Global Credit Research Update

Transcription

1 Global Credit Research Update As of Third Quarter 2017 Market Commentary Global Credit Research Summary After several years of extraordinarily accommodative monetary policy, global central banks are (finally) set to begin withdrawing from asset purchase markets. Indeed, net asset purchases from advanced economy central banks could be close to zero by the end of 2018, after being as high as $180bn/month in mid-2016 (Citigroup Investment Research: Global Strategy and Macro Weekly; 9/18/17). While the improved global economic performance is the main driver of this policy shift, there are political and technical considerations involved as well, including- but not limited to the potential ability to loosen monetary policy in the future, if conditions warrant. For sure, the timing of the policy shift seems appropriate, given the recent combination of: stronger/synchronized global growth, solid corporate earnings across the globe, and the continuance of easy financial conditions. As the policy shift pertains to global credit markets and the current credit cycle, we see risks related to cycle timing. As noted last quarter, we view the current non-financial global credit cycle as extended. While the exceptionally long period of global monetary policy accommodation is a primary driver of its extension, a marginally better operating environment for global banks and corporations over the past 12 months is partly responsible for the latest leg of the cycle. The main question we have is whether the end of extraordinary accommodation will disrupt the cycle and expedite the timing of its conclusion. The primary avenue of disruption would likely be financial stability. It is our view that the current, benign financial conditions should give central banks more room to withdraw stimulus. However, there is risk that tighter financial conditions lead to a material revaluation of asset prices and causes financial instability. Further, the prospect of near-term risk events such as tensions in the Korea Peninsula, US political dysfunction (debt ceiling, tax reform and health care debates) and Brexit negotiations could also combine with tighter financial conditions to cause instability. The tail risk scenario is that instability leads to a downward spiral of asset prices and an even more pronounced tightening of financial conditions that could tip the global economy back into recession. We view this scenario as unlikely, in the near-term, for a few reasons. First, if tighter financial conditions were to negatively impact growth, global central banks would likely cease tightening, and/or even revert to policy loosening. Second, the material improvement in the structure and stability of the major global banking systems should enable banks to provide support to economies under most macroeconomic scenarios a positive legacy from post-financial crisis global bank regulatory reforms. To be sure, we are closely monitoring current situations that represent pockets of risk. For example, we expect that we will continue to see negative headlines with regard to: US retailers, US auto lending, potential excesses in the US commercial real estate market, the Chinese banking/ financial system, and signs of bubbles in the Canadian, Australian and Nordic housing markets. All of these risks have implications for the Global Cash credit universe and will be acute focuses for the Cash Credit Research team as we analyze the impacts from the normalization of global monetary policy. Financial Institutions United States Volatility reemerged in the 3rd quarter, at least temporarily, as investors grappled with geopolitical risks in the Korean peninsula, uncertainty around the new administration s policy agenda and the impact of the Fed s intention to shrink its balance sheet. Yet another important topic, the US debt ceiling, was effectively deferred into Under this backdrop, credit spreads in the banking sector compressed early in the quarter, spiked in mid-august and then stabilized. Although spread movements outperformed industrial peers, it is noteworthy that bank equity prices have underperformed the overall market, reflecting a recalibration of the benefits accruing to the sector from rates, deregulation and the implementation of progrowth policies. Fundamentally, the most recent quarterly earnings reflected an improving environment, as higher rates and modest loan growth helped boost net interest income, offset partially by weaker trading income. While deposit repricing trends continue to be supportive of net interest margins, this could change as the Fed unwinds QE. The industry s asset quality remained excellent though we expect higher reserves over time as asset classes normalize from historically low loss levels. Anecdotally, note that banks continued to tighten lending standards this quarter in auto, credit cards and commercial real estate. On capital, our expectation is that regulatory reform will coincide with higher leverage and lower capital ratios, albeit materially better than pre-crisis levels.

