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


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