Tag: Puerto Rico

September 2, 2016September 2, 2016

August 26 – September 1, 2016

A novel way of paying off debt – issue more of it, the savings are already accruing. It’s official, Nigeria is in a recession.

Headlines

WSJ – Food Price Deflation Cheers Consumers, Hurts Farmers, Grocers and Restaurants 8/29. “The U.S. is on track this year to post the longest stretch of falling food prices in more than 50 years…”
Visual Capitalist – Interactive: What Futuristic Tech Will You See In Your Lifetime? 8/30. This is fun.
WSJ – Google Takes on Uber With New Ride-Share Service 8/30. Things are about to get a little less chummy in the Bay Area.
NYT – Dilma Rousseff Is Ousted as Brazil’s President in Impeachment Vote 8/31. It’s official, Rousseff is no longer President of Brazil following a 61 to 20 vote by the Senate that convicted Ms. Rousseff on charges of manipulating the federal budget.
NYT – Scheduled Flights to Cuba From U.S. Begin Again, Now With Jet Engines 8/31. Regular air service from the U.S. into Cuba just resumed after a more than 50 year hiatus.

Briefs

Steven Russolillo of the Wall Street Journal points to why math doesn’t work for current stock market valuations.

“Stock valuations rise and fall, but when an important factor driving market performance is mathematically unsustainable, it is worth a closer look.” Specifically corporate dividends.
“Aswath Damodaran, a professor at New York University’s Stern School of Business, sees this as the market’s biggest risk. Mr. Damodaran, who is considered an authority on valuation, says S&P 500 companies through the first two quarters of the year collectively returned 112% of their earnings through buybacks and dividends. That is the highest since 2008 and well above the 82% average over the past 15 years, he said in a blog post last week.”
“Mr. Damodaran, who likes to be provocative, says with rates this low, traditional valuation metrics are distorted. Instead, the inability of companies to keep paying off their investors will cause the next downturn. ‘This is the weakest link in this market,’ Mr. Damodaran said in an interview. ‘We know cash flows will go down. What we don’t know is what the market is pricing in.'”

Gabriel Wildau of the Financial Times highlighted the growing schism between mobile payment providers and the big banks in China – big data.

“The rise of third-party mobile payments in China at the expense of credit and debit cards is threatening commercial banks’ access to the customer data viewed as crucial to newly emerging financial and consumer business models.”
Further UnionPay, the state-owned settlement network, and other rank and file banks are missing out on the merchant fees that these third-party platforms are redirecting.
“The move by more Chinese consumers to switch from swiping plastic cards to scanning QR codes with mobile wallet apps knocked $20bn from banks’ fee income in 2015, according to Kapronasia, a Shanghai-based fintech consultancy.”
While the fees hurt, the key is that third-party payment providers are “depriving lenders of valuable data on consumption patterns.”

Anjani Trivedi of the Wall Street Journal drew attention to why Chinese banks portfolio shift to more property isn’t necessarily all hunky dory.

China’s big-state lenders are making a shift in their lending portfolios from commercial loans to property. “China Construction Bank (CCB) this week reported residential mortgage lending rose almost 30% in the first half of this year compared with the same period last year. Meanwhile corporate lending fell 2%. At Bank of China, mortgages rose by more than a quarter.”
“On the face of it, banks are moving away from risky lending. That helps their capital cushions because for every loan extended to a company, banks assign a 100% risk-weight. For residential mortgages, banks only have to set aside half that.”
Of course, it helps that residential prices are rising; however, “lending into the property market would make more sense if the mortgage loans weren’t going bad so fast. At CCB, while mortgage nonperforming loans accounted for only 6% of total NPLs, they rose 67% on the year compared with 26% for all loans. And that’s with prices rising nationally, and rising sharply in the biggest cities.”

