Month: January 2016

January 22 – January 28, 2016

Challenges of being born a millennial. Continued struggles for Energy & Mining companies. Zika virus.

While these postings cover articles from Friday – Thursday, I would be remiss not to mention the Bank of Japan’s move to lower the interest rate on excess reserves from 0.1% to minus 0.1% today.  Inflation has yet to gain traction in Japan (note that Q4 2015 GDP growth in the U.S. came in at a lower than expected 0.7% today as well), and so the policy makers are stepping up efforts.  While the negative interest rates in Japan only apply to a portion of deposits, the key in this is that as Aaron Back of The Wall Street Journal points out in “Japan’s Negative-Rate Plunge More Like a Toe in the Water” is that this policy directive is modeled on the Swiss and it is likely that there is more to come.  The world is at a challenging crossroads, desperately seeking economic growth central banks are trying to do their part resulting in monetary stimulus measures just trying to get something going.  Note that US interest rates continue to drop (the 30-year fixed rate mortgage rate as reported by Freddie Mac came in at 3.79% yesterday down from over the 4% reached after policy rates were first raised) as investors expect US policy rates to stay unchanged or even to revert back to zero.  Good for asset owners, but all this uncertainty continues to prove challenging for employees.

This week there was a special feature in The Economist and the Financial Times did a good article on the challenges the current economic environment has had on millennials.  The brief from The Economist can be found in the Other Interesting Articles section below and I’ll go into Sarah O’Connor’s “Tragedy of the millennials is they are not entitled enough” in the Financial Times.  The other article I am going to cover is Christopher Adams, James Wilson, and Mark Vandevelde’s “Moody’s puts 175 energy and mining companies on downgrade watch” in the Financial Times that highlights the continued symptoms of the energy crunch.  Lastly, for those that haven’t been following the progress of the Zika virus, here are two good articles from The New York Times and The Washington Post to help you understand what’s going on and how quickly it’s spreading.  As a parent, this scares me… especially considering the “first case of the mosquito-borne virus in a birth on U.S. soil” was here in Honolulu.

*Note: bold emphasis is mine, italic sections are from the articles.

Tragedy of the millennials is they are not entitled enough. Sarah O’Connor. Financial Times. 26 Jan. 2016.

Full disclosure, I like Sarah O’Connor am a millennial (granted, at the very front end of the generation).  Further, I always find it interesting when I hear or read ‘experts’ making statements that certain trends have changed forever because millennials have different tastes than their predecessors – millennials don’t want single family homes, they want to live in the city… millennials prefer flex work spaces rather than private offices… etc..   The thing is we’re not that different from those that have come before us.  Yes technology has enabled certain behaviors that our parents couldn’t tap into as easily, but bottom line, the reason certain buying and work habits haven’t taken hold yet is that the majority of millennials are 25 and for most of our working career the jobs economy has been shaky while asset prices have been shooting for the moon.  Buying habits have been simply delayed – maybe forever as some experts have stated, but not for reason of taste, rather out of a lack of ability.

From Ms. O’Connor, using the example of the U.K., but applicable in general.

The general consensus of millennials in the work place is that they “expect different things from employers than previous generations – rapid promotions, constant positive feedback, flatter corporate structures, a better work-life balance and a sense of purpose beyond profit. The press releases wrap up with a few quotes from experts urging companies to adapt to this new generation.”

“Most millennials – those born between the early 1980s and early 2000s – entered the labor force in the aftermath of a brutal downturn. It is almost a decade since the financial crisis, and global youth unemployment remains about 13%. Far from demanding that employers adjust to their needs, many young people have bent over backwards to persuade anyone to give them a foothold in the labor market.”

“While the income of the median UK household finally regained its pre-recession level last year, the income of the average 22-to-30 year old is still about 8% lower than in 2008.”

“…everyone should be rooting for the unlucky ones who had a tough start, since it will fall to them to pay for the pensions and healthcare of the generations ahead of them. This will be a heavy responsibility: the world has only three “super-aged” societies today (countries where more than one in five of the population is 65 or older) but by 2020 it will have 13. The more long–term the damage to young people’s careers, the less they will earn over their lifetimes and the less tax they will be able to pay.”

In regard to a speech by Minouche Shafik, a deputy governor at the Bank of England, “She was trying to figure out why wage growth is still so weak in Britain even though joblessness has fallen to pre-recession levels. This is a puzzle in the US and Japan too. Perhaps, she said, the crisis was so severe that it had a lasting effect on employees’ psyches and made them reluctant to push for pay rises or switch jobs in pursuit of higher salaries.

