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Agenda
Credit Strategy Jeff Melis Piece Credit Research Jonathan Glionna Head of Global Bank Credit Research Corporate Bonds/CDS Trading Andrew Layng Financials Cash Yoni Gorelov Yankee Credit Yana Bouchkanets Barclays Capital Live Conference Call Information Tuesday, 7:45am (EST) Conference ID: 25800338 Dial-in: +1-866-644-3260 +1-706-634-9973 Replay: Live.barcap.com Credit Conference Calls
Last week, credit performance was mixed with CDS tighter and IG cash wider
CDX IG (9/129/19, bp)
140.0 138.0 136.0 134.0 132.0 130.0 128.0 126.0 124.0 122.0 9/12 135
From the wides on 9/12, IGs have tightened ~11.5bp Yest: +2.25bp
9/15
9/16 Close
9/19
75 Aug-09
CDX HY (9/129/19, $)
95.0 94.0 93.0 92.0 91.0 90.0 89.0 9/12 9/13 9/14 Intraday Range 9/15 9/16 Close 9/19
Yest: -$0.25
w/w change in price CDX HY: +$2.40 HY Index: -$0.32 w/w chg: -5bp w/w chg: -67bp
Feb-10 CDX HY Aug-10
Other risk assets performed well as equities rose sharply and volatility declined. Last weeks moves, however, were partially reversed yesterday amid renewed risk aversion
S&P 500 Sectors (w/w Change)
8% 7% 6% 5% 4% 3% 2% 1% 0% Cons HcareEnergy Telco Mat Stp Util S&P Fin Ind Cons Tech Disc
Underperformed Outperformed
5.35%
Last weeks strong performance was partially reversed yesterday; France was a notable underperformer
US macro data continue to point to a slowdown, and recent confidence surveys indicate a dampened outlook across both consumers and executives
Advance Retail Sales (m/m, sa %)
1.5 1.0 0.5 0.0 (0.5) (1.0)
Retail sales were flat in Aug, and July was revised lower
Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Survey Actual
___________________________ Source: Commerce Department, Philadelphia Federal Reserve, NY Federal Reserve, University of Michigan/Thomson Reuters, Duke University/CFO Magazine, Haver Analytics, Bloomberg, Barclays Capital
In light of the weak data and persistently high unemployment, our economists expect the most likely outcome of the upcoming FOMC meeting will be a maturity extension of the Feds portfolio
FOMC Meeting 9/20/11-9/21/11
The debate at this weeks 2-day FOMC meeting will likely hinge on the relative risks of long-term unemployment vs. inflation Headline CPI inflation rose 3.8% y/y in August, boosted by a gain in gasoline prices. Our economists expect this factor to moderate, however core CPI still rose 2.0% y/y Long term unemployment as a percentage of total unemployment is high with nearly half of the unemployed having been unemployed for 27 weeks or longer. This poses a significant risk that this population could face a gradual erosion of marketable job skills Our economists believe the most likely FOMC meeting outcome will be a maturity extension of the Feds portfolio, or Operation Twist. Another option would be to reduce the interest paid on excess reserves (IOER). However, we view this option as less likely due to its asymmetric risk/reward profile1 Cutting IOER from 25bp would be unlikely to have a significant stimulative effect as FDIC insurance already discourages US banks from stockpiling excess reserves With short-term yields already low, cutting IOER could possibly destabilize the already stressed short term funding market
6 5 4 3 2 1 0 -1 -2 -3 2005
1961
1971
1981
1991
2001
2011
___________________________ 1. Fed set to ease further despite firming inflation. Global Economics Weekly, September 16th, 2011. Source: Bloomberg, Barclays Capital
Headlines out of the euro area continue to be a key driver of market activity, as mostly positive news supported the risk asset rally
Last Weeks Key Events
On Wednesday, Moodys downgraded the long-term debt rating of Societe Generale, citing funding and liquidity issues, and Credit Agricole, citing Greek exposure. Following a conference call with Greek PM Papandreou, German Chancellor Merkel and French President Sarkozy announced they are convinced Greece will remain in the Euro area The ECB announced in coordination with the Fed, BOE, BOJ, and SNB that it would conduct three USD liquidity operations with maturity of three months on Oct 12, Nov 9, and Dec 7, in addition to the existing 1-week USD liquidity operations. Following the announcement, Euro basis swaps and the 3m Euribor-Eonia spread declined Markets appeared hopeful ahead of the weekends ECOFIN meeting, However, the meeting yielded no new significant announcements
___________________________ Source: Bloomberg, Barclays Capital
Last week was the best week for European CDS indices since July
19-Aug
16-Sep
CDS moved wider yesterday across the core and periphery, reversing some of last weeks tightening
80 60 40 20 0 31-Aug
4-Sep
8-Sep France
12-Sep Spain
16-Sep Italy
Germany
However, concerns around the Greek debt situation remain, and virtually every potential outcome or solution appears marginal at best
Greek Government Bond Yields (%)
80 70 60 50 40 30 20 10 Jan-11 Mar-11 2y May-11 Jul-11 5y (rhs) Sep-11 30 28 26 24 22 20 18 16 14 12 10
Orderly Default
Disorderly default
Feb-07
Jul-08
Dec-09
May-11
___________________________ 1. See Global Synthesis: Europe contemplates a controlled insolvency, Global Economics Weekly, September 16, 2011. Source: Bank of Greece, Bloomberg, Barclays Capital
Within credit, our analysts have re-initiated coverage on European banks with an underweight. While capital ratios and financing sources have improved, questionable asset quality limits the potential upside
European Banks Core Tier 1 %
18% 16% 14% 12% 10% 8% 6% 4% 2% 0% UBSN CSGN ISP RBS HSBA DBK LLOY CBK
Core Tier 1 Ratios are improved across the board vs. 1H07
SAN
BBVA
UCG
BNP
ACA
GLE
0 2006H1
European banks have decreased their reliance on wholesale financing in favor of more stable deposit funding
2007H1 2008H1 2009H1 2010H1
1H07
1H11
Aggregate Deposits
6% 5% 4% 3% 2% 1% 0%
___________________________ Source: SNL, Company Reports, Bloomberg, Barclays Capital For details, see European Banks: Reinitiating Coverage Underweight, by Jonathan Glionna, Miguel Angel Hernandez, and Conor Pigott, September 13th 2011.
