Tuesday June 20

Stock prices retreated today after posting record highs yesterday. The S&P 500 fell 0.7% to 2,437 and the Dow Jones fell 0.3% to 21,467. The KBW Bank index lost 1% while utilities were unchanged. Stanley Fischer spoke today and expressed concern about rising home prices, which could suggest that he is more likely to take a hawkish stance. Eric Rosengren also spoke about the concerns about keeping interest rates too slow for too long. Robert Kaplan of the Dallas Fed capped off the day for Fedspeak, and he seemed to be a little more dovish saying that he is keeping an “open mind” to future rate hikes as opposed to some members who are full steam ahead for one more in 2017. Sentiment today was negatively affected by falling oil prices, which officially entered a bear market down from its peak reached in February. The two year Treasury yield fell 1bp to 1.35%. The ten year Treasury yield fell 4bp to 2.15%. Accordingly 2yr vs 10yr bull flattened to 0.80%, which makes sense given the big drop in commodity prices. The dollar was mixed on the day against peers. USD rose 0.2% against EUR to $1.1132. USD fell 0.2% against JPY to Y111.46. USD fell 0.1% against GBP to $1.2629 after BoE governor Mark Carney showed that he didn’t agree with the hawks on the BoE who last week were in favor of a rate hike. WTI fell 2% to $43.34 and Brent fell 1.9% to $46.01.

After a few years of underperformance compared to peers investors are looking for Citi to change this trend. Since 2012 Citigroup shares have produced a total return of just under 80% which has underperformed peers including Goldman Sachs, Bank of America, and Morgan Stanley which have returned 94%, 165% and 176% respectively. Over that time period the KBW Bank index and the S&P 500 have both returned 87%. The first way investors will look for Citi to turnaround its performance is through returning capital to shareholders in the form of dividends and share buybacks. Citigroup’s annual capital returns have increased significantly from close to zero in 2012 to more than $12bn in 2016. This year investors are hoping that Citi will return capital in excess of earnings which means that its dividend payout rate would be more than 100%, allowing Citi to draw down on its capital instead of building it up. Investors are also looking on CEO Michael Corbat to offer reasons why Citi’s valuation should increase, as the bank trades at 85% of book value which gives it the lowest valuation compared to its peers. The company is trying to focus its efforts on increasing profitability in credit cards and retail banking. The corporate and investment bank has been either at or near targets in recent quarters, but retail banking has lagged targets by several percentage points. It has been refocusing its efforts on the corporate side by decreasing the number of clients it serves from 30,000 to 14,000. On the retail side it is investing into promising markets, highlighted by a $1bn into retail banking in Mexico. It is also focusing retail efforts on its card business following a purchase of $10bn in card loans from Costco and making investments into its own card offerings. Over the past several quarters it has been in the investment phase on each of those endeavors, and soon is the time for those investments to start paying off.

Argentina’s century bond issuance is reflective of some of the trends that country and emerging markets are seeing and investor demand more broadly. Argentina issued $2.75bn in debt with a 100 year maturity at a yield of 7.9%. According to someone at one of the underwriting banks, this type of issuance is typically a “reverse inquiry” in which a large investors approaches the issuer with terms for a deal that would work for both parties. This would be one way for an investor to take a levered view on Argentina’s economic recovery. A traditional money manager may not be able to take out leverage, so buying a very long duration product would be one way to amplify returns. In spite of all the debt the country has issued since emerging from bankruptcy just last year, analysts still put Argentina’s debt level at a sustainable level assuming the country is able to reduce its deficit and meet its fiscal target. Analysts note that if yields on this issuance were to fall by around 150bp it would produce returns in the double digits for investors. It seems as if enough investors bought into the recovery story as the deal attracted offers of $9.75bn. Yields in the country have decreased over the last year while the country’s stock market has rallied as well. That comes as investors generally have been bullish on emerging markets which have reported billions of dollars in net inflows. The risks to this deal are obvious however. Argentina has defaulted eight times since its independence in 1816, so for it to not default at all over the next hundred years would be a significant break from the historical trend. Additionally as the Fed raises interest the risk of another taper tantrum is out there, and there high duration bonds would be the first hit. However for now it seems that the search for yield is overpowering those risks.

KKR is making an aggressive push into the leveraged lending arena through its capital markets business. In just the first five weeks of 2017 KKR underwrote more leveraged loans than it did throughout all of last year. It has pushed its way in the league tables to eleventh which markets ahead of more established UBS, Nomura, and HSBC compared to 229th last year. Historically large banks have dominated this business however as regulators have increasingly scrutinized these deals done by banks, unregulated lenders such as KKR have stepped in. To reflect this earlier in the year the UFC wanted to refinance some if its debt however Goldman Sachs had to turn down the deal because of regulatory scrutiny, and KKR stepped in its place. KKR is able to both sponsor deals by providing capital and using its balance sheet, as well as broker deals by using its relationships with sovereign wealth funds and pension funds to sell loans if needed. That is a powerful combination, coupled with KKR’s stellar reputation in the private equity space. Some banks have complained that the regulatory environment gives KKR an advantage through an uneven playing field, and that if the tables were fair they wouldn’t be as competitive. Already the Treasury’s report released last week calls for some changes to the way banks are regulated when making leveraged loans, which would give KKR less of an advantage in this space. In Europe however the regulations that benefit KKR and similar lenders are still going strong.

Tuesday June 20

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