If this is true for the average worker, you can see why it might be particularly true for a young person who has never known a time when the economy seemed truly secure.”

Moody’s puts 175 energy and mining companies on downgrade watch. Christopher Adams, James Wilson, and Mark Vandevelde. 22 Jan. 2016.

While this article is from a week ago and oil prices have rebounded somewhat over the last week, the structural challenges remain.

“Several of the world’s biggest oil and gas groups – including Royal Dutch Shell, Total and Chesapeake Energy – are among 175 energy and mining companies at risk of rating downgrades following a collapse in crude and other commodities markets, Moody’s warned on Friday.”

“Moody’s has put on review for downgrades 69 US-based companies – including Schlumberger and Chesapeake.”

“Multi-notch downgrades are particularly likely among issuers whose activities are centered in North America, where natural gas prices have declined dramatically along with oil prices,” said the rating agency.”

“Moody’s notice for 120 energy companies and 55 miners is its largest single warning of potential corporate downgrades since the financial crisis.”

“China’s outsized influence on the commodities market, coupled with the need for significant recalibration of supply to bring the industry back into balance indicates that this is not a normal cyclical downturn, but a fundamental shift that will place an unprecedented level of stress on mining companies,” said Moody’s.

This graph below is from a separate FT article, but it illustrates the rising stress in emerging market debt.

FT_Troubled EM Debt_1-25-16

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Saudi Arabia’s Secret Holdings of U.S. Debt Are Suddenly a Big Deal 1/21

Bloomberg – So Yes, the Oil Crash Looks a Lot Like Subprime 1/25

FT – The tiny shifts that can signal huge changes 1/21

FT – A history of betrayal that leads to Donald Trump 1/24

FT – Investors rush online to ditch stakes in China rural lenders 1/24

FT – Emerging markets’ stressed debt reaches record levels 1/24

FT – US junk-rated energy debt hits two-decade low 1/24

FT – Capital controls may be China’s only real option 1/25

FT – Currency risk matters for China’s property sector 1/25

FT – Pay attention to long-term debt cycle (Ray Dalio) 1/25

FT – China mouthpiece warns Soros against shorting renminbi 1/26

FT – South Korea export growth slows to trickle as China demand wanes 1/26

FT – China’s toughest test is within its walls 1/26

FT – Protectionism at play in Sharp takeover drama 1/26

NYT – African Economies, and Hopes for New Ear, Are Shaken by China 1/25

NYT – El Salvador’s Advice on Zika Virus: Don’t Have Babies 1/25

NYT – Inquiry in China Adds to Doubt Over Reliability of Its Economic Data 1/26

Vanity Fair – Hedge Funder John Paulson Puts Up His Own Fortune to Save His Firm 1/26

WSJ – What’s Wrong With The Producer-Price Index? Rent Is Too Damn High 1/14

WSJ – China Cinema Companies Produce Box-Office Hype 1/25

WSJ – Vacant Office Spaces Pile Up in Houston 1/26

WSJ – Tougher Times for Mall Owners 1/26

WSJ – China Sharpens Efforts to Halt Money Outflow 1/27

WSJ – Malaysia Antigraft Agency Asks for Review of Decision to Clear Najib Razak 1/27

WSJ – Heeding Softer Market, Extell Development Furnishes One57 Condo for Sale 1/28


January 15 – January 21, 2016

Dalian Wanda. Chinese Property Developers trading USD denominated debt for yuan debt. Construction input prices continue to fall.

As I mentioned last week, expect more interesting behavior from the Chinese property developers – granted, I’m sure the behavior has been going on for some time, it’s just that media coverage is increasing.  This week the three articles I am focusing on are, 1) Jill Mao’s “Wanda Group Plans Five ‘Substantial” Acquisitions as Sales Slump” covered in Bloomberg, 2) Fiona Law and Carol Chan’s “No Place Like Home for Chinese Property Companies’ Debt” in The Wall Street Journal, and 3) is an interesting piece put forth in AZ Big Media “Construction material prices continue free fall”.

Additionally, I want to call attention to a few other things that can be found in the Other Interesting Articles below.  First, as reported by Chris Flood in the Financial Times Vanguard continues to kick butt in terms of attracting cash to the low-cost index model. Last year they had net inflows of $256bn… “more than any rival and an increase of 5.3% on 2014. In the past five years total net inflows from investors are almost $1tn, substantially more than twice the sum attracted by the entire hedge fund industry over the same period.”  You can imagine the pressure this is having on industry fees.

