The Company has a mortgage lending subsidiary, and an investment banking and securities brokerage subsidiary.

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Bank Of America (BAC US)

US Banks and the SLR Situation: Overweight JPM Tier 1 Securities

JPM’s fortress foundation needs repair. It has the lowest SLR buffer, and its Tier 1 suffers from this. Leverage slimming and a deeper capital...

Hank Calenti, CFA

Biden's Huge Stimulus Is Obliging the Fed to Edge Away from Unlimited QE

The 14% of GDP stimulus will oblige the Fed to tighten policy by mid-year, strengthening the US$.S&P500 dividend yield (1.5%) has been lower only...

Prasenjit K. Basu

US Financials: Back in Vogue

After a heavy sell of during the first few months of COVID-19, US Financials exposure bottomed out in August 2020 and turned sharply to the...

Steven Holden

Visa Inc – Noise Creates Buying Opportunity

VISA: The DOJ has again begun investigating Visa over anticompetitive practices due to alleged merchant restrictions to rout online debit-card...

Thomas J. Monaco

HSBC Holdings Plc –American Result Intimates Group Miss

HSBC HOLDINGS PLC: HSBCNA reported troubling results in 4Q20 - declining 195% linked quarter, as operating costs exceed recurring revenues. This...

Thomas J. Monaco

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