2 The ability of the new administration to enact its deregulatory agenda requires that it fill key personnel vacancies including those at the Federal Reserve Board of Governors. We anticipate that this will remain a primary focus going forward. While the overall credit implications of deregulation are mixed and will depend upon the ultimate changes, we caution that credit rating agencies could derive negative ratings pressure from changes that either significantly alter the current US resolution framework or materially weaken capital and liquidity standards. Europe The second quarter earnings season was fairly uneventful for European banks. Even with low volatility, banks generated decent investment banking results. Exceptions being Deutsche Bank and Credit Suisse, who remain restructuring laggards. However those banks have breathing-room with regards to their fundamental credit profiles, due to their recent capital increases. Loan growth was skewed to retail (mortgages and consumer finance) over small and mediumsized enterprises and large corporates. Asset quality was again stellar as banks remain at the top of the cycle. Low rates and home price recoveries prompted reversals of previously established loan loss provisions. This more than absorbed any oil or shipping related impairments. Positively, litigation is increasingly being covered by existing provisions. While legal threats are by no means over, the lack of major losses in 2Q17 is encouraging. Settlements include: two BNP FX cases, RBS with the FHFA, and SocGen with the Libya Investment Authority, and were all largely within previously established provisions. Overall, second quarter results did not alter our positive view of EU banks recovery. Supporting factors include: the 1H17 capital increases, clean-up of distressed peripheral banks, a pause in political risk (next Italian general election is no later than 05/20/18), legal settlement progress, and continued TLAC/MREL issuance. Canada The Canadian economy has performed well of late with GDP growth of nearly 4% in 1H17, and handily outpacing consensus estimates. This growth prompted the Bank of Canada to raise its benchmark interest rate twice during the 3rd quarter, representing its first tightening actions in seven years. Though elevated household debt levels remain an overarching concern in the economy, the unemployment rate has slid to pre-recession lows, average weekly earnings are rising and trends in retail sales have been favorable. In addition, consumer asset quality metrics continue to be stable including in unsecured debt. Recent quarterly results for the major Canadian banks showed continued growth in earnings. Although this has largely been accompanied by a decline in return-on-equity (a measure of the bank s profitability in relation to the book value of its shareholder equity), this reflects higher capital levels and is a favorable development for creditors. Performance was driven by better results in in Canadian retail banking, wealth management and international banking, offset by weaker results in wholesale banking. Looking ahead, the finalization of bank bail-in rules should occur later this year with implementation set for It remains to be seen how the rating agencies will react as lower government support from the enactment of a resolution regime is offset by a greater amount of lossabsorbing debt. Australia Economic growth has been below-trend over 1H17 (1.8%) driven by lower private consumption. Positively, recent labor market indicators have been favorable and suggest stronger consumption in the back-half of the year. Looking ahead, the RBA expects growth of around 3% over the next couple of years driven by stronger commodity exports, an end to the long slide in mining investment and a pickup in non-mining investment. In our view, an end to the recent residential construction boom, high levels of household debt and weak income growth are key risks, offset by income growth in Asia which is driving growth in key Australian service sectors such as education and tourism. One of the largest Australian banks reported its half-year results in August, while other major banks provided trading updates. Results were favorable from a credit standpoint with strong profitability continuing to be at internationally-robust levels and capital levels edging higher. The latter should continue to benefit from stricter capital standards which were finalized during the quarter, as well the potential for future changes in risk-weightings on residential mortgages. On asset quality, consumer delinquencies were relatively stable, excluding exposures in Western Australia, demonstrating continued resilience in the household segment. Asia The world s largest economies are showing signs of recovering, resulting in a boost to global demand. This has helped the growth momentum across the APAC region thanks to a pickup in exports. Domestic demand has also been supported by infrastructure spending and accommodative monetary policies. However, the situation with North Korea is an unknown factor, providing a high level of geopolitical risk. Although UN sanctions have been agreed, tension remains. State Street Global Advisors 2