Second, covered by Max Seddon and Jack Farchy in the Financial Times, the Russian rouble continues to slide against the U.S. dollar.  As of January 21, it had reached Rbs85.97 for each greenback as the Russian central banks has stepped back its intervention measures.  In the summer of 2014, the trading range was in the Rbs30s.  According to Ivan Tchakarov, chief economist for Russia and the CIS at Citibank “If the rouble gets to 100, we may see panic. But going from 30 to 80 is different from going from 70 to 85. People are psychologically adjusted.”  Crazy how that works – to my behavioral psychologist readers, reference points…

Third, for my property developer readers, apparently in India property developers can use buyers deposits raised from one project on completely unrelated projects.  WTF!  It should be no surprise that there are unfinished projects in India as reported in The Wall Street Journal.  Well rest assured, there is draft legislation “that would require builders to put 70% of the money they receive from home buyers into escrow for use on the project for which it was paid.”  That may help, but definitely doesn’t address the conflict of interests.

To help break up the monotony of all this text and because there were a lot of good graphics this week:

From Bloomberg Graphics, stock markets around the world are feeling pain.

Bloomberg_Fragile 40 Stock Indexes_1-21-16

From The Wall Street Journal, private-label MBS is starting to make a comeback, albeit not really.

WSJ_Private label MBS_1-18-16

In the Financial Times, you can see the effect low oil prices is having on delaying oil projects.

FT - Oil projects delayed_1-13-16

Lastly, before I get to the articles I’ll leave you with two quotes.  First in Tom Mitchell’s “The ugly subtext beneath China’s two-track economy tale” in the Financial Times.

“For years we have been waiting for China to make the tough choice and sacrifice near-term growth in order to stabilize macro balance sheets and stop its exploding debt cycle… the costs of taking real adjustment are clearly too high for the government to bear… Right now we put the initial potential crisis threshold at around five years.” – Jonathan Anderson at the Shanghai based Emerging Advisors Group

And second, as reported in the Lex column in the Financial Times’ “IBM: Where’s the growth?”

IBM duly racked up its 15th consecutive quarter of falling revenues on Tuesday evening. At least the technology company’s nuclear winter has helped eradicate a couple of cliches. ‘Nobody ever got fired for buying IBM,’ is now said by nobody.

*Note: bold emphasis is mine, italic sections are from the articles.

Wanda Group Plans Five ‘Substantial” Acquisitions as Sales Slump. Jill Mao. Bloomberg. 17 Jan. 2016.

To be fair, Dalian Wanda Group took advantage of China’s industrialization by being in the property sector and now that it is a behemoth company and the breakneck pace of growth in the property sector is behind, they are transitioning into a conglomerate with a variety of business lines that have a shot at meaningful growth going forward.  I can imagine that many western public real estate companies are jealous as they are punished in the markets for not being anything but pure play real estate businesses in a specific sector.  However, the reason I call attention to this article is that if the ‘smart’ money property developers are reducing their exposure to Chinese real estate, you probably should too.

“Dalian Wanda Group Co., the property-to-entertainment conglomerate headed by Asia’s richest man, is planning five “substantial” acquisitions this year as the company braces for a drop in sales.”

“Wanda’s pursuit of targets will focus on companies in the entertainment and sports industries…”

“Wang is increasingly looking toward entertainment to spur growth as China’s slowing economy undermines his main property business.”

Last week Wanda agreed to buy Legendary Entertainment for $3.5bn in cash (movies include Godzilla, Jurassic World and the new Batman films.)

“Legendary will join Wang’s growing global entertainment portfolio that already includes the likes of U.S. theater chain AMC Entertainment Holdings Inc., Infront Sports & Media AG and a stake in Spain’s Club Atletico de Madrid soccer team.”

“Wanda forecasts that sales will fall 12% in 2016 as slumping revenue from its main real estate business overshadows gains from the burgeoning entertainment operations.”

“Wang said that his firm is diversifying away from property – currently Wanda’s biggest revenue generator – because it’s not a long-term growth business.

“Longer term, Wang said on Tuesday that Wanda’s revenue will climb at least 15% each year until it reaches $100 billion by the end of the decade as the group diversifies away from real estate property.”

No one would accuse Wang of not being ambitious.

No Place Like Home for Chinese Property Companies’ Debt. Fiona Law and Carol Chan. The Wall Street Journal. 19 Jan. 2016.

Property developers are large consumers of debt and Chinese developers have been large consumers of US dollar denominated debt. However, with the greenback appreciating against the yuan, many Chinese developers are raising yuan denominated debt to retire their US dollar obligations.  Side note: this will only exacerbate capital outflows from China.

“Late last year, the company (China SCE Property Holdings Ltd.) sold bonds domestically worth a combined 3.5 billion yuan ($531 million), at an interest rate just above 5%, much lower than the around 11% coupon it used to pay for its dollar bonds.”

