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Monthly Archives: January 2019

6th January 2019

Tell me why

MARKET CLOSE:
iTraxx Main

88.5bp, -4.6bp

iTraxx X-Over

357.3bp, -16.2bp

🇩🇪 10 Yr Bund

0.20%, +5bp

iBoxx Corp IG

B+177.6bp, +2bp

iBoxx Corp HY

B+543bp, unchanged

🇺🇸 10 Yr US T-Bond

2.66%, +11bp

🇬🇧 FTSE 100

6144.25, (+1.26%)
🇩🇪 DAX

11657.69, (+1.33%)
🇺🇸 S&P 500

3036.13, (+0.74%)

It’s the economy…

With the noise associated with the opening week of any year out of the way, we can now focus properly on the near-term outlook for the markets. It was some noise, with the markets flying in the closing session, equities up by over 3% in some instances. The US jobs report was excellent and the principal driver of the rally, while there was hope in some quarters of a trade breakthrough as US-Chinese representatives are due to meet. However, we’re not sure that last week’s closing rally will have done much to have altered anyone’s view. We would not be buying into it. Still, it has likely opened the window for a few deals in credit primary as we kick off business this week. Borrowers should grasp the opportunity.

In addition, Powell’s upbeat assessment of the US economy was welcomed (it’s his job after all) and also went some way in helping to quash the downward spiral in sentiment and markets.

Macro is going to dominate for the moment though. Even if the Fed’s Powell suggests otherwise, industrial data from the US suggests all is not well (labour market aside) as the corporate sector and the economy overall feel the heat of a slowdown, and adds to the gloomy data before it from China. The Chinese have reacted by reducing their banks’ reserve requirement (again) and it also might have added lift spirits – but only temporarily. We think they’re pushing against a string.

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3rd January 2019

Clobbered… again, of course

MARKET CLOSE:
iTraxx Main

93.1bp, +3.7bp

iTraxx X-Over

373.5bp, +11.5bp

🇩🇪 10 Yr Bund

0.15%, -2bp

iBoxx Corp IG

B+175.8bp, +2.8bp

iBoxx Corp HY

B+544bp, +5.5bp

🇺🇸 10 Yr US T-Bond

2.56%, -10bp

🇬🇧 FTSE 100

6144.25, (+1.26%)
🇩🇪 DAX

11657.69, (+1.33%)
🇺🇸 S&P 500

3036.13, (+0.74%)

Recession fears mounting…

China. That old chestnut. It’s all tumbling down around it, as the importance of her economy reverberates through the global economic system. Apple might have tumbled just now, but swathes of exposed – mainly industrial/luxury groups – have been hit before it. Others will follow. A Brexit (no-deal) timing will be a nail in the coffin for the Eurozone and the establishment needs to wake up. Recession looms.

We feared that the opening quarter, if not most of 2019, would be bad – but as things stand it looks as though it could get quite ugly. We’re not betting against the benchmark 10-year Bund yield falling below 0.10% (currently 0.15%), while that 0% yield level could come quicker than some might think.

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2nd January 2019

Back to work

MARKET CLOSE:
iTraxx Main

89.4bp, +1.3bp

iTraxx X-Over

362.0bp, +7.6bp

🇩🇪 10 Yr Bund

0.17%, -8bp

iBoxx Corp IG

B+173bp, +0.6bp

iBoxx Corp HY

B+535bp, +11bp

🇺🇸 10 Yr US T-Bond

2.67%, -2bp

🇬🇧 FTSE 100

6144.25, (+1.26%)
🇩🇪 DAX

11657.69, (+1.33%)
🇺🇸 S&P 500

3036.13, (+0.74%)

More of the same…

No line in the sand signalling a fresh, brighter period for the markets. We kicked off the new year with all the ills with which we experienced so much volatility from in 2018 still with us. And it doesn’t look pretty for the opening period. China got the ball rolling, reporting that December’s manufacturing activity contracted for the first time in 19 months amid weakness in both external and domestic demand. Equities took a tumble in Asia and Europe followed – initially anyway, rates (safe havens) were massively better bid throughout and credit edged wider in the quietest of sessions. Sound familiar? The move in rate markets is suggestive of material pain to come (macro, geopolitical or whatever the driver) because a 10bp drop in the Bund yield, from an already low 0.24% is a panic adjustment.

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2nd January 2019

European Banks – 2019 Outlook | Bank Capital

It may look so bad, yet there is scope for 10%+ returns through careful single name selection.

General macro outlook

Growth slowdown and dis-inflation will lead to ECB staying put on rates and potentially re-introducing QE. Another round of TLTRO funds is likely to be made available to banks as capital markets remain shut. Credit contraction likely to persist as banks further de-risk. Populism means tail risks remain high. And finally banking union and an EU wide bank deposit insurance program unlikely to happen anytime soon and that means more fragmentation. Non-bank financial institutions likely to further disrupt lending business models.


Earnings Outlook

Further margin compression to be expected with funding costs going up. Slowdown in capital market activities leading to further revenue pressure. Cost pressure leading to more restructuring and capacity shrinkage. Compliance, legal and settlement costs across the industry to remain elevated.

All of above means expect further profitability issues for the industry and ROE to come under pressure. Most banks unlikely to meet COE and expect mid to high single-digit ROEs for most banks. Capital distributions in the form of dividends and share buybacks to slow down.