Indeed, euro area banks continue to have significant sovereign debt exposure. This risk could potentially be mitigated using the EFSF, either through capital injections or debt guarantees
EFSF Options for Supporting Euro Banking
Recently, IMF Managing Director Christine Lagarde has called for capital injections to European banks, possibly via the EFSF1 A direct EFSF injection could position European banks to withstand large haircuts to SGIIP debt but would require ~230bn and leave many SGIIP banks semi-nationalized A guarantee would be less burdensome but would be riskier and might be too stressful on several individual countries
Private ownership of several SGIIP banking systems would be called into question following a direct injection
Potential liabilities in a guarantee could bring several nations liabilities close to levels of Ireland 2010 which required a bailout
Slovakia
Slovenia
France
Sovereign Debt
___________________________ 1. Lagarde sees global crisis of confidence. Financial Times, September 15, 2011. Source: ECB, Federal Reserve, Bloomberg, Barclays Capital Equity Research For details, see Thinking the Thinkable?: What saving the euro means for European banks. Barclays Capital European Banks Equity Research, September 15, 2011.
Luxembourg
Belgium
Germany
Netherlands
Estonia
Austria
Spain
Finland
Malta
Cyprus
In the UK, the ICB report was mixed for bondholders. Ring-fencing and loss absorption rules should allow banks to remain competitive, while depositor preference is a negative for unsecured bondholders
Under the ICB recommendations, capital requirements for the bank and group are similar
20% 700 6.50% 15% 500 2.00% 10% 1.50% 3.00% 2.00% 1.50% 2.50% 300 200 5% 7.00% 7.00% 100 0 0% Ring-fenced bank Basel III T1 Common G-SIFI Buffer Basel III Tier 2 Bank group Ring-Fence Buffer Basel III T1 Non-Common Bail-In Bonds Without depositor preference Bank deposits, repos, CP/CD Customer deposits Senior unsecured bonds Equity With depositor preference Covered bonds, securitisations Senior unsec. & cust. deposits Subordinated liabilities 400 7.00% 600
Depositor preference, when implemented, will place senior unsecured bondholders behind depositors
___________________________ Source: ICB, Company Reports, Barclays Capital For details, see European Banks: ICB Final Report Mixed for Bondholders, by Jonathan Glionna, Miguel Angel Hernandez, and Conor Pigott, September 15th, 2011.
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When comparing US banks to European banks, it is interesting to note that sub-senior spreads in US banks have compressed, while spreads in European banks have widened
US Banks, 1/01/2009, OAS (bp)
600 500 400 300 200 100 0 BAC Senior C GS Sub Holdco
RBS LT2
ISPIM
DB Senior
RBS LT2
ISPIM
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In the US, GDP growth expectations for 2011 have fallen, yet IG revenue expectations have not. However, this is not unusual, especially when viewed in a historical context
Factors Influencing IG Revenue Growth
There is an inherent selection bias in a given IG credit index population reflecting the strength of those firms relative to the economy as a whole IG constituents estimate revenue growth as a nominal dollar series, so inflation can influence revenue growth vs. real GDP growth IG constituents also derive revenues from overseas. In a declining dollar environment, this should cause revenue growth to outpace nominal GDP growth
Average excess revenue growth for IG firms vs. nominal GDP growth is 2.9%
-12.3%
2012 revenue growth expectations are tracking much more closely with GDP growth expectations than in 2011
___________________________ Source: Factset, Capital IQ, Bloomberg, Barclays Capital For details see: Investment Grade: Revenue and GDP: More Than Meets the Eye, US Credit Alpha, September 16, 2011.