It helps that cost of debt in China has been declining, regardless of credit quality.

“Property companies have on average raised funds at interest rates two to three percentage points lower than their offshore borrowing costs, partly thanks to a series of rate cuts by the country’s central bank since the end of 2014.

The lower cost of borrowing at home is also down to home builders gaining much higher credit ratings from domestic agencies; abroad they are often rated as “junk”, or below investment grade. Domestic investors are often more familiar with the companies they are investing in, and hence demand a lower coupon on bonds. Chinese local governments have a history of bailing out failing companies, meaning domestic investors are less worried about bond defaults.

What’s that phrase again? Oh yeah, moral hazard…

“Chinese property developers were given another boost last January when Beijing loosened restrictions on them raising debt in the domestic market, part of its efforts then to bolster the property sector.”

WSJ - Chinese developer issuance of yuan debt_1-19-16

Construction material prices continue free fall. AZ Big Media. 15 Jan. 2016.

Basically, the input prices into the source materials for construction continue to fall.  Yet, ask any property developer and follow the RLB cost indices and you’ll note that construction prices continue their quick ascent…  So if the cost of the raw materials are declining, either the cost of labor is jumping or profit margins are expanding. Go ahead and ask your construction laborer friends if their wage rates have been increasing 5 – 20% per year.  Granted, they may be making more simply by having more hours of work, but ask if their wage rates per hour have increased meaningfully over the past year and a half.

“Construction material prices fell for the sixth consecutive month in December, losing 1.2% on a monthly basis and 4% on a yearly basis, according to an analysis of the Bureau of Labor Statistics Producer Price Index released today by Associated Builders and Contractors (ABC).”

“Construction input prices have fallen 7.2% since peaking in August 2014, and have fallen in eleven of the previous sixteen months.”

“Construction input prices continued to sink to the end of 2015, due in large measure to global deflationary forces that have become increasingly apparent.” – ABC Chief Economist Anirban Basu

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Housing Starts in U.S. Unexpectedly Declined 2.5% in December

FT – Shipping’s globalization woes 1/14

FT – Amazon lands China ocean shipping license 1/14

FT – China borrowing surges in December 1/14

FT – US equity funds hit by outflows for second straight week 1/15

FT – What goes down eventually comes up 1/15

FT – Vanguard attracts record cash for fourth year running 1/17

FT – Mexico bank chief calls for EM monetary policy action 1/17

FT – How to wean the world off monetary stimulus 1/18

FT – Surging inflation leaves Brazil’s rate setters with headache 1/18

FT – Rise of the robots seen boosting the dollar 1/19

FT – Hong Kong property: bargain bin 1/19

FT – Seven ways technology has changed us 1/19

FT – China’s great economic shift needs to begin 1/19

FT – Capital flight from China worse than thought 1/20

FT – Oil price collapse heightens concern over sovereign wealth funds 1/20

FT – First US Oil tanker arrives in Europe 1/20

FT – Russian rouble tumbles as central bank stands back 1/21 – Real Estate M&A Reaches New Peak 1/21

NYT – Indebted Chinese Companies Increase Pressures on Government 1/17

NYT – 2015 Was Hottest Year in Recorded History, Scientist Say 1/20

Project Syndicate – The Polish Threat to Europe 1/19

WSJ – How Wal-Mart’s Store Closings Paint Wider Retail Picture 1/15

WSJ – China’s Monetary Policy on Treadmill to Nowhere 1/15

WSJ – New York City Property Values Surge 1/15

WSJ – Market for Private-Label Mortgage Bonds Is Recovering, but Slowly 1/18

WSJ – China’s Party Isn’t Over – That’s the Problem 1/19

WSJ – China GDP: Long Slog Increases the Pain 1/19

WSJ – Unfinished Apartments Haunt Home Buyers In Big Indian Cities 1/19

WSJ – Rising Debt in Emerging Markets Poses Global Threat 1/19

WSJ – Dry-Bulk Shipping Firms Face Unprecedented Crisis 1/20



January 8 – January 14, 2016

China’s credit binge. Evergrande Real Estate. This Bond is for you.

Not quite the roller coaster that was last week. Granted the Powerball Lottery added some excitement to the mix.  This week I’m going to focus on the following three articles, 1) George Magnus’ “China’s credit binge is the real concern” in the Financial Times, 2) Jacky Wong’s “This Chinese Developer Is No Grand Slam” in The Wall Street Journal, and 3) Eric Platt and Gavin Jackson’s “Demand soars to record $110bn for AB InBev bond deal” in the Financial Times.

