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

Specialist in Indian Banking and Economic Research

Hemindra Hazari

Thematic (Sector/Industry)

In the last 7 1/2 years private sector  banks have increased their market share in overall deposits and credit in the industry. More importantly, in the critical metropolitan (population 1 mn+) areas, which account for the majority of banking business, their gains have been even higher. Government banks have borne the brunt of the loss in market share. This has been on account of their asset quality losses arising from a major feature of economic reforms, namely, the privatisation of infrastructure, funded primarily by government banks; the economic slowdown; and the failure of the government to adequately recapitalise its own banks, ostensibly for fiscal reasons.  While many in the capital market may applaud the increase in market share of private sector banks as a positive development, and as a benign backdoor entry for the further privatisation of the banking sector, policy makers and the public should be aware of some critical aspects. Firstly, the majority of India’s population resides in rural areas, and the overwhelming bulk of the business of private sector banks comes from metropolitan centres. The concentration of private sector banks in metropolitan centres is much higher than that of the overall banking industry, and correspondingly the private sector banks’ rural business is much lower than the industry average. Allowing private sector banks to continue to increase their market share in concentrated areas may further widen the lopsided socio-economic development of India. Secondly, foreign ownership is prevalent in Indian private sector banks; in the 5 largest private sector banks by market capitalisation, foreigner ownership is nearly 60%.Banking in any economy is a strategic industry, in which ownership is not only expected to be diversified, but also encouraged to be domestic. As domestic depositors are the largest stakeholders in Indian banks, it is imperative to check the influence of foreign owners over Indian banks. Foreign portfolio owners are naturally governed by their own interests, which may override domestic interests. While the Reserve Bank of India (RBI) has regulated banks to ensure diversification of ownership, and prevented foreign investors from owning more than a certain threshold of shares, and exercising control over a local bank, over time this could change.In such a scenario it is unfortunate that the government ignores its own banks and provides an impetus to further privatise government banks. In a developing country like India, where the vast majority survive on low incomes, profitability cannot be the sole indicator to measure bank performance, but should be one of others focusing on a more balanced socio-economic development model. While the capital market and government may rejoice with the privatisation of Indian banking, there may be long term repercussions for Indian stakeholders.

In the last 7 1/2 years private sector  banks have increased their market share in overall deposits and credit in the industry. More importantly, in the critical metropolitan (population 1 mn+) areas, which account for the majority of banking business, their gains have been even higher. Government banks have borne the brunt of the loss in market share. This has been on account of their asset quality losses arising from a major feature of economic reforms, namely, the privatisation of infrastructure, funded primarily by government banks; the economic slowdown; and the failure of the government to adequately recapitalise its own banks, ostensibly for fiscal reasons.  While many in the capital market may applaud the increase in market share of private sector banks as a positive development, and as a benign backdoor entry for the further privatisation of the banking sector, policy makers and the public should be aware of some critical aspects. Firstly, the majority of India’s population resides in rural areas, and the overwhelming bulk of the business of private sector banks comes from metropolitan centres. The concentration of private sector banks in metropolitan centres is much higher than that of the overall banking industry, and correspondingly the private sector banks’ rural business is much lower than the industry average. Allowing private sector banks to continue to increase their market share in concentrated areas may further widen the lopsided socio-economic development of India. Secondly, foreign ownership is prevalent in Indian private sector banks; in the 5 largest private sector banks by market capitalisation, foreigner ownership is nearly 60%.Banking in any economy is a strategic industry, in which ownership is not only expected to be diversified, but also encouraged to be domestic. As domestic depositors are the largest stakeholders in Indian banks, it is imperative to check the influence of foreign owners over Indian banks. Foreign portfolio owners are naturally governed by their own interests, which may override domestic interests. While the Reserve Bank of India (RBI) has regulated banks to ensure diversification of ownership, and prevented foreign investors from owning more than a certain threshold of shares, and exercising control over a local bank, over time this could change.In such a scenario it is unfortunate that the government ignores its own banks and provides an impetus to further privatise government banks. In a developing country like India, where the vast majority survive on low incomes, profitability cannot be the sole indicator to measure bank performance, but should be one of others focusing on a more balanced socio-economic development model. While the capital market and government may rejoice with the privatisation of Indian banking, there may be long term repercussions for Indian stakeholders.

Creeping Denationalisation of India’s Banking Sector

India Financials

Saumya Agarwal

Equity Bottom-Up

City Union Bank, the oldest Private sector Bank in India, has been focused on providing credit to the small and medium businesses in South India. Despite being a regional bank, its stock commands premium valuation vis-à-vis many other private sector banks. What is driving the superior valuation for this South- India focused Bank?

