HSBC sell-off: A buying opportunity

Credit markets widened last week on the back of a weaker macroeconomic backdrop, increased trade tensions between the US and China, and political turbulence in the UK and Italy. This was exacerbated by the escalation of protests in Hong Kong, which in particular led to a sell-off in HSBC debt: 5-year senior widened about 10bps, while AT1’s fell on average 1% – more than double the wider market.

This market reaction is understandable. Despite being a global bank, in the first half of 2019 Hong Kong represented 52% of HBSC group’s pre-tax profits (and over 90% of profit before tax in its retail/wealth-management operation), making it significantly more exposed to Hong Kong than global peers such as JP Morgan and Citigroup.

There are also wider strategic concerns. The bank wants to expand and tilt towards mainland China, while still maintaining its European/US operations and a large USD clearing business. If global trade tensions continue to worsen this would become more challenging. The recent departure of the group CEO (as well as the head of Greater China) adds to the uncertainty. Finally, due to its large deposit surplus, HSBC is generally seen as a relative beneficiary of higher US rates, which are now unlikely to come through following the Fed’s recent action and messaging.

HSBC’s credit fundamentals nevertheless remain robust, with solid balance sheet ratios. In Hong Kong (about 30% of total lending), asset quality metrics look very strong and the average mortgage loan-to-value ratios are below 40%. The bonds have recovered some ground in recent days, and we would view any renewed widening as an opportunity to add to exposure.

Kames Capital holds bonds from HSBC in its fund range.

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Deutsche – finally a case for cautious optimism

There have been a number of Deutsche Bank restructurings in recent years, but the most recent one announced last week finally make sense. For too long it has been a bank without a coherent business model or disciplined capital allocation. Exiting unprofitable investment banking operations and tilting the bank towards corporate banking is a step in the right direction.

Yes, the financial targets are ambitious (to put it mildly) with significant room for error. The challenge of growing core revenues by 10% to 2022 cannot be overstated considering how European banks are struggling with revenue pressure – in particular in overbanked Germany – and competitors are likely to exploit Deutsche’s weakness of no longer being a full-service investment bank. To achieve a 25% cost reduction when banks’ IT and compliance spend is on the rise will be another substantial challenge.

But it doesn’t matter if the targets are not fully met, provided the direction of travel is right, i.e. costs are decreasing, legacy assets are running off and core revenues are at least holding up. For all its flaws, Deutsche has a strong position in the areas it is consolidating into, and with renewed focus should be able to see some positive momentum. No doubt there are more chapters to be written in the sad story that is Deutsche, but overall this restructuring should be positive for senior and tier-2 bonds, all else being equal.

AT1s are the exception and here we are more cautious. The bank has lowered its capital target from 13.0% CET1 to 12.5% versus a current requirement of 11.8%, and expects the CET1 ratio to fall to 12.7% in 2020 (currently 13.7%). In light of the execution risks, the difficult operating environment and regulatory uncertainty regarding future risk weight inflation, the new management buffer seems on the low side and will put AT1 holders at increased risk of a coupon restriction.

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