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

*Result Beat On Unwarranted Provision Reduction: Federal Bank (FB.IN) posted FY 3Q21 bottom-line results of INR 4.0 bn, exhibiting linked quarter improvement of INR 965 mn (31.4%). Two factors drove the bottom-line – one legitimate, the latter simply ridiculous: a) net interest income improved INR 571 mn (4.1%) tracking both loan growth of INR 26.0 bn (2.1%) and NIM improvement of 10 bp to 3.00%; and b) a drop of INR 1.7 bn (29.0%) in its loss provision despite an annualized net new problem loan increase of over 67%; and*Reserve Cover Is Shallow: If we look at coverage of total problem loans, which includes the restructured book, coverage amounts to just 59.0% versus 57.7% at FY 2Q21. Although we are encouraged by the linked quarter improvement, we do feel that reserve cover is quite light by close to INR 50.0 bn – nearly three years of bottom-line performance.

*Result Beat On Unwarranted Provision Reduction: Federal Bank (FB.IN) posted FY 3Q21 bottom-line results of INR 4.0 bn, exhibiting linked quarter improvement of INR 965 mn (31.4%). Two factors drove the bottom-line – one legitimate, the latter simply ridiculous: a) net interest income improved INR 571 mn (4.1%) tracking both loan growth of INR 26.0 bn (2.1%) and NIM improvement of 10 bp to 3.00%; and b) a drop of INR 1.7 bn (29.0%) in its loss provision despite an annualized net new problem loan increase of over 67%; and*Reserve Cover Is Shallow: If we look at coverage of total problem loans, which includes the restructured book, coverage amounts to just 59.0% versus 57.7% at FY 2Q21. Although we are encouraged by the linked quarter improvement, we do feel that reserve cover is quite light by close to INR 50.0 bn – nearly three years of bottom-line performance.    

*Provision Unnecessarily Lowered: Bajaj Finance (BAF.IN) [Bajaj] posted FY 3Q21 results of INR 11.5 bn, improving INR 1.8 bn (18.8%) linked quarter.  FY 3Q21 results were driven primarily by an INR 4.0 bn (20.5%) drop in the loss provision, despite a 123.4% linked quarter increase in gross NPLs;  and*Credit Challenges Far From Over With: The day of reckoning is coming for Bajaj as net new NPLs amounted to INR 23.0 bn at FY 3Q21 – increasing at 520% on an annualized basis. By our calculation, reserves need to increase INR 177 bn or nearly 8x  - representing nearly three years of PBT and over 50% of shareholder’s equity. Bajaj has actually lowered its loss provision guidance to between INR 59.25-59.75 bn for FY 2021 versus INR 60-63 bn earlier.

*Provision Unnecessarily Lowered: Bajaj Finance (BAF.IN) [Bajaj] posted FY 3Q21 results of INR 11.5 bn, improving INR 1.8 bn (18.8%) linked quarter.  FY 3Q21 results were driven primarily by an INR 4.0 bn (20.5%) drop in the loss provision, despite a 123.4% linked quarter increase in gross NPLs;  and*Credit Challenges Far From Over With: The day of reckoning is coming for Bajaj as net new NPLs amounted to INR 23.0 bn at FY 3Q21 – increasing at 520% on an annualized basis. By our calculation, reserves need to increase INR 177 bn or nearly 8x  - representing nearly three years of PBT and over 50% of shareholder’s equity. Bajaj has actually lowered its loss provision guidance to between INR 59.25-59.75 bn for FY 2021 versus INR 60-63 bn earlier.

*NIM Driven Bottom-line: L&amp;T Finance Holdings (LTFH.IN) [LTFH] reported FY 3Q21 operating results of INR 2.9 bn, increasing INR 260 mn (9.8%) linked quarter. Much of LTFH’s strength during the quarter was attributed to net interest income growth of INR 2.1 bn (15.8%) associated with improving cost of funds (down 72 bp linked quarter) on liquidity improvement.*Credit Risk Challenges: While LTFH would like to have the investment community believe that it has turned the corner with credit, that notion is patently false. Inclusive of INR 12.8 mn in NCOs, we calculate a continued acceleration of net new NPL growth to 101% on an annualized basis – which is troubling. We calculate that reserves need a boost close to INR 80 bn or nearly five years of pre-tax earnings; and   *Banking License May Be Out of Reach: LTFH's Tier-1 ratio was 17.8% at FY 3Q21. However, if our reserve shortfall analysis is correct, LTFH’s stated Tier 1 capital ratio will be quite challenged, leaving it short of the Reserve Bank of India’s (RBI) plan for larger NBFCs to become banks.