City Union Bank, the oldest Private sector Bank in India, has been focused on providing credit to the small and medium businesses in South India. Despite being a regional bank, its stock commands premium valuation vis-à-vis many other private sector banks. What is driving the superior valuation for this South- India focused Bank?

City Union Bank: What Is Driving Premium Valuation for This Oldest Private Sector Bank?

Debt Capital Markets

SBI (State Bank of India) / Debt Capital Markets

We see fair value at T+150 for <a href="https://www.smartkarma.com/entities/state-bank-of-india" target="_blank" data-smartkarma-citation="entities:160:1" rel="noopener">State Bank of India (SBIIN)</a> new 5.5-year senior unsecured US$-bond in the current market environment, despite the difficulties facing India post-COVID-19. This bond was marketed with an initial price talk of 175 basis points (bps) over similar maturity Treasuries. Our enclosed relative value assessment is based on bond spread comparisons with regional peer banks and entities tied to the Republic of India. We anticipate that market demand may drive this bond inside fair value as global monetary accommodation pushes investors down the credit curve. Although BBB- rated SBIIN operates a capital-light franchise, with a Common Equity Tier 1 ratio of only 10.8%, the real risk to bondholders is another rating downgrade. Negative outlooks placed on India by Moody’s and Fitch in June suggest the significant risk of a downgrade over the next 12 months. A non-investment grade rating would reduce the population of investors that are able to own this security. Given these dynamics, we believe that you buy this bond to own it and not to trade it over the long term.Concurrently, in an act of bad timing, Moody's withdrew a rating on SBIIN while the bank was marketing the new senior unsecured note. Moody’s withdrew its P-3 short-term rating on State Bank of India and its branches. The rating agency cited business reasons. This is code for the fact that SBIIN was not paying for this rating and should not be confused with anything related to the fundamental credit strength of the institution.

We see fair value at T+150 for State Bank of India (SBIIN) new 5.5-year senior unsecured US$-bond in the current market environment, despite the difficulties facing India post-COVID-19. This bond was marketed with an initial price talk of 175 basis points (bps) over similar maturity Treasuries. Our enclosed relative value assessment is based on bond spread comparisons with regional peer banks and entities tied to the Republic of India. We anticipate that market demand may drive this bond inside fair value as global monetary accommodation pushes investors down the credit curve. Although BBB- rated SBIIN operates a capital-light franchise, with a Common Equity Tier 1 ratio of only 10.8%, the real risk to bondholders is another rating downgrade. Negative outlooks placed on India by Moody’s and Fitch in June suggest the significant risk of a downgrade over the next 12 months. A non-investment grade rating would reduce the population of investors that are able to own this security. Given these dynamics, we believe that you buy this bond to own it and not to trade it over the long term.Concurrently, in an act of bad timing, Moody's withdrew a rating on SBIIN while the bank was marketing the new senior unsecured note. Moody’s withdrew its P-3 short-term rating on State Bank of India and its branches. The rating agency cited business reasons. This is code for the fact that SBIIN was not paying for this rating and should not be confused with anything related to the fundamental credit strength of the institution. 

