HSBC - US Credit Strategy

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					US Credit Research
Investment Grade
                                                                                                  Global Research

US Credit Strategy                                            At face value, stretched valuations in
                                                               risk markets increasingly look out of
                                                               step with the troubled economic and
Keep on dancin’???                                             political backdrop

                                                              But, "good enough" fundamentals and
                                                               strong technicals underpinning credit
                                                               as an asset class, along with a strong
                                                               relative value story, keep us
                                                               constructive on US credit

                                                              At the risk of invoking one of the credit
                                                               bubble's most memorable lines, "as
                                                               long as the music's playing, you've got
                                                               to get up and dance"

                                                             Over the last few months, risk markets have been on a roll.
                                                             Since the beginning of Q3, the S&P 500 is up 6.2% while
                                                             investment grade cash bonds have tightened 19%. Given that
                                                             we touched the tightest levels since March 2011 in IG credit
                                                             just two weeks ago, a pullback was not unexpected. The
                                                             question is where do we go from here?

                                                             We believe there is more room to run. While there is no
                                                             shortage of worrying overhangs for this market: US fiscal
                                                             cliff, Spanish and Greek debt crises, and Middle East
                                                             uprisings to name but a few, we are of the opinion that credit
                                                             can tighten further in large part due to favorable technical
                                                             factors and an attractive relative valuation story.
28 September 2012                                            Furthermore, with governments and central banks showing a
Van Hesser                                                   ready willingness to “do whatever it takes”, we feel
Analyst                                                      comfortable holding on to credit in this environment.
HSBC Securities (USA) Inc.
+1 212 525 3114

Arjun Bowry
HSBC Securities (USA) Inc.
+1 212 525 3119
View HSBC Global Research at:
Issuer of report:    HSBC Securities (USA) Inc.

Disclaimer & Disclosures
This report must be read with the
disclosures and the analyst certifications
in the Disclosure appendix, and with the
Disclaimer, which forms part of it
      US Credit Research
      Investment Grade                                                                                      abc
      28 September 2012

Putting it in perspective
 After a notable run tighter over the course of the summer,
       investors are naturally asking if it is time to selectively harvest
       some gains
 With spreads back to 2008 levels, we compare the outlook then
       versus today; we feel better where we are today
 While we expect volatility to pick up in Q4, we remain constructive
       on US credit
Keep on dancin’???                                     credit (3.37% according to FINRA/Bloomberg
                                                       data) and high yield (6.51%) have reached historic
Regardless of whatever else he might have
                                                       lows. While equity valuations are less dramatic
accomplished in his career, a big part of former
                                                       on a traditional price to 2012 consensus estimated
Citigroup CEO Chuck Prince’s legacy will always
                                                       earnings (13.5x for the S&P 500), we do get more
be his unfortunate but totally honest comment at
                                                       extreme on a Shiller p/e (10-year cyclically
the height of the credit bubble that “as long as
                                                       adjusted), which, at 22.9x, is at levels reached
the music is playing, you’ve got to get up and
                                                       only four times since the 1930s. And since credit
dance. We’re still dancing.” He was referring to
                                                       is clearly correlated with equities, we probably
his bank’s continual lending to leveraged buyouts,
                                                       should take that into consideration.
despite clear signs that the market was stretched,
but his musings might very well describe investor      At the risk of stating the obvious, all of this is
sentiment today toward risk markets.                   taking place against a very unsettled backdrop of
                                                       a global economic slowdown and rising political
Many markets are now trading in extreme
                                                       instability. The near-term hurdles alone—Spanish
territory. Driven by a historic rally in US
                                                       and Greek debt crises, Middle East uprisings, US
Treasuries, yields on credit, both investment grade