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In addition, given the strength of corporate fundamentals, it appears spread levels are not reflecting the current state, but rather appear to be indicating an increasingly binary outcome for IG credit
US IG Corporate Index Fundamentals
Summer 2011 Start Date of Comparable Sell-off Spread At Sell-off Start Spread 30d After Sell-off Start Subsequent Wide Spread in Credit Cycle Net Leverage at Sell-off Start Peak Net Leverage (ex. Financials) Cash / ST Debt Cash / Total Debt Upgrade / Downgrade Ratio 7/26/11 152 213 NA 1.2x NA 5.1x 32.0% 1.87 2008 Credit Crisis 6/17/08 237 283 618 1.2x 1.6x 3.4x 10.7% 1.18 2001/2002 Credit Downturn 6/21/02 172 201 266 1.9x 1.9x 3.1x 14.0% 0.67
Current spread levels do not reflect IG fundamentals, but rather appear to be indicating an increasingly binary outcome: either the debt crisis is resolved and spreads tighten to reflect fundamentals, or the situation worsens and US credit trades wider with Europe
80 Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
May-10
Sep-10
Jan-11
May-11
Sep-11
___________________________ Source: Capital IQ, Barclays Capital For details, see Focus: Beginning or End of the Sell-Off?, US Credit Alpha, September 9, 2011.
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Notably, cash has underperformed both CDS and equities in the current sell-off
US IG Corp OAS vs. IG Cash-CDS Basis(1) (bp)
225 215 (40) 205 195 185 175 165 155 145 (90) 135 125 Jan-10 (100) Sep-11 120 100 1000 (70) (50)
(30)
Relative to historic performance over the past two years, IG cash has significantly underperformed equities
Sep 16th
(60) 220 200 180 160 140
(80)
May 2nd
S&P 500
May-10
Sep-10
Jan-11
May-11
1050 2010
1100
1150
1200
1250
1300
1350
1400
IG Corp OAS
___________________________ 1. Basis defined as CDX IG OTR spread minus US IG Corp OAS. Source: Bloomberg, Barclays Capital
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One potential explanation for the underperformance is that IG supply has been robust and new issue concessions have risen
IG and HY Weekly Supply ($bn)
45 40 35 30 25 20 100 15 10 5 0 7-Jan 50 200
While the primary markets have been effectively closed for HY, IG supply remains robust
250
New issue concessions have risen and have contributed to the widening of secondary spreads
150
0 1.55% '14 2.35% '15 2.65% '16 3.00% '16 4.3% '21 4.375% '21
11-Feb
18-Mar
22-Apr HY
27-May
1-Jul IG
5-Aug
9-Sep
Oustanding
New Issue
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Another potential explanation is that the cash index continues to have a significant financial weighting, especially when compared to equities
US IG Corp Index Sector Weightings (%)
Utility 10% Industrials 11% Financial 43%
Industrial 47%
Tech 15%
Jan 2007
Jan 2007
Energy 10%
Utility 11%
Industrials 10%
Other 10%
Financials 14%
Sep 2011
While the weighting of financials in the IG Corp Index has declined by ~19% since Jan 07
Consumer Discr 11%
Sep 2011
the decline in the equity weighting has been even greater (~39%)
Financial 35%
Tech 20%
Industrial 54%
Energy 12%
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In Summary
Last week, IG cash underperformed the broad risk asset rally as both CDX IG and the S&P experienced their best week since the beginning of July Macro data in the US continue to support the notion of a slowdown as August retail sales were flat, July retail sales were revised lower, and both the Empire State and Philly Fed surveys indicated contraction Risk asset performance continues to be dictated by news out of the euro area. A somewhat better tone to the headlines supported positive performance last week Our base case continues to be that there will be an orderly resolution of the European sovereign debt crisis. However, given the lack of clarity around a concrete plan to address contagion and questions around the level of political will to address the crisis, our conviction level remains low The situation appears increasingly binary, were either we will avoid a near-term major systemic event and spreads will rally strongly, or we will see something akin to the fall of 2008 before officials step in decisively. We recommend investors focus on areas of the market where the upside-downside is appealing
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Date: Thursday, 13 October 2011 at 4:30pm EST Venue: Barclays Capital 745 Seventh Avenue, New York City 4:30pm-4:35pm 4:35pm-4:55pm 4:55pm-5:40pm Agenda: Opening Remarks (Paul Degen, Co-Head of US Credit Sales) Market Outlook (Larry Kantor, Global Head of Research)
Barclays Capital Live Demonstration (Yana Bouchkanets, Barclays Capital Live Sales) A cocktail reception will be held after the Demonstration
RSVP: Yana Bouchkanets, at +1 212 526 5537 or email yanabouchkanets@barcap.com by Friday, 23 September 2011. We look forward to seeing you there.
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Disclaimer
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Disclaimer (contd)
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