3 Singapore Singapore, which maintains an exceptionally strong external balance sheet and robust fiscal framework, reported year on year GDP growth for Q of 2.9% (source: Bloomberg), which is within the government s forecast of 2.0% 3.0% for the year. Growth was supported by improving exports and government consumption spending. The credit profiles for Singapore s three main Banks remains strong. Profitability has improved for H aided by improving net interest margin, lower impairment charges and stronger fees. Asset quality was stable despite continued stresses in the oil-services sector, with non-performing loans ratio also stabilizing. This seems to be the trend for 2017, slightly better NIM and stable credit costs. The Banks continue to benefit from strong, stable deposit base, providing healthy funding and liquidity, with capitalization levels remaining strong. Japan Recent data shows that the Japanese economy has continued to grow in 2017, supported by strong domestic demand and export growth. The ongoing pick-up in the global trade and manufacturing cycle has benefited the Japanese economy. GDP on an annualized basis for Q was 4% (source: Bloomberg), well above the estimate of 2.5%. This represents the 6th consecutive quarter of growth. Employment levels have increased significantly and climbed above its 1990 level. However, this has not yet translated into higher wages. The operating environment for the Japanese megabanks has stabilized, but remains subdued. NIM continues to decline due to the low domestic interest rates, intensive competition and maturing higher-yield loans. Loan growth is currently between 3 4%, but this is unlikely to be sufficient to compensate. Non-interest income, typically accounts for 30% 35% of mega banks operating profit. However this is unlikely to provide any significant growth with competition remaining strong. The banks overall asset quality remains favorable, aided by a supportive domestic operating environment. However the megabanks have strong domestic franchises meaning that they have a stable deposit base. China There are a number of factors in play for China. There remains a high level of inter-connectedness across a variety of areas with a strong level of control or influence by the government. As such, the government has a variety of tools available to be able to mitigate risks. From a political perspective, a number of congresses and conferences will be held over the next 6 months. This includes the 19th Party Congress, the Central Economic Working Conference and the National People s Congress. The result of all of these is that a new group of leaders will be elected although Premier Li is expected to remain. There will a review and setting of specific economic policies. Therefore it is unlikely that there will be any material change to the current economic policy until the new cabinet is appointed in March 2018 as the current economic position is in line with expectations. Real GDP growth remained strong in Q at 6.9% (source: Bloomberg), unchanged from the previous quarter, and up from 6.7% in Growth was facilitated by resilient consumer trends and strengthening external demand, on top of support from previous stimulus measures. The strong growth momentum has meant that authorities continue to address financial risks, including new guidelines to enhance bank supervision and reduce regulatory arbitrage and tighter interbank market liquidity. Credit growth has marginally slowed but shadowing banking has slowed more rapidly. From an economic perspective, the GDP growth target and credit driven growth remains an issue. This has the implication of increasing the debt burden from an existing large position, which in turn increases vulnerability to economic and financial shocks. This has prompted S&P to recently downgrade the Chinese sovereign to A+ from AA-. However this was not unexpected and places the S&P rating in line with the other rating agencies. The Big 4 banks in China reported H results. These confirmed a fundamental difference between these entities and the rest of the financial sector. The Big 4 saw NIM improvements as interbank loan yields improved and deposit costs eased, while the other banks saw rising cost on interbank and deposit funding. The Big 4 Banks are net providers of liquidity to the interbank system, while the other banks are net liquidity takers. The PBOC has been providing liquidity to financial institutions to maintain stability in the financial system following the tightening of financial regulations. Shadow banking and off-balance sheet wealth management products balances have declined owing to regulation and higher funding costs. However it is estimated that off-balance-sheet WMPs and interbank borrowing made up 43% of mid-tier banks funding compared with 19% at state-banks (source: JP Morgan Asis Pacific Equity Researh: China Financials; June 12, 2017). Asset quality was more stable, impairment costs were lower with NPL ratios remaining stable. Loan growth has picked up mainly to infrastructure related sectors, but remains muted for the manufacturing, trade, mining and construction sectors. State Street Global Advisors 3

4 Structured Finance Asset-Backed Securities (ABS) US Figure 1: US ABS Issuance Volume Asset Type (in Millions) YTD 2017 YTD 2016 Δ% Credit Cards $35.90 $ Autos Student Loans Equipment Floorplan Other Total $ $ Source: JPM BAS Weekly Volume Data Sheet; 9/15/17. New issue volume has been steady during the first nine months of Total consumer ABS issuance reached $152.2 billion as of Sept. 15, which is about 5% higher on YoY basis. At its current pace, consumer ABS is set to finish the year in the $195 billion $200 billion range for new issue volume, which would represent post-financial crisis highs, if achieved. Issuance from bank credit card lenders has been a driver of YoY gains in primary market activity. A heavy maturity schedule and attractive pricing levels (for issuers) has made refinancing maturing credit card ABS debt an attractive course of action for banks. More bank card ABS issuance also tends to boost market liquidity because of its position as a