    Average US A-rated ten-year corporate bond yield    Shiller P/E ratio

    Source: Bloomberg                                   Source: Robert Shiller

     US Credit Research
     Investment Grade                                                                                                                             abc
     28 September 2012

elections/fiscal cliff—are formidable. How on                                           one globally pervasive force—government
earth does this square up with extremely positive                                       intervention, and positive technicals.
valuations? Is the music still playing?
                                                                                        Risk markets are now conditioned it seems to
We believe it is. Our thinking goes something                                           having governments step in to provide economic
like this:                                                                              stimulus as needed. And as long as stimulus
                                                                                        remains the flavor of the month (or at least the
       •       Investors continue to seek out safety with
                                                                                        post-crisis recovery era), you run the risk of
                                                                                        getting run over if you are underweight risk.
       •       Corporate fundamental performance in
                                                                                        As a reminder, consider the performance of risk
               the US is sufficiently stable, yet not
                                                                                        assets over the past three tumultuous years, when
               strong enough to get managers to take
                                                                                        risk-on periods have at least kept pace with risk-
               creditor-unfriendly risks
                                                                                        off ones. Also note that the latest period, 2012
       •       The US economic story has de-linked to                                   year-to-date, has shown the strongest rally in risk,
               some degree from Europe                                                  reflecting two evolutionary factors, (1) the
                                                                                        growing belief among investors that the US
       •       US Credit’s spread pickup over
                                                                                        economically can de-link meaningfully from
               Treasuries is still wider than recent tights
                                                                                        Europe, and (2) governments around the world
       •       Several positive technical factors have                                  have stepped up to intervene as necessary to
               increased demand for credit                                              prevent economies from going over a cliff.

So, this really comes down to a fundamental
analyst’s worst scenario—a classic momentum
market, where the relationship between risk and
reward is vulnerable to breaking down. The good
news, we guess, is that the momentum behind this
market is reasonably well-supported, driven by

Rollercoaster ride: Quarterly CDS and Equity moves
   _____Investment Grade (a) ______                                 ________ High Yield (b)_________            _________ Stocks (c) __________
Period              Direction            Move                         Period      Direction     Move               Period    Direction     Move
1Q10                   Wider             3.0%                          1Q10          Wider      6.8%                1Q10       Higher      4.9%
2Q10                   Wider            39.5%                          2Q10          Wider     17.8%                2Q10        Lower     11.9%
3Q10                  Tighter           13.2%                          3Q10         Tighter    13.6%                3Q10       Higher     10.7%
4Q10                  Tighter           20.4%                          4Q10         Tighter    23.6%                4Q10       Higher     10.2%
1Q11                   Wider            12.6%                          1Q11          Wider      5.2%                1Q11       Higher      5.4%
2Q11                  Tighter            4.1%                          2Q11          Wider      1.7%                2Q11        Lower      0.4%
3Q11                   Wider            57.1%                          3Q11          Wider     80.2%                3Q11        Lower     14.3%
4Q11                  Tighter           16.9%                          4Q11         Tighter    17.8%                4Q11       Higher     11.2%
1Q12                  Tighter           23.9%                          1Q12         Tighter    15.7%                1Q12       Higher     12.0%
2Q12                   Wider            22.7%                          2Q12          Wider      2.2%                2Q12        Lower      3.3%
3Q12 YTD              Tighter           12.2%                      3Q12 YTD         Tighter    14.5%            3Q12 YTD       Higher      6.2%
Better                                      6                                                      5                                          7
(out of 11)
FY 2010                Tighter           0.7%                       FY 2010        Tighter     17.0%              FY 2010      Higher     12.8%
FY 2011                 Wider           41.2%                       FY 2011         Wider      58.4%              FY 2011         Flat     0.0%
YTD 2012               Tighter          18.0%                     YTD 2012         Tighter     26.4%            YTD 2012       Higher     15.1%
2010 - 2012             Wider           15.0%                    2010 - 2012       Tighter      3.2%           2010 - 2012     Higher     29.8%
YTD                                                                     YTD                                           YTD
Source: Bloomberg (a) CDX IG 5 Yr Index (b) CDX HY 5 Yr Index (c) S&P 500 Index

    US Credit Research
    Investment Grade                                                                                         abc
    28 September 2012