Additionally, I want to call attention to a post in The Economist’s Buttonwood’s Notebook about Martin Taylor’s decision to close the $1.5 billion Nevsky Capital after averaging an annual return of 18.4% since 1995, definitely worth the read.  Basically, it’s hard to make investment decisions when you can’t trust the data from some of the most important elements in the market.  Further (and not to be a buzz kill), it’s worth reading Stephen King’s (not the thriller writer, rather HSBC’s senior economic adviser and author of ‘When the Money Runs Out’) Falling oil prices and a darker global economic outlook in the Financial Times.  Here is a little bit of it:

“Put another way, oil prices have come down not because of an outward move in the supply curve – which would be largely positive for the global economy – but, instead, because of an inward move in the demand curve. The price effect is much the same but the consequences are rather different: unlike the late-1980s, agony for oil-producing nations is not offset by ecstasy for oil-consuming nations.”

“Seen in this light, collapsing oil prices are less a sign that things are about to get a lot better and more a sign that things are in danger of getting a lot worse.”

*Note: bold emphasis is mine, italic sections are from the articles.

China’s credit binge is the real concern. George Magnus. Financial Times. 10 Jan. 2016.

While all eyes are focused on China’s stock markets more focus should be on the growing level of debt in the country.

“It (debt) has risen from about 100% to about 250% of GDP but far from slowing down with the economy, the pace of debt accumulation has actually picked up in the last one to two years.”

“Total Social Financing, a broad measure of monthly credit creation, is growing at nearly three times the rate of officially recorded money GDP growth, or more if you don’t believe the official GDP data. Curiously, many private companies face tight credit conditions and so rapid credit creation may be largely for the benefit of the cash-flows of already highly indebted real estate sector, local governments and state enterprise sectors.

In regard to policy initiatives,

“… all we are likely to see is more credit easing, in the wake of the six initiatives since late 2014 to cut interest rates and banks’ reserve requirements, albeit to no economic effect. The credit binge, then, will continue until it can’t.”

“It is in this context that we might reflect on the recent announcement of a $512bn fall in currency reserves in 2015. Since China has a current account and net direct investment surplus of about $600bn, implied capital outflows must have been close to $1tn.”

This Chinese Developer Is No Grand Slam. Jacky Wong. The Wall Street Journal. 11 Jan. 2016.

You’ll note that I’ve been covering Chinese Real Estate Developers quite a bit lately.  Expect more.  As the real estate and credit markets (for real estate) slow in China, expect more and more interesting behavior.  In this case, Evergrande.

“Evergrande Real Estate is borrowing for all the wrong reasons. That the leverage-laden Chinese developer hasn’t generated cash for five years is a warning to investors tempted to dabble in its debt.”

“Evergrande went on (a) buying binge last year, spending at least $9.5 billion acquiring projects from other developers. More than half that sum was spent in December alone.”

“The company has reported negative operating cash flow every year since 2010 as interest costs surged. Interest payments in the first six months of 2015 came to 8.3 billion yuan ($1.3 billion), a 43% increase from a year earlier and equal to roughly 11% of its revenue. That’s for a company with a gross profit margin of only 28%.”

“Evergrande’s reported net debt-to-equity ratio last June was 86%. But that level rises to 230% when perpetual bonds are counted as debt, as they should be, rather than as equity.”

“Standard & Poor’s expects Evergrande’s total debts, including perpetual securities, to rise to nearly 300 billion yuan this year, from around 250 billion yuan in mid-2015.”

Lately the company has been using debt issuance to buy back shares, despite their current lofty valuation.  Further, subsequent to this article Jacky Wong did a follow up article “Is Chinese Developer’s Trading Prowess Too Good?” in the Wall Street Journal that points to an interesting coincidence that the company seems to buy shares when its key insiders are selling…

Demand soars to record $110bn for AB InBev bond deal. Eric Platt and Gavin Jackson. Financial Times. 13 Jan. 2016.

Not all is bearish news.  There is still a ton of money out there looking for a home, especially if there is some yield available and it’s not tied to commodities.

“Anheuser-Busch InBev has pulled in a record $110bn of demand for an upsized $46bn bond deal, as investors rush to pile into the relative safety of high-grade US corporate debt at the start of a turbulent new year for markets.”

“The brewer’s offering, which will help fund its takeover of rival SABMiller, has eclipsed the $102bn order book that Verizon attracted when the telecoms group sold its $49bn deal in 2013. AB InBev initially set out to raise $25bn but increased the deal more than 80% to $46bn following heavy demand.”