Leo Lewis and Lucy Colback of the Financial Times covered an interesting development in how the Bank of Japan is distorting the Japanese stock indices through their massive fund flows.
- “From July 29, when the Bank of Japan said it would nearly double its annual purchases of exchange traded funds from ¥3.3tn ($32bn) to ¥6tn, brokers in Tokyo have been selling stocks with a simple, unsettling message.”
- “In an equity market where the central bank is the biggest whale, and where the government in various forms has become the biggest shareholder in a quarter of First Section Tokyo stocks, it’s time to buy the fund flows, not the fundamentals.”
- “Goldman Sachs estimates that the doubling in BoJ buying coupled with the skew towards Nikkei weighting means that the central bank will own at least one-tenth of the equity in 32 companies by this time next year, up from five currently.”
- “The BoJ, according to its current schedule, must buy an average of ¥70bn worth of ETFs every three trading days throughout the year.”
- Helicopter money…

Special Reports / Opinion Pieces

Graphics

FT – Puerto Rico: An island’s exodus – Eric Platt 8/25

Visual Capitalist – Which Countries Are Damaged Most by Low Oil Prices? – Jeff Desjardins 8/26

WSJ – Food Price Deflation Cheers Consumers, Hurts Farmers, Grocers and Restaurants 8/29

WSJ – China’s Private Investment Crash May Be Mirage, but Pain Is Still Real 8/28

Visual Capitalist – Do Newly Built Skyscrapers Signal The Top of the Stock Market? – Jeff Desjardins 8/29

Featured

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

Falling bond yields save taxpayers $500bn. Eric Platt. Financial Times. 31 Aug. 2016.

“The collapse in sovereign bond yields has saved taxpayers more than $500bn in annual interest expenses, allowing countries to rein in budget deficits and continue government-backed programs that would have otherwise been shelved, according to a new report.”

As of the end of last week there was $13.2tn of debt with negative yields.

“Japan, France, Germany and Switzerland are now paid to issue short-dated sovereign bonds.”

“Benefits have effectively been transferred from global investors to sovereign issuers, as sovereign borrowing costs have dropped. Should rates remain low for an extended period, it would likely erode earnings power for many large investment institutions and pension funds.” – Robert Grossman, analyst with Fitch, a rating agency

“The median 10-year government bond now yields 1.17%, down from 3.87% five years ago. Japan has saved more than $95bn a year as a result of the decline in rates, while the US, UK and Germany collectively pay $104bn less annually, the study estimates.”

“Central banks have cut interest rates more than 670 times since Lehman Brothers filed for bankruptcy in 2008, or roughly one reduction every three trading days of the year, according to JPMorgan.”

Nigeria falls into recession as economy shrinks in second quarter. Maggie Fick. Financial Times. 31 Aug. 2016.

“Nigeria has slipped into recession for the first time in more than two decades as growth in Africa’s top oil producer shrank for the second consecutive quarter.”

“The economy contracted 2.1% in the three months to the end of June, worse than analysts expected, while inflation hit a 11-year high of 17.1%, underlining the depth of the west African nation’s crisis.”

“Nigeria, which depends on petrodollars for 70% of state revenues and 90% of export earnings, has been battered by the slump in oil prices. The economy shrank 0.4% in the first three months of the year and the International Monetary Fund is forecasting that growth in 2016 will contract 1.8%.”

“The central bank increased the main interest rate by 200 basis points last month in an attempt to combat inflation, but it rose for the ninth consecutive month in July.”

“The continent’s most populous nation was one of the world’s fastest growing economies during the oil boom, but Mr. Buhari (President Muhammadu Buhari) said this month that Nigeria ‘suddenly appears to be a poor country.'”

It’s currency is having difficulties as well, “in the official market, the naira is trading below N300 to the dollar, having lost more than 40% of its value since its peg was lifted in June (to ease the country’s quickly depleting reserves of hard currency), but on the black market the currency is far weaker – it has been trading at below N400 to the dollar this week.”