State Bank of India: New 5.5-Year Senior -  Until Downgrade Do Us Part

Asia’s Subordinated debt, both Additional Tier 1 (AT1) and Tier 2 bonds outperformed higher ranked Senior Unsecured notes over the holiday shortened week. We attribute this to a shift into higher duration exposure as most of the outperformers were 2025 or longer first call bonds.<a href="https://www.smartkarma.com/entities/bangkok-bank-public-co-ltd" target="_blank" data-smartkarma-citation="entities:213:1" rel="noopener">Bangkok Bank's (BBLTB)</a> 5% coupon and <a href="https://www.smartkarma.com/entities/bank-of-east-asia-ltd" target="_blank" data-smartkarma-citation="entities:341:1" rel="noopener">Bank of East Asia's (BNKEA)</a> 5 7/8% coupon AT1 bonds, both with 2025 first call dates, led amongst liquid securities. <a href="https://www.smartkarma.com/entities/indiabulls-housing-finance-ltd" target="_blank" data-smartkarma-citation="entities:13086:1" rel="noopener">Indiabulls Housing Finance's (IHFLIN)</a> 6 3/8% coupon 2022 maturity bond led performance amongst less liquid notes by tightening 41bps following last week’s 56bps performance. The bond now trades within 1300bps of its benchmark but remains very illiquid. Otherwise, high grade Senior Unsecured returns were dragged lower by India-based bank issuers. <a href="https://www.smartkarma.com/entities/icici-bank-ltd" target="_blank" data-smartkarma-citation="entities:547:1" rel="noopener">ICICI Bank's (ICICIBC IN)</a> and <a href="https://www.smartkarma.com/entities/canara-bank" target="_blank" data-smartkarma-citation="entities:543:1" rel="noopener">Canara Bank's (CBKIN)</a> debt curve sold off while <a href="https://www.smartkarma.com/entities/state-bank-of-india" target="_blank" data-smartkarma-citation="entities:160:1" rel="noopener">State Bank of India's (SBIIN)</a> notes saw mixed performance.Once again, thin markets were directionless over the last week, so we focus on bond performance in this note. For a deeper assessment of bank credit performance in December and an assessment of potential January outcomes, please see <a href="https://www.smartkarma.com/insights/bank-credit-compass-regime-change-may-limit-the-annual-january-bounce" target="_blank" data-smartkarma-citation="insights:46712" rel="noopener">Bank Credit Compass: Regime Change May Limit the Annual January Bounce</a>. Market Outlook: The Goldilocks market may morph into a market wolf if the US Senate changes leadership from the runoff races in Georgia. Higher stimulus could be offset by concerns of higher taxes and regulations. This could negatively impact the annual January market bounce. Concurrently, reduced economic activity over the near term from increased virus-related lockdowns may not be fully reflected in asset prices. Against this background, thin markets may exacerbate price moves over the next week.

Asia’s Subordinated debt, both Additional Tier 1 (AT1) and Tier 2 bonds outperformed higher ranked Senior Unsecured notes over the holiday shortened week. We attribute this to a shift into higher duration exposure as most of the outperformers were 2025 or longer first call bonds.Bangkok Bank's (BBLTB) 5% coupon and Bank of East Asia's (BNKEA) 5 7/8% coupon AT1 bonds, both with 2025 first call dates, led amongst liquid securities. Indiabulls Housing Finance's (IHFLIN) 6 3/8% coupon 2022 maturity bond led performance amongst less liquid notes by tightening 41bps following last week’s 56bps performance. The bond now trades within 1300bps of its benchmark but remains very illiquid. Otherwise, high grade Senior Unsecured returns were dragged lower by India-based bank issuers. ICICI Bank's (ICICIBC IN) and Canara Bank's (CBKIN) debt curve sold off while State Bank of India's (SBIIN) notes saw mixed performance.Once again, thin markets were directionless over the last week, so we focus on bond performance in this note. For a deeper assessment of bank credit performance in December and an assessment of potential January outcomes, please see Bank Credit Compass: Regime Change May Limit the Annual January Bounce. Market Outlook: The Goldilocks market may morph into a market wolf if the US Senate changes leadership from the runoff races in Georgia. Higher stimulus could be offset by concerns of higher taxes and regulations. This could negatively impact the annual January market bounce. Concurrently, reduced economic activity over the near term from increased virus-related lockdowns may not be fully reflected in asset prices. Against this background, thin markets may exacerbate price moves over the next week.

Bank Credit Weekly: Duration Desires Deliver Asia's AT1 & Sub Outperformance

India

ICICI Bank Limited operates a network of banks located throughout India. The Group specializes in retail and corporate banking, in addition to Forex and treasury operations. ICICI Bank also provides a wide variety of investment banking, insurance and financial services to its clients.

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Icici Bank Ltd Spon Adr (IBN US)

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

Creeping Denationalisation of India’s Banking Sector

With foreign investors holding majority ownership of major private banks; & with such private banks increasing their market share, it is difficult...

Hemindra Hazari

City Union Bank: What Is Driving Premium Valuation for This Oldest Private Sector Bank?

City Union Bank, the oldest Private sector Bank in India has been commanding premium valuation vis-à-vis many other private sector banks. What is...

Saumya Agarwal

State Bank of India: New 5.5-Year Senior - Until Downgrade Do Us Part

We derive fair value at T+150. Market demand may drive this bond inside fair value. However, given rating directionality, we believe that you buy...

Hank Calenti, CFA

Bank Credit Weekly: Duration Desires Deliver Asia's AT1 & Sub Outperformance

Duration desires drove performance over the holiday shortened week. A US Senate leadership change could negatively impact the market as Goldilocks...

Hank Calenti, CFA

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