*NIM Driven Bottom-line: L&amp;T Finance Holdings (LTFH.IN) [LTFH] reported FY 3Q21 operating results of INR 2.9 bn, increasing INR 260 mn (9.8%) linked quarter. Much of LTFH’s strength during the quarter was attributed to net interest income growth of INR 2.1 bn (15.8%) associated with improving cost of funds (down 72 bp linked quarter) on liquidity improvement.*Credit Risk Challenges: While LTFH would like to have the investment community believe that it has turned the corner with credit, that notion is patently false. Inclusive of INR 12.8 mn in NCOs, we calculate a continued acceleration of net new NPL growth to 101% on an annualized basis – which is troubling. We calculate that reserves need a boost close to INR 80 bn or nearly five years of pre-tax earnings; and   *Banking License May Be Out of Reach: LTFH's Tier-1 ratio was 17.8% at FY 3Q21. However, if our reserve shortfall analysis is correct, LTFH’s stated Tier 1 capital ratio will be quite challenged, leaving it short of the Reserve Bank of India’s (RBI) plan for larger NBFCs to become banks.

L&T Finance Holdings – Credit Risk Jeopardizes Bank License

*Strong Results, But Managed: HDFC Bank (HDFCB.IN) [HDFCB] reported FY 3Q21 results of INR 76.5 bn, which increased INR 12.5 bn (16.6%) linked quarter. On a core operating basis, results improved INR 11.5 bn (17.7%) to INR 76.5 bn over the period. Other income drove the results outperformance;*Credit Still Breaking Down Ex-Supreme Court Ruling: The Supreme Court of India, in a public interest litigation directed that accounts which were not declared NPL through August 31, 2020 shall not be declared as such until further notice. On an apples-to-apples basis, we find that HDFCB’s stated gross NPLs increased 18.1% linked quarter. Inclusive of NCOs of INR 34 bn, we calculate that net new NPLs actually increased INR 65 bn or 151% on an annualized basis; and*Reserve Cover Needs Improvement: At this time, provisions barely cover NCOs – down from 2.4x in FY 3Q21. We would be more comfortable if HDFCB was a bit more aggressive with its provisions – especially during periods when volatile sources of fee revenues give HDFCB a gift to build reserves. By our calculation, reserves are currently short by nearly INR 328 bn or over a year of core operating results based on FY 3Q21 results.

*Strong Results, But Managed: HDFC Bank (HDFCB.IN) [HDFCB] reported FY 3Q21 results of INR 76.5 bn, which increased INR 12.5 bn (16.6%) linked quarter. On a core operating basis, results improved INR 11.5 bn (17.7%) to INR 76.5 bn over the period. Other income drove the results outperformance;*Credit Still Breaking Down Ex-Supreme Court Ruling: The Supreme Court of India, in a public interest litigation directed that accounts which were not declared NPL through August 31, 2020 shall not be declared as such until further notice. On an apples-to-apples basis, we find that HDFCB’s stated gross NPLs increased 18.1% linked quarter. Inclusive of NCOs of INR 34 bn, we calculate that net new NPLs actually increased INR 65 bn or 151% on an annualized basis; and*Reserve Cover Needs Improvement: At this time, provisions barely cover NCOs – down from 2.4x in FY 3Q21. We would be more comfortable if HDFCB was a bit more aggressive with its provisions – especially during periods when volatile sources of fee revenues give HDFCB a gift to build reserves. By our calculation, reserves are currently short by nearly INR 328 bn or over a year of core operating results based on FY 3Q21 results.   

HDFC Bank – Credit Remains A Serious Challenge

Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Democratic Party control of the Senate has clearly moved the goal posts for fixed income investors. The reflation trade is back. This requires repositioning by bank credit investors.The good news is that the rise in Treasuries is beneficial to bank securities over the short term, especially since it is occurring in tandem with continued bear steepening from the short end of the curve. Globally, higher net interest margins should follow from the steepening of the U.S. yield curve as excess reserves are allocated into US$ securities. However, the impact on India-headquartered banks may be less as we discuss within.There are two less positive impacts. First, if the rise in rates is a reflection that inflation is expected to return, then this is not duration friendly. In fact, long duration fixed income securities suffered over the last week. Theoretically, credit curves should flatten in response to the yield curve steepening. However, given the enormous level of monetary accommodation over the last nine months, the question then becomes, how much further can spreads tighten? Credit only has limited upside in the current reflation scenario. Second, higher rates will raise the real effective US$ exchange rate. All else equal, a higher real effective US$ exchange rate is dollar positive.  Asia and emerging market (EM) securities could suffer.Against this backdrop, higher risk Additional Tier 1 (AT1) bank bonds outperformed, principally driven by Thailand- and other higher risk China-centric securities on expectations of increased economic activity. Thai banks performed across the credit continuum in Senior Unsecured, Tier 2 and AT1 notes. This seems to be a case of cognitive dissonance which ignores vaccine distribution and time extension risks. The COVID-19 situation is deteriorating in Thailand and elsewhere. High financial market valuations seem inconsistent with economic activity. A pronounced degradation of asset prices could materialize. Our preference is to fade the Thai-bank rally.France’s central bank noted that systemic risk may rise over the coming months due to high corporate debt and the current round of Covid-19 lockdowns. The regulator stated that a significant rise in defaults could occur in a slow economic recovery. Please see <a href="https://www.smartkarma.com/insights/bnp-paribas-capital-forbearance-and-cds" target="_blank" data-smartkarma-citation="insights:46684" rel="noopener">BNP Paribas: Capital, Forbearance and CDS</a> for our assessment of this situation.In addition, we note that<a href="https://www.smartkarma.com/entities/commerzbank-ag" target="_blank" data-smartkarma-citation="entities:21596:1" rel="noopener">Commerzbank AG (CBK GR)</a> set a high bar for balance sheet clean-up by announcing a 50% increase in loan loss provisions for COVID-19. We would not be surprised to see additional healthy increases in loan loss provisioning. In fact, credit investors should be concerned if there are limited additional provisions taken. US banks kick-off the global bank earnings season on Friday.Market Outlook: Absent another behavioral lapse by the US President, ebullience over the prospects of additional stimulus spending should continue to positively impact the markets. Another lapse by the US President could see a temporary rise in demand for safe-haven assets. Eventually, the real issue of how much is too much stimulus as the vaccine is rolled-out will lead to concerns on how the Fed reacts. In this environment, artificially engineered credit costs may come back to hurt bank investors. Credit only has limited upside in the current reflation scenario and duration is not your friend at this point in the cycle.