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – J.C. Penny Aims to Be King of the Mall as Rivals Retreat 8/25

CoStar – Disparity in Mall Values Driven by Powerful Combination of Forces 8/31

Economist – Grim employment prospects for young people around the world 8/26

FT – How the super-rich are making their homes ‘invisible’ 8/24

FT – Chinese banks braced over industrial restructuring 8/28

FT – Mexico spends $1bn to lock in oil export prices for 2017 8/29

FT – Apple’s EU tax dispute explained 8/29

FT – DBS sells $750m in cocos at record-low yield 8/30

FT – Chinese future looms for Hong Kong’s real estate sector 8/30

FT – China turns away from the market 8/31

Inhabitat – The world’s tallest timber building was just topped off ahead of schedule 8/26

National Real Estate Investor – 2016 Could Signal a Cyclical Peak in Commercial Construction 8/25

NYT – Today’s Inequality Could Easily Become Tomorrow’s Catastrophe 8/26

NYT – Crackdown on For-Profit Colleges May Free Students and Trap Taxpayers 8/28

Zero Hedge – “I’ve Never Seen Anything Like This Before” – The Housing Markets In The Hamptons, Aspen And Miami Are All Crashing 8/28

WSJ – Which State Is a Big Renewable Energy Pioneer? Texas 8/29

WSJ – Housing Market: Why Millennials Are Getting Priced Out 8/29

WSJ – What Happens When a Central Bank Buys Property Stocks 8/30

WSJ – Shopping Malls’ New Product: Fun 8/30

WSJ – Chinese Cash Pours Into U.S. Real Estate 8/30

WSJ – Emerging Markets: Catch the Yield Where You Can 8/31

WSJ – Birth of the Index Mutual Fund: ‘Bogle’s Folly’ Turns 40 8/31

July 29, 2016July 28, 2016

July 22 – July 28, 2016

How much spare crude oil is there – hard to tell. Nontraded REIT sales struggling. There are a lot of dangers lurking in the Chinese P2P market, but the yield is just SO GOOD…

Headlines

FT – Singapore vows more ‘intrusive’ bank probes after 1MDB scandal 7/24. Turns out banks in Singapore were used to channel the more than $3.5bn siphoned from the Malaysian state investment fund.
NYT – Is China Stealing Jobs? It May Be Losing Them, Instead 7/22. “If anyone is claiming that China is still enjoying a healthy or robust jobs market, they have no idea what they’re talking about.” – Leland Miller, chief executive of China Beige Book International
NYT – Panama Papers Reveal Wide Use of Shell Companies by African Officials 7/25. Can’t say I’m surprised.
FT – A world map of subsidies for renewable energy and fossil fuels 7/25. Subsidies for “dirty” fuels (fossil fuels) were approx. $490bn in 2014 vs. subsidies for renewables at $112bn and another $23bn on biofuels.
Star-Advertiser – N. Korea: U.S. has crossed red line, declared war 7/28. By putting Kim Jong Un on the list of sanctioned individuals, N. Korea claims the U.S. has crossed the red line and should the U.S. and S. Korea hold its planned war games next month, it’s on like Donkey Kong – according to N. Korea.

Briefs

Financial Times journalist Gabriel Wildau highlighted that China’s insurance regulator has warned insurance companies from using policies as an ‘ATM’ for corporate buyouts.

Chinese wealth management products are looking a lot like the junk bonds used for corporate raiding in the late 1980s rather than the traditional insurance policies they are supposed to be.
“China’s insurance regulator has warned against insurers becoming ‘automatic teller machines’ for activist shareholders, in a veiled reference to the battle for control of China Vanke, China’s largest residential developer, by insurance conglomerate Baoneng Group.”
“We will let those that truly want to do insurance come and do insurance and absolutely not allow companies to become financing platforms and ‘ATMs’ for large shareholders.” – Xiang Junbo, chairman of the China Insurance Regulatory Commission
“There are major regulatory gaps that need to be addressed. These ‘universal’ products have absolutely nothing to do with insurance. Some of them are very risky, but commercial banks are distributing them, and people trust the banks.” – senior financial regulator

John Dizard of the Financial Times called attention to the dangerous precedence that was just set concerning Puerto Rican debt.