Better today than 2008                                 Earnings power has substantially recovered.
                                                       Today, banks are very much part of the solution.
Consider another perspective. Spreads are back to
2008 levels. Ask yourself if you feel better about     Corporates are also in much better shape. We’ve
risk today than you did then?                          written recently (see Uncertainty’s silver lining,
                                                       30 July 2012) about the silver lining to
With the benefit of 20/20 hindsight, we now know
                                                       uncertainty, in terms of how it positively affects
that there was simply too much leverage in the
                                                       corporate performance and risk taking. Margins
private sector in 2008. Consumers, corporates,
                                                       are up, while financial and strategic risk is down.
and banks were laden with debt. Today, of
                                                       Corporates very much have their houses in order,
course, a fair chunk of that has been pushed into
                                                       and are in strong position to weather whatever the
the public sector, but it’s clear that the private
                                                       economy throws at them.
sector’s balance sheet is in much better shape
today than in 2008, and its ability to service its
debt has been greatly aided by the ultra-low rate

Economically, we’re in a similar place---troubled.
On one hand, housing is in much better shape,
having been re-priced 35% lower than the 2006
peak. The improved outlook has clearly boosted
consumer confidence, helping to offset persistent
concerns on the jobs front. Business confidence,
however, remains relatively low, stifled by
uncertainty created in part by US government
policy response (or lack thereof), a Eurozone
recession, and an emerging markets slowdown.

The most dramatic change over the past several
years is improvement in the financial system. We
knew in 2008 that the system was full of bad
assets that needed to be written down or off over
time. Lenders had become gun-shy in the face of
stifling uncertainty. Resources that ordinarily
would be used to fuel the economic recovery were
siphoned off instead to balance sheet repair.
Banks were a big part of the problem, not part of
the solution.

Today, the repair work is largely complete, save
for some lingering residential mortgage exposure
(credit and litigation). Bank balance sheets are
significantly stronger, not only in terms of asset
quality, but also in terms of capital and liquidity.

   US Credit Research
   Investment Grade                                                                                                                                        abc
   28 September 2012

Positive technicals tip the
 Demand for fixed income and credit has increased as a result of
    several noteworthy trends, including a new push from QE3
 Risk and reward characteristics in the asset class compare
    favorably to competing asset classes in this income-starved
 Heavy supply, unlikely to last, has been easily absorbed
Inflows and QE consequences                                                                        Another pillar support of support for credit is
                                                                                                   likely to be QE3 and the consequences it will have
The technical support for credit is also superior
                                                                                                   for investors. In fact, our colleagues Steven Major
today. Inflows into fixed income have solidly
outpaced those into equities since the crisis for                                                  and Lawrence Dyer discuss this in detail in their
several reasons. Bonds’ outperformance relative                                                    recent report (see It’s not about the money, 27
to stocks over the past 30 years has brought about                                                 September 2012). They argue that QE3 will likely
a sea change, in our opinion, from the way the                                                     prove bullish for credit given the need for
asset class is viewed, transforming it in many                                                     investors to find alternatives to agency mortgages
investor minds from a diversifying afterthought to                                                 and debt which will be purchased by the Fed. In
an asset class moving closer to center stage. It                                                   this environment, mutual funds, pension funds,
won’t hurt that the developed world’s populations                                                  and insurance companies who have traditionally
are aging—a demographic that prefers fixed                                                         been significant holders of the aforementioned
income. And growth in ETFs make accessing the                                                      securities, could look to credit as a replacement
asset class easier than ever.
                                                                                                   within their portfolios. Given that the total size of
 Credit in favour: Cumulative net flows to bond funds worldwide, by type

 Source: EPFR (“Other” includes muni funds, MBS funds, total return funds and funds able to invest in a mix of bond type)

      US Credit Research
      Investment Grade                                                                                                              abc
      28 September 2012

the corporate bond market has been stable, this                           And US credit figures to benefit from credit
could result in some incremental demand, thus                           portfolio managers reallocating investments from
tightening credit spreads.                                              troubled markets—Europe—to safer ones (US).

    Total corporate holdings                                            A case can also be made when factoring in current
                                                                        valuations. While yields are at or near historic
                                                                        lows, investment grade credit spreads remain
                                                                        above recent tights hit in 2011 and 2010. There is
                                                                        some room to run, especially in the “yieldier”
                                                                        financial institutions sector.