FT - Top corporate bond issues_1-10-16

“Bankers tightened the pricing of the bonds across the yield curve as orders ratcheted higher, with AB InBev’s 10-year bond expected to yield 160 basis points above the benchmark US Treasury – implying a yield of 3.69%. The mega brewer spread its seven-part offering across three, five, seven, 10, 20 and 30-year maturities, comprised of both floating and fixed rate notes.”

“Rating agency Moody’s has assigned a provisional rating of A3 to the bonds.”


Other Interesting Articles

Bloomberg Businessweek


Bloomberg – Blackstone Becomes No. 1 NYC Real Estate Buyer, Sees More Deals 1/8

Contra Corner – Narrow Door, Crowded Hall – RBS Says Sell it All 1/12

Economist – Buttonwood’s Notebook: Is this really 2008 all over again?

Economist – Buttonwood’s Notebook: Nevsky’s prospects – China, fat tails and opaque markets

FT – US bond yields sound warning on economy 1/7

FT – China opens new front in war on speculators 1/11

FT – Brazil cans carnival as recession bites 1/11

FT – Swiss canton tells taxpayers to delay settling bills 1/11

FT – Philippines clears US defense agreement 1/12

FT – Delayed oil projects total nears $400bn 1/13

NYT – San Francisco Office Rents Pass Manhattan as Most Expensive in Country 1/8

NYT – U.S. Will Track Secret Buyers of Luxury Real Estate 1/13

WSJ – Oil Plunge Sparks Bankruptcy Concerns 1/11

WSJ – Bonds Signal Credit Turning Point 1/12

WSJ – How to Profit From Rising Rents: Build Apartments 1/12

WSJ – Why China’s Hefty Trade Surplus Is Dwarfed by Outflows 1/13

WSJ – China Drinks Up Oil and Spits It Out 1/13

WSJ – China’s Jittery Savers Could Pose Capital-Flight Threat 1/14

WSJ – Is Chinese Developer’s Trading Prowess Too Good? 1/14


December 25, 2015 – January 7, 2016

Sovereign-backed corporate debt. Chinese Real Estate Developers in America. Hanergy shares unloaded at a 95% discount. RCAP files for Chapter 11 bankruptcy.

The S&P 500 is down nearly 5% through Thursday, the circuit breakers in China have been triggered twice this week (market is closed for the day after a fall of 7% – the rule was just implemented at the start of 2016 and China is already suspending it), one gigabit/second WiFi kiosks are being rolled out in New York City, North Korea has detonated a nuclear bomb as a test (apparently not a hydrogen bomb, doesn’t make me feel all that better), Crude Oil dropped below $33 a barrel (good for consumers, bad for producers) Venezuela is quickly heading to hyperflation (monthly inflation greater than 50%), Sunni – Shia tensions have spiked in the middle east after Saudi Arabia executed a high profile Shia cleric… basically welcome to 2016.  Hope you had a restful holiday.

I recognize that these topics are getting a lot play in the press, so I won’t go into detail.  For those who haven’t been following: for more on the Chinese stock market and the knock on effect to the rest of world markets see “Why China Is Rattling the World” by Karl Russell and K.K. Rebecca Lai in the New York Times.  Note that China’s foreign exchange reserves fell $108bn in December to $3.33tn according to central bank figures (see graphic below from “China’s Shortest Day Will Prolong the Pain” in The Wall Street Journal).

WSJ - China's Forex Reserves_1-7-16

For context on the history between Sunni and Shia Muslims see “Sunni and Shia: explaining the divide” by Heba Saleh in the Financial Times.

And it’s worth showing the following graphic that was in the Financial Times that highlights the company valuations of the FANGs (Facebook, Amazon, Netflix, and Google Alphabet).  Irrational exuberance for some (note the PE multiples)…

FT Graphic - FANGs_1-6-16

Sorry, I digress.  Since it has been two weeks since the last post, there are many articles in the “Other Interesting Articles” category worth reading, but I’m only going to focus on 1) Elaine Moore and Jonathan Wheatley’s “Fears mount over rise of sovereign-backed corporate debt” in the Financial Times, 2) Eliot Brown and Esther Fung’s “Chinese Developers Build In America, but Look for Buyers at Home” in The Wall Street Journal, 3) Ben Bland’s “Hanergy Thin Film founder sells 6% stake” in the Financial Times, and 4) just because RCAP filed for bankruptcy this week, I’ll cover a little of the rise and fall of this once star of public non-traded REITs.

*Note: bold emphasis is mine, italic sections are from the articles.

Fears mount over rise of sovereign-backed corporate debt.  Elaine Moore and Jonathan Wheatley. Financial Times. 5 Jan. 2016.