With Puerto Rico facing approximately a $2bn interest and principal payments due on its general obligation bonds on July 1 and not being able to make the payments, the U.S. Congress recently passed a law that was meant to give Puerto Rico a temporary reprieve from “legal sanctions by creditors so it could restructure its obligations in an orderly way, and to maintain essential services.”
Well, Puerto Rico took this reprieve to pay about half of the amounts due, only they chose to whom went the payments. “Puerto Rico did not pay any interest or principal on the most senior, or general obligation bonds, but did make payments on more junior bonds. The government also paid its employees’ pension funds $170m more than what was required for this year, despite the pensions supposedly being legally subordinated to bondholders.”
The thing is that US Treasury officials advised on some of this reprioritization… you can see the dangerous precedence this sets for municipal bonds…
“The bonds on which interest payments were made on July 1, such as the Puerto Rico convention center district and the Puerto Rico Highways and Transportation Authority, are disproportionately owned by bondholders on the island. Supposedly more-sophisticated mainland US investors had avoided these lower ranked issues on the misinformed premise that financial and legal analysis should outweigh political calculation.”

The Buttonwood column of The Economist highlighted a rather large potential problem the world is facing: the vanishing of working age adults…
- “The world is about to experience something not seen since the Black Death in the 14th century-lots of countries with shrinking populations. Already, there are around 25 countries with falling headcounts; by the last quarter of this century, projections by the United Nations suggests there may be more than 100.”
- “The big question is whether economic growth and rising debt levels go hand-in-hand, or whether the former can continue without the latter. If it can’t, the future can be very challenging indeed. To generate growth in our ageing world may require a big improvement in productivity, or a sharp jump in labor-force participation among older workers.”
Christian Shepherd of the Financial Times covered that China is now enforcing its ban on original news reporting.
- “A spokesman for Beijing Cyber Administration confirmed that state press reports that said conducting original reporting was a gross violation of the regulations (rule in place since 2005) and brought about ‘extremely nasty effects.’ The reports also said that the companies had been given a fixed period to ‘rectify’ the offending sites.”
- “The trigger for the shutdown, according to media analysts, was coverage of flooding in northern China which – according to the official count – has left 130 dead and racked up damages of more than Rmb16bn ($2.4bn) in Hebei province alone.”
- “The government does not want these platforms to provide their own news. They are only allowed to forward reports by outlets like Xinhua and the People’s Daily.” – Qiao Mu, a journalism professor in Beijing.

Special Reports

Graphics

FT – Renminbi drops to sixth in international payment ranking 7/20

FT – Tough outlook for Hong Kong property – 7/21

Visual Capitalist – The Illusion of Choice in Consumer Brands – 7/21

Bloomberg – Relief for Renters Will Prolong Fed’s Wait to Hit Inflation Goal 7/24

The Daily Shot 7/25

FT – Landscape shifts for pipeline operators – Ed Crooks 7/24

Economist – Buttonwood – Vanishing workers: Can the debt-fueled model of growth cope with ageing population? 7/23

WSJ – Why Pensions’ Last Defense Is Eroding – Timothy W. Martin 7/25

Economist – The Big Mac index: Patty-purchasing parity 7/23

Featured

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

How Much Oil Is in Storage Globally? Take a Guess. Dan Strumpf and Nicole Friedman. Wall Street Journal. 24 Jul. 2016.

“The historic fall in oil prices has created a pileup of inventories, much of it stashed in tanks in the U.S. and other industrialized countries that are committed to disclosing the latest tally, but millions of barrels of oil are flowing to locations outside the scope of industry trackers.”

“At the beginning of July, 23 supertankers capable of holding 43 million barrels of oil were anchored for a month or more in the Singapore straits, according to Thomson Reuters’s vessel-tracking service, up from 15 ships at the start of the year. If they were full, it would be enough to meet the U.S.’s oil needs for more than two days.”

“‘OPEC has stopped being a swing supplier,” said Antoine Halff, director of the oil market program at Columbia University’s Center on Global Energy Policy. ‘Given the uncertainty about whether shale-oil production in the U.S. can take the role of swing supplier, it falls on stocks’ to replace lost barrels in the case of a supply disruption.”

“Uncertainty around storage was highlighted after attacks on Nigerian oil facilities in May and June. Following the assaults, some analysts forecast that Nigerian output would fall, which helped push oil prices above $50 a barrel. But shipping data showed Nigerian exports holding steady above 1.5 million barrels a day, according to data provider Windward.”

“Where did the exports come from?”

“In China, another storage mystery is unfolding. Government data show oil imports rising at a faster rate than refiners are processing it. The figures suggest the country has built a surplus 160 million barrels during the first half of the year, enough to meet its oil needs for about two weeks.”