Asset Quality Outlook

Expect a small deterioration in asset quality this year and future NPL formation depends on how low growth gets in 2019. Further, banks exposed to leveraged loan markets, EM cross-border lending and consumer financing should see a large tick up in credit costs this year.

Capital and funding outlook:
Current regulatory capital ratios are fine across the large cap banks but leverage is still an issue. Pressing need is to meet TLAC and MREL requirements and to that expect significant issuance of Non-Preferred senior and Holdco senior paper. Most of AT! Issuance already done but refinancing for 2020 calls may come by if markets open up. Expect non-call in AT1 and LT2 as banks preserve capital.


What does the sector need for us to get excited?

  • Interest rate regime to normalise
  • Regulatory regime to stabilise
  • Merger activity and/or capacity shrinkage
  • Significant cost base reduction
  • Banking and capital markets union
  • Political risk premium to subside

…but there is scope for plenty of dispersion and hence single name selection becomes key.

Winners are likely to be those firms with:

  • A transparent and relatively straightforward business model
  • Strong customer franchise especially in retail banking and able to defend interest margins
  • Low cost to income ratio
  • Solid asset quality with high reserve coverage
  • Good RWA/Leverage ratio density
  • Solid equity capitalisation

Whom to own and whom to avoid/dodge?

Names that screen well on above criteria: Lloyds, HSBC, UBS, ING, Nordea, Svenska, DnB NOR, Credit Agricole

Names that score fine but will be a continuous focus to market participants – Barclays, SANTAN, BNP, ISPSIM, RBS, STANLN, CS

Names that have issues on one or more topics mentioned above and hence need more scrutiny – DB, UCGIM, SG, DANKSE, BBVA, BPIM, CMZB

The outlook for bank capital instruments:

AT1 – likely to further underperform but will find clearing levels around 8% yield to perp. It is all about relative value within AT1 with defensive names holding up better than higher beta names.

LT2 – potentially the best part of capital structure to own (depending on name) due to limited issuance and overall yields relative to AT! Or NPS. Better to own operating bank LT2 given potential for spread compression.

NPS / Holdco – likely to underperform from current levels due to ongoing issuance requirements and risk premium required for potential bail-in risks. Holdco Senior is structurally better to own ahead of NPS as it benefits from diversified cash flows from operating subsidiaries

When is AT1 attractive to own?

Once the right issuer has been identified, then AT!s issued by that bank would be attractive to own if:

  • Yield to Perp is close to 80% of bank’s COE
  • AT1 yield is double the bank’s dividend yield
  • No more issuance to meet regulatory capital thresholds
  • Significant headroom on both coupon paying ability test and conversion trigger test
  • Bank’s equity is trading at or above 0.6 P/TNAV
  • Issue level rating likely to move to IG at all 3 agencies.

Conclusion

2019 is going to be a very interesting year for bank capital and clearly there is significant scope for generating substantial returns based on single name selection and dynamic portfolio risk management.

As usual, the devil is in the detail and through careful single name and single-issue selection there is scope for 10%+ returns in bank capital space.

Get in touch if you need any further clarification on information here or if you want to discuss the above outlook and/or on single names:

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1st January 2019

Credit Outlook 2019 (Free Content)

MARKET CLOSE:
iTraxx Main

88bp

iTraxx X-Over

354.4bp

🇩🇪 10 Yr Bund

0.24%

iBoxx Corp IG

B+172bp

iBoxx Corp HY

B+524bp

🇺🇸 10 Yr US T-Bond

2.69%

🇬🇧 FTSE 100

6144.25, (+1.26%)
🇩🇪 DAX

11657.69, (+1.33%)
🇺🇸 S&P 500

3036.13, (+0.74%)

The good, the bad and the downright ugly…

Greetings for 2019. We’re going be looking at one the most exciting years for a while. That there’s no hiding from the fact that it promises to be just as difficult as last year, riddled with as much – if not greater levels of – uncertainty, and we’re going to need to be on our toes right through it. That’s because many of 2018’s situations will continue to play out this year. Be that the real more material impact of the central bank tightening cycle, tense Sino/US relations and the impact of those trade tariffs, a raft of geopolitical event risks, the various developing friction between the sovereign states of the EU and the establishment, and Brexit. Oh yes, then there’s President Trump.

In 2018 we lost ugly in equities, it was bad in credit and commodities, while (Eurozone especially) rates were the good in performance terms. The Dax lost 18%, the S&P recovered to close around 6% lower (had been a stunning 12% YTD loss just before Christmas), euro IG credit returned -1.2% and euro high yield -3.6%. Brent was down $13 per barrel while Eurozone rate total returns were alone in the black at +0.9%.

The year might have ended in rollercoaster fashion for equities but it was with maximum turmoil. And nearly all of the issues came from the White House generated turmoil. All eyes will remain focused here. In the thick of it all was Trump. In no particular order, we had a partial shut down of the government as Trump battled the Democrats for ‘wall’ funding.

Trump’s foreign policy antics infuriated the US’s global military defence allies, while he was aiming fire at the Fed (speculation he wanted to fire Fed chairman Powell) irritated by their hawkish rate move in December. If ever there was a need to calm the markets amid some serious losses, Treasury Secretary Mnuchin took the rather unusual – rather mis-timed, almost rookie-esque, step to assure us about the banking sector’s liquidity!

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