Democratic Party control of the Senate has clearly moved the goal posts for fixed income investors. The reflation trade is back. This requires repositioning by bank credit investors.The good news is that the rise in Treasuries is beneficial to bank securities over the short term, especially since it is occurring in tandem with continued bear steepening from the short end of the curve. Globally, higher net interest margins should follow from the steepening of the U.S. yield curve as excess reserves are allocated into US$ securities. However, the impact on India-headquartered banks may be less as we discuss within.There are two less positive impacts. First, if the rise in rates is a reflection that inflation is expected to return, then this is not duration friendly. In fact, long duration fixed income securities suffered over the last week. Theoretically, credit curves should flatten in response to the yield curve steepening. However, given the enormous level of monetary accommodation over the last nine months, the question then becomes, how much further can spreads tighten? Credit only has limited upside in the current reflation scenario. Second, higher rates will raise the real effective US$ exchange rate. All else equal, a higher real effective US$ exchange rate is dollar positive.  Asia and emerging market (EM) securities could suffer.Against this backdrop, higher risk Additional Tier 1 (AT1) bank bonds outperformed, principally driven by Thailand- and other higher risk China-centric securities on expectations of increased economic activity. Thai banks performed across the credit continuum in Senior Unsecured, Tier 2 and AT1 notes. This seems to be a case of cognitive dissonance which ignores vaccine distribution and time extension risks. The COVID-19 situation is deteriorating in Thailand and elsewhere. High financial market valuations seem inconsistent with economic activity. A pronounced degradation of asset prices could materialize. Our preference is to fade the Thai-bank rally.France’s central bank noted that systemic risk may rise over the coming months due to high corporate debt and the current round of Covid-19 lockdowns. The regulator stated that a significant rise in defaults could occur in a slow economic recovery. Please see BNP Paribas: Capital, Forbearance and CDS for our assessment of this situation.In addition, we note thatCommerzbank AG (CBK GR) set a high bar for balance sheet clean-up by announcing a 50% increase in loan loss provisions for COVID-19. We would not be surprised to see additional healthy increases in loan loss provisioning. In fact, credit investors should be concerned if there are limited additional provisions taken. US banks kick-off the global bank earnings season on Friday.Market Outlook: Absent another behavioral lapse by the US President, ebullience over the prospects of additional stimulus spending should continue to positively impact the markets. Another lapse by the US President could see a temporary rise in demand for safe-haven assets. Eventually, the real issue of how much is too much stimulus as the vaccine is rolled-out will lead to concerns on how the Fed reacts. In this environment, artificially engineered credit costs may come back to hurt bank investors. Credit only has limited upside in the current reflation scenario and duration is not your friend at this point in the cycle.

Bank Credit Weekly: Moving the Goal Posts

India

Canara Bank Ltd. provides a full range of banking services throughout India. The Group's activities include retail banking, commercial and personal banking, investment management, treasury & NRI services, cash management and assorted ATM facilities.

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Canara Bank (CBK IN)

Federal Bank – Deserving No Credit

FEDERAL BANK: FB FY 3Q21 bottom-line results improved 31.4% linked quarter, as it dropped its provision 29.0% despite its annualized net new...

Thomas J. Monaco

Bajaj Finance – Credit Disaster

BAJAJ FINANCE: BAF FY 3Q21 results increased 18.8% linked quarter, driven by a 20.5% drop in provisions despite a 123.4% increase in NPLs. We...

Thomas J. Monaco

L&T Finance Holdings – Credit Risk Jeopardizes Bank License

L&T FINANCE: LTFH reported a FY 3Q21 result increase of 9.8% linked quarter. Continued acceleration of net new NPL growth and a reserve shortfall...

Thomas J. Monaco

HDFC Bank – Credit Remains A Serious Challenge

HDFC BANK: HDFCB reported FY 3Q21 results increased 16.6% linked quarter. Net new NPLs increased 151% annualized, and reserves are currently short...

Thomas J. Monaco

Bank Credit Weekly: Moving the Goal Posts

Fixed income goal posts were clearly moved by Democratic Party control of the Senate. Credit has limited upside in the current reflation scenario....

Hank Calenti, CFA

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