Daily Archives: 30th October 2018
Daily Archives: 30th October 2018
|🇩🇪 10 Yr Bund
|iBoxx Corp IG
|iBoxx Corp HY
|🇺🇸 10 Yr US T-Bond
|🇬🇧 FTSE 100 7,382.01, (-0.58%)||🇩🇪 DAX 13681.19, (-0.75%)||🇺🇸 S&P 500 3370.29, (-0.39%)|
Rallies are all too often becoming false dawns, leaving us to genuinely believe we could be at an inflection point for the markets. That means there will be no theme until we get some better clues as to where we are going. Treading water is a well-known survival technique until a ship arrives. It is eerily quiet in the corporate bond market resulting in volumes and confidence at rock bottom levels, with sentiment impacted by the huge levels of intra-day volatility in equities.
The European bank earnings season continues with HSBC, BNP & BBVA all reporting in the last two days. All three banks reported better than expected net income and improved operating performance relative to Q3 2017. However, the share price reaction in the respective banks’ post announcement reflects the differing investor perception of future prospects.
All three banks have a common thread – diversified business models with a strong domestic franchise and large international presence, especially in EM. The standout feature is that HSBC is in fast-growing Asian markets where it is a dominant player and is able to use its retail banking franchise as a solid platform to cross-sell other services.
HSBC stock is up almost 5% in the last few days as the bank reported positive jaws with revenue growth in its key Asian markets comfortably outpacing costs. With a low level of loan loss impairments, the bank delivered a double-digit return on tangible equity (RoTE) in most of its business divisions with the Retail Bank & Wealth Management Unit reporting a very strong 22% RoTE.
HSBC’s key strength permeates from its very strong deposit-taking franchise (especially in Asian markets) and this is reflected in the loan-to-deposit ratio of 73% – hence very little reliance on wholesale markets for funding. With very little margin pressure, the bank is able to generate stable net interest income and any loan growth/cross-selling of products leads to revenue growth. Capital metrics continue to be strong with a reported CET1 of 14.3% and a leverage ratio of 5.4%.
The real question going forward is the sustainability of the very low loan loss impairment charges (Q3 18: 0.30%) and what happens if there is a full-blown recession/slowdown in the Asian markets. Pre-provision income is robust enough to handle a large spike in loan losses but earnings growth/momentum may yet be impacted. Delivering positive jaws in operating performance is welcome but it remains to be seen if it will change equity investor perception for a permanent re-rating.
BNP reported earnings that would have normally been sufficient to please most investors. Yet, the stock was down almost 4% post-announcement. It seems that the ongoing drop in revenues in CIB (especially in FICC business) is causing investors to reassess forward-looking earnings momentum. The key issue is – how to get revenue growth within FICC business (which is undergoing fundamental structural change) and yet keep the cost base low? In addition, the bank’s presence in Italy and Turkey exposes it to potentially higher loan losses in coming periods. Risk management has been the bank’s strength over the years and hence is well placed to handle this.
Asset quality and liquidity metrics are holding up very well. In my personal view, the bank’s reported capital metrics are just about fine with a CET 1 ratio of 11.7% and a leverage ratio of 4%. Further, some of the bank’s large cap global peers report much higher capital metrics, especially on leverage ratio, and the bank may yet need to build further capital buffers or reduce risk exposure in coming periods. In my opinion, BNP used to be a very defensive play within the European banks but of late some underlying issues have crept up.
BBVA (stock was down almost 3%) reported earnings that were much better across the spectrum with positive operating jaws and low loan loss impairments. However, earnings were boosted by a one-off EUR 633 million gain from the disposal of BBVA Chile.
Overall, ROTE of 14.8% is decent and reflects the strength of the bank’s retail banking franchise. Asset quality continues to improve with falling NPLs and “low” cost of risk. Capital metrics look decent with a CET1 ratio of 11.4% and a leverage ratio of 6.6%. With the bank’s AT1 and LT2 buckets fully covered, the likelihood of further issuance is limited.
The real issue is the bank’s presence/exposure in Turkey and LATAM (Mexico, Peru, Columbia and Argentina). Clearly, equity investors are starting to apply a much higher equity risk premium and now seen as an EM proxy. Perception is reality in some cases, it seems.
Purely on a standalone basis, all three banks have good credit profiles. But each one of them has separate mmacro-related issues to contend with – HSBC (potential China slowdown and Asia recession), BNP (Italy, structural issues in FICC land), BBVA (periphery spread widening, EM sell-off) and to that extent credit spread will be impacted by overall risk perception especially from an equity investor angle.
BNP and BBVA equity is trading at a big discount to tangible net asset value reflecting some of the macro headwinds and underlying business model factors. Within sub debt, it appears to me that the AT1s issued by the three banks will continue to be driven by the ongoing rates and equities volatility and market liquidity issues. Senior parts of the capital structure especially for HSBC and BNP should hold up reasonably well from a spread widening perspective.