One way for a sovereign country to keep its debt levels down is to hide it in companies that are effectively (either explicitly or implicitly, but preferably implicitly) controlled by the government.

“More than $800bn of emerging market sovereign debt is being camouflaged by the growing use of bonds that offer implicit state backing without always appearing on government balance sheets, according to new research.”

Why not, especially considering the buyers of this debt have been willing to oblige.

“The growing use of such bonds suggests developing countries are increasingly transferring debt obligations to third parties that have taken advantage of historically low interest rates to load up with cheap debt.”

“Although official debt-to-GDP levels of countries such as India, Russia and China remain low by global standards, the growth of less visible debt which they might still have to guarantee in a crisis underlines the potential scale of their liabilities.”

“New figures from JPMorgan and Bond Radar show that issuance of quasi-sovereign bonds outpaced that of sovereign bonds in emerging markets last year, raising the stock of such debt from $710bn in 2014 to a record $839bn by the end of 2015.

By comparison, the stock of all external emerging market sovereign debt stood at $750bn at the end of last year, according to JPMorgan.”

For example,

“Quasi-sovereign borrowers include 100% state-owned entities such as Mexico’s Pemex, local governments in countries such as China and entities in which the government owns more than 50% of the equity or has more than 50% of the voting rights – a description that encompasses Brazil’s Petrobas.

However, the treatment of such debt is not uniform. Bonds issued by Pemex are included in debt-to-GDP calculations for Mexico, but this is unusual and only 19 of the 181 quasi-sovereign bonds tracked by JPMorgan carry an explicit sovereign gurantee.”

Therefore, it is of no surprise that the big ratings agencies have been down grading the sovereign debt of countries with large amounts of corporate debt tied up in semi-sovereign companies.

“What can really break the dam is the quasi-sovereign element in EM external debt,” says Gary Kleiman of Kleiman International, an emerging market investment consultant. “People have always assumed there is an implicit backing, but that capacity has not been called into question explicitly.”

“Analysts say the problem extends beyond that of dollar-denominated debt. Emerging market companies have issued an estimated $23.7tn including dollar and local currency debt, up from about $5tn a decade earlier. Many such issuers are quasi-sovereigns. About $16.7tn had been issued by companies in China, according to the BIS, almost all of which carry an implicit or explicit state backing.”

Chinese Developers Build in America, but Look for Buyers at Home. Eliot Brown and Esther Fung. The Wall Street Journal. 29 Dec 2015.

As real estate developing opportunities are becoming scarce (or more financially risky) in China, the large Chinese developers are expanding into various unrelated business lines and more naturally, have expanded into new markets abroad.  Interestingly, they tend to bring their buyers with them.

“Big Chinese development companies, including Greenland, Dalian Wanda Group and Oceanwide Holdings, are collectively planning billions of dollars of U.S. development, including Chicago’s third-tallest tower and a $5 billion apartment project in Brooklyn. Most of the large developers have ambitions one day to collect as much as 20% of their income from international markets such as the U.S. and England.”

“Buyers out of China thus far account for about 40% of Greenland’s Los Angeles project… Wanda is expecting foreign buyers – the bulk of which are Chinese – to buy about 30% of its 94-story, 406-unit condo and hotel project in Chicago.”

“Chinese purchases of commercial property grew to about $5 billion through the third quarter of 2015, already a record that is up from $2.5 billion in all of 2014 and $1 billion in 2010, according to real-estate services firm JLL.”

“Nowhere has the interest been more concentrated than in Los Angeles, where at least 10 Chinese developers have purchased large development sites, all within the last two years, according to JLL.”

Of course, savvy to Chinese demand for real estate in the U.S., several domestic developers of higher priced condo projects in the U.S. have set up sales offices in or agreements with listing agents in China as well.

Hanergy Thin Film founder sells 6% stake. Ben Bland. Financial Times. 29 Dec. 2015.

“Li Hejun offloaded the shares at a 95% discount to their last traded price in May, before they were suspended from the Hong Kong exchange after plunging 47% in one day.”

“This week’s share sale values HTF at $1.16bn, far below the $21bn market capitalization recorded in May.”

So here’s the skinny.  Hanergy Thin Film Power, once one of the most highly valued solar companies in the world utilized shell companies and accounting methods in an investment environment that was desperately looking for renewable-high tech investments particularly with a China tie.  The company’s leader, Li Hejun, in the process briefly became China’s richest person.