benchmark sector. Strong demand has moved ABS spreads back to levels at or near post-crisis tights. Most sectors, with the exception of FFELP student loans, are within 10 bps 15 bps of the lows. Figure 2: US ABS Credit Spread Update US Consumer ABS Spreads to LIBOR (in bps) As of 9/15/16 As of 9/15/17 52 Week Δ 2 Yr AAA Auto (-)10 2 Yr AAA Credit Card (-)8 Source: Citi Research; Securitized Products; 9/21/17. Despite the current strong market for US ABS, we would note that during periods of broad market dislocation, spreads can widen rapidly, which suggests a lack of depth of ABS buyers. Tiering among sectors and issuers has compressed somewhat, which will make security selection even more important, in our view. With Hurricane Irma (Southwest FLA) right on the heels of Harvey (Houston, TX) we wanted to quickly comment on relevance to US ABS. ABS is a logical asset class to examine, given the potential impacts (even if temporary) on local jobs, wages, as well as damages related to property and automobiles. In summary, the fundamentals in the overall ABS market should see relatively modest impacts from hurricanes, as ABS exposure (across asset classes) in top tier issuer shelves is very diversified by geography, and as such, will have limited direct exposure to the region impacted by the storm. For US credit card ABS master trusts, Florida concentrations are in the 5% 9% range (compared to Texas concentrations in the 6% 10% range). However, the South Florida concentration will be materially smaller (estimated to be in the 2% to 3% range). On the auto side, comprehensive insurance does cover vehicle loss/damage due to storms, and all lenders require such coverage in order underwrite a loan or lease. In most Auto ABS issues, Texas and Florida are both top three state for loan/lease concentration. For the entire universe of US auto ABS shelves, average Texas and Florida concentration is ~12% each for prime auto. However for subprime auto, Texas tends to be a higher concentration, with an average concentration of 15%, compared to 10% for Florida. Initially, we would expect some slowing in prepayments as borrowers whose vehicles were damaged work through the insurance claims process. Lenders may also let borrowers defer payments for some time although borrowers would typically have to initiate the process. As claims are paid for totaled vehicles, we would expect prepayments to speed up for a time. It is worth noting that we did not see clear evidence of deterioration in collateral performance in the headline auto or credit card ABS performance indices in the aftermath of Superstorm Sandy (NYC, Northeast US) in Corporate/Industrial Global Non-financial issuers in the Global Cash credit universe have continued report modestly improving fundamental credit profiles in 2017 with operating profit growth (rather than debt reduction) being the primary driver of improvement. Indeed, 2Q corporate earnings- on the top and bottom line had their strongest showing since 2010, on a global basis. While some sectors benefitted from easy YoY comps (commodities), almost every sector reported State Street Global Advisors 4

5 decent revenue and operating profit growth for the quarter, continuing the positive momentum from the beginning of the year. Indeed, JP Morgan US High Grade Research reported that companies in its coverage universe reported the strongest YoY revenue growth in 22 quarters (JPM US High Grade Strategy and CDS Research: High Grade Fundamentals: 2Q17; 8/24/17). And while non-financial IG companies have not been reducing nominal debt burdens, debt growth has moderated from its rapid growth during the three previous years. For global IG companies, debt increased less than operating profit over the last twelve months the first time this has occurred in 5 years. The moderation in debt growth occurred on the back of limited M&A related issuance this year. In the first half of 2017, M&A related USD issuance was $61 bn, compared to $139 bn in 1H16. Most of the large deals expected this year have already come to market leaving only Bayer-Monsanto as a potential large deal for 2H17 (JPM US High Grade Strategy and CDS Research: High Grade Fundamentals: 2Q17; 8/24/17). All that said, leverage in the non-financial IG universe remains well above historical levels, even with the recent improvement in operating profits. Companies in this universe continue to increase nominal levels of debt, as management teams continue to look to return cash to shareholders. While the pace of share buybacks has decreased, companies continue to increase dividend payments. Technology companies continue to be the largest driver for debt growth. Microsoft, Apple and Oracle have all come to market with large debt deals ($32 bn, $23 bn, and $14 bn respectively) in These companies continue to lever up (modestly) and return cash to shareholders. ssga.com State Street Global Advisors Worldwide Entities Australia: State Street Global Advisors, Australia, Limited (ABN ) is the holder of an Australian Financial Services Licence (AFSL Number ). Registered office: Level 17, 420 George Street, Sydney, NSW 2000, Australia. T: F: Belgium: State Street Global Advisors Belgium, Chaussée de La Hulpe 120, 1000 Brussels, Belgium. T: F: SSGA Belgium is a branch office of State Street Global Advisors Limited. State Street Global Advisors Limited is authorized and regulated by the Financial Conduct Authority in the United Kingdom. Canada: State Street Global Advisors, Ltd., 770 Sherbrooke Street West, Suite 1200 Montreal, Quebec, H3A 1G1, T: and 30 Adelaide Street East Suite 500, Toronto, Ontario M5C 3G6. 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