“Analysts believe those barrels have gone to commercial tanks or to government-owned strategic reserves.”

“The distinction is critical. If most of the oil has gone to strategic reserves, demand could shrink once the tanks reach capacity, which some analysts say could happen this year.”

Nontraded REIT sales fall off a cliff as industry struggles to adapt. Bruce Kelly. InvestmentNews. 24 Jul. 2016.

“Over the first five months of the year, sales of full-commission REITs, which typically carry a 7% payout to the adviser and 3% commission to the broker-dealer the adviser works for, have dropped a staggering 70.5% when compared with the same period a year earlier, according to Robert A. Stanger & Co. Inc., an investment bank that focuses on nontraded REITs.”

“Their recent sharp drop in sales is part of a longer cycle. The amount of equity raised, or total sales of nontraded REITs, has been sinking by about $5 billion a year since 2013, when sales hit a high watermark of nearly $20 billion.”

As a result, independent broker-dealer company commissions are down in tandem. “Industry bellwether LPL Financial said in its first-quarter earnings release that commission revenue from alternative investments, the lion’s share of which comes from nontraded REITs, was just $7.8 million, a staggering decline of 86.7% when compared with the first quarter of 2015.”

Four key factors have hit the industry. The blowup of Nicholas Schorsch’s REIT empire, recent FBI raids of United Development Funding (after hedge fund manager Kyle Bass called the company a Ponzi scheme), the Financial Industry Regulatory Authority Inc. rule 15-02, and the new DOL fiduciary rule.

The first two basically have brought the public and regulatory spot light to the industry and has shown the light on the less savory parts of the industry and its excessively high fees.
Finra rule 15-02 basically have caused an increase in transparency in the fees that the industry charges, now making them more accurately reflected on account statements.
And the DOL fiduciary rule “which will be phased in starting April, requires advisers to select investments for retirement accounts that are in the client’s best interest. Investments with high commission structures might not pass that test.” However, this rule also has a flip side, nontraded REITs may now be placed in retirement accounts (also as of April thanks to a Dept. of Labor ruling).

On the plus side, the industry is changing. New T shares are meant to reduce upfront commissions while spreading them over time (still high commissions) and larger financial institutions like Blackstone Group and Cantor Fitzgerald & Co. are looking at getting into the industry. Hence references are made to the evolution of the mutual fund industry that also started out with high commission structures.

As Allan Swaringen, CEO of Jones Lang LaSalle Income Property Trust, put it “nontraded REITs have lived almost exclusively across independent broker-dealer channels. I don’t think that’s a model that will be successful going forward. It has to be sold by a variety of advisers.”

Chinese P2Ps plagued by flaky guarantees (fintech blog). Gabriel Wildau. Financial Times. 25 Jul. 2016.

“‘It’s just too easy to attract investment. That’s why it draws so many scammers,’ says Michael Zhang, chairman of Beijing-based Puhui Finance, a large P2P platform with a clean reputation.”

“Beyond the problem of outright fraud is the thornier issue of raising risk awareness in a culture where debt investments are traditionally seen as carrying an implicit guarantee from issuers who are mainly state-owned institutions.”

“Dianrong.com, one of China’s largest P2P platforms, investment products carry a label that says ‘multiple guarantees.’ While the Chinese term used – baozhang – is distinct from the word for legally binding guarantees, it still translates as ‘guarantee’ or ‘safeguard.’ Many platforms now divert a portion of borrower interest payments into a ‘reserve fund’ used to protect investors from defaults, an arrangement that looks a lot like bank capital.”

“Soul Htite, the co-founder of Dianrong.com who previously co-founded US-based Lending Club, says that in an investing culture where defaults are rare, Chinese investors tend to choose products purely based on yield.”

“In the US we have a very good history of investing and people understand risk. (But) one problem we had in the first couple of years with Chinese investors is, we noticed that when you listed all the loans – this one yields 8% and another one yields 14% – people put all their money on the 14%. And we explained, ‘It’s not guaranteed, it might default.’ Still they put their money there. So that’s when we started forcing diversification on them.” – Soul Htite

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Gasoline Prices Around the World: The Real Cost of Filling Up 7/