There is a good amount of coverage on the subject, but two articles that will help you get your head around it pretty quickly are Abheek Bhattacharya’s “Hanergy’s High Demands for Rehabilitation” in The Wall Street Journal (8/17) and Miles Johnson and Lucy Hornby’s “FT Investigation: The strange tale of ticker ‘566’” in The Financial Times (7/20).

Basically, Hanergy maintained the highest profit margins (near 50%) in the industry (despite continual sales price pressure in the industry) by selling almost all of its product to its unlisted parent company at above market pricing.  But no worry, the parent company didn’t actually pay for most of the product. Rather Accounts Payable and Accounts Receivables increased on both ends.  The “listed Hanergy racked up receivables equal to 101% of annual revenue.”  Still, to the investment community, the stock looked to be a winner and as a result several high profile emerging market funds added the stock and helped push the valuation to about 80 times trailing earnings.  Then of course the façade began to fade (particularly after the China stock market collapse in the summer).  The stock was suspended and now several months later…

“The founder and chairman of Hanergy Thin Film (Li Hejun), who was once briefly crowned China’s richest man, has sold a 6% stake in his solar power group for just US$70m – valuing the company at 1/40th of the $40bn it was worth at its peak.”

RCAP files for bankruptcy; Cetera to emerge as independent company. Bruce Kelly. Investment News – Crain Communications Inc. 4 Jan. 2016.

RSC Capital Corp (RCAP) said on Monday, January 4, that it is planning on filing for Chapter 11 bankruptcy protection by the end of the month.  The debt holders (Fortress Investment Group, Carlyle Investment Management, and others) will infuse $150 million of new capital and take Cetera Financial Group from the carcass and the equity holders will be wiped out.  At its peak RCAP reached $39.50 a share on April 1, 2014 (assuming the current number of shares outstanding that would have implied a market cap over $3.5bn). As of January 7 the shares are trading in the OTC market at $0.0335 a share for a $3m market cap.

For a great synopsis on the rise and fall of RCAP and particularly its founder, Nick Schorsch, Bruce Kelly’s “How Nick Schorsch lost his mojo” in Investment News is a great read.  In a matter of two years, Schorsch’s American Realty Capital Properties’ (ARCP) real estate portfolio went from $100 million to $21 billion (largely assisted by the related financing vehicle of RCAP).  Imagine the effort of buying that much property that quickly and the prices that would have to be paid to “win” that many properties.  Of course, the timing was perfect (with bottomed out pricing after the 2009 crash which subsequently rebounded meaningfully) until it wasn’t.

Other Interesting Articles

Bloomberg Businessweek

The Economist


Bloomberg – Manhattan Luxury-Home Prices in a Slide, Defying Broader Market 12/24

Bloomberg – The Return of the Affordable Starter Home 12/29

Bloomberg – Landlords Face Slowing Price Gains After U.S. Records Shattered 12/30

Bloomberg – U.S. Real Estate to Draw More Foreigners in 2016, Survey Says 1/3

Contra Corner – The Next Big Short: Jeff Bezos’ Brobdingnagian Bubble 12/31/15

FT – China orders SOEs to hire former soldiers 12/28

FT – Sydney property: pride or a fall 12/28

FT – Tokyo property: bargain basement 12/28

FT – Oil’s prologue likely to be a harbinger of worse things to come 1/3

FT – China’s currency remains on path to more downside 1/3

FT – Equities: And then there were nine 1/3

FT – Venezuela central bank curbs fuel fears over hyperinflation 1/5

FT – First WiFi kiosks set to land on New York’s streets 1/5

FT – Why global economic disaster is an unlikely event 1/5

FT – China to extend temporary share-sale ban to calm markets 1/6

Investment News – RCAP files for bankruptcy; Cetera to emerge as independent company 1/4

Mauldin Economics: Cubicle Hell Warning Signs Scream “Recession” 1/5/16

NYT – When a Unicorn Start-Up Stumbles, Its Employees Get Hurt 12/23

NYT – Private Capital Fund-Raising Goal Rises to a Record $946 Billion 1/6

WSJ – After a Down 2015, Real-Estate Stocks Hope for Savior in Indexes 12/29

WSJ – Fannie and Freddie Give Birth to New Mortgage Bond 12/29

WSJ – What Happens When Japan’s Central Bank Runs Out of Bonds to Buy? 12/30

WSJ – China’s Stock-Market Interventions Postpone Grim Reality 1/5

WSJ – Apple Scales Back Orders for Its iPhones 1/5

WSJ – Why Odds Are Long for Macau Recovery 1/6

WSJ – China’s Shortest Day Will Prolong the Pain 1/7

WSJ – Norway’s Oil Fund Is Finding it Hard to Spend $6 Billion 1/7


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