                                                                        New issue deluge? No
                                                                        It is also clear that these positive tailwinds for credit
                                                                        have overcome robust supply. The combination of
    Source: HSBC, Federal Reserve
                                                                        low interest rates, improving corporate
                                                                        fundamentals and positive investor sentiment
Relative value appeal
                                                                        towards the asset class have encouraged issuers
Within fixed income, the appeal of credit to us is                      across the spectrum to come to market, either to
clear. With rates just off of historic lows, and                        refinance or to issue new debt opportunistically at
government markets “creditizing” to varying                             record low rates. Indeed, IG issuance YTD of
degrees, US credit stands out at the high quality                       USD829bn has only been surpassed once in the
end as a safe haven in its own right, with a pickup                     previous five years, back in 2009.
in yield. Credit continues to benefit from the
dramatic downsizing of the asset-backed
securities market, picking up many of its
displaced investors. And at the “yieldier” end of
things, returns compare favorably to equities
without the volatility.

    Room to run: Yields at historical lows but spreads some way above their tights

    Source: Bloomberg

    US Credit Research
    Investment Grade                                                                                                   abc
    28 September 2012

Robust supply hasn’t derailed the credit story                   It won’t take much, in our opinion, to push this
YTD                                        IG Issuance (USDbn)   market into risk-off mode. The fourth quarter is
2012                                                      829    full of events along the eurozone trail that could
2011                                                      696
2010                                                      653    trip market sentiment up, most notably ongoing
2009                                                      863    triage efforts in Spain and Greece. Our base case,
2008                                                      625
                                                                 however, continues to be a muddle through
Source: Bloomberg
                                                                 scenario, though plenty of spread-widening fat tail
What stops the music?                                            events loom.

The near-term risk we see is simply a correction, a              As disruptive as Europe has been, concerns over
market pullback, and it could be painful given                   the US fiscal cliff has now supplanted Europe as
how far risk has run. A 10% correction in US                     the single greatest weight on investor sentiment.
stocks and credit takes us back to mid-summer                    But few expect any progress on that issue until
levels, but still in positive territory on the year.             after the US elections in November.

                                                                 So that leaves us constructive on US credit, even
                                                                 if it is the “least dirty shirt in the laundry.”

    US Credit Research
    Investment Grade                                                                                           abc
    28 September 2012

Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the
opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their
personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific
recommendation(s) or views contained in this research report: Van Hesser and Arjun Bowry

Basis for financial analysis
This report is designed for, and should only be utilised by, institutional investors. Furthermore, HSBC believes an investor's
decision to make an investment should depend on individual circumstances such as the investor's existing holdings and other

HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which
depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations.
Given these differences, HSBC has two principal aims in its credit research: 1) to identify long-term investment opportunities
based on particular themes or ideas that may affect the future earnings or cash flows of companies on a six-month time
horizon; and 2) from time to time to identify trade ideas on a time horizon of up to three months, relating to specific
instruments, which are predominantly derived from relative value considerations or driven by events and which may differ
from our long-term credit opinion on an issuer. HSBC has assigned a fundamental recommendation structure only for its long-
term investment opportunities, as described below.

HSBC believes an investor's decision to buy or sell a bond should depend on individual circumstances such as the investor's
existing holdings and other considerations. Different securities firms use a variety of terms as well as different systems to
describe their recommendations. Investors should carefully read the definitions of the recommendations used in each research
report. In addition, because research reports contain more complete information concerning the analysts' views, investors
should carefully read the entire research report and should not infer its contents from the recommendation. In any case,
recommendations should not be used or relied on in isolation as investment advice.

HSBC Global Research is not and does not hold itself out to be a Credit Rating Agency as defined under the Hong Kong
Securities and Futures Ordinance.

Definitions for fundamental credit recommendations
Overweight: The credits of the issuer are expected to outperform those of other issuers in the sector over the next six months

Neutral: The credits of the issuer are expected to perform in line with those of other issuers in the sector over the next six

Underweight: The credits of the issuer are expected to underperform those of other issuers in the sector over the next six

Prior to 1 July 2007, HSBC applied a recommendation structure in Europe that ranked euro- and sterling-denominated bonds
and CDS relative to the relevant iBoxx/iTraxx indices over a 3-month horizon.

Distribution of fundamental credit opinions
As of 27 September 2012, the distribution of all credit opinions published is as follows:

    US Credit Research
    Investment Grade                                                                                              abc
    28 September 2012

                                ___All Covered Companies___      Companies where HSBC has provided Investment Banking in the past 12 months
                                    Count        Percentage                                 Count                               Percentage
Overweight                            145               23                                     61                                       42
Neutral                               359               56                                    142                                       40
Underweight                           138               21                                     44                                       32
Source: HSBC

Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment
banking revenues.

For disclosures in respect of any company mentioned in this report, please see the most recently published report on that
company available at

* HSBC Legal Entities are listed in the Disclaimer below.

Additional disclosures
1     This report is dated as at 28 September 2012.
2     All market data included in this report are dated as at close 27 September 2012, unless otherwise indicated in the report.
3     HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its
      Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research
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     US Credit Research
     Investment Grade                                                                                                                   abc
     28 September 2012

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Global Fixed Income Research Team

Steven Major, CFA
Global Head of Fixed Income Research
+44 20 7991 5980
Rates                                                  Credit
Europe                                                 Europe
Bert Lourenco                                          Lior Jassur
Head of Rates Research, Europe                         Head of Credit Research, Europe
+44 20 7991 1352           +44 20 7991 5632
Subhrajit Banerjee                                     Dominic Kini
+44 20 7991 6851     +44 20 7991 5599
Theologis Chapsalis                                    Laura Maedler
+44 20 7992 3706     +44 20 7991 1402
Wilson Chin, CFA                                       Remus Negoita, CFA
+44 20 7991 5983            +44 20 7991 5975
Di Luo                                                 Anna Schena
+44 20 7991 6753                 +44 20 7991 5919
Chris Attfield                                         Peng Sun, CFA
+44 20 7991 2133   +44 20 7991 5427
Johannes Rudolph                                       Pavel Simacek, CFA
+49 211 910 2157          +44 20 7992 3714
Sebastian von Koss                                     Raffaele Semonella
+49 211 910 3391          +44 20 7991 3153
Asia                                                   Jayadev Mishra
André de Silva, CFA                                    +971-4-4235509
Head of Rates Research, Asia-Pacific                   Asia
+852 2822 2217          Dilip Shahani
Pin-ru Tan                                             Head of Global Research, Asia-Pacific
+852 2822 4665              +852 2822 4520
Grace Qiu                                              Zhiming Zhang
+852 2822 6569             +852 2822 4523
Himanshu Malik                                         Devendran Mahendran
Associate                                              +852 2822 4521
+852 3941 7006        Philip Wickham
Americas                                               +65 6658 0618
Larry Dyer                                             Keith Chan
+1 212 525 0924       +852 2822 4522
Jae Yang                                               Louisa Lam
+1 212 525 0861              +852 2822 4527
Pablo Goldberg                                         Yi Hu
Head of Global Emerging Markets Research               +852 2996 6539
+1 212 525 8729
                                                       Crystal Zhao
Bertrand Delgado                                       +852 2996 6514
EM Strategist
+1 212 525 0745    Linus Fung
                                                       +852 2822 4687
Gordian Kemen
+1 212 525 2593       Alex Zhang
                                                       +852 2822 3232
Victor Fu
+1 212 525 4219           Americas
                                                       Van Hesser
Alejandro Mártinez-Cruz                                Head of Credit Research, US Financial Institutions
+52 55 5721 2380   +1 212 525 3114
                                                       Robert J Schmieder
                                                       Head of Latam Corporate Credit
                                                       +1 212 525 4829
                                                       Mary Ellen Olson
                                                       +1 212 525 0191
                                                       Sarah R Leshner
                                                       +1 212 525 3231
                                                       Arjun Bowry
                                                       +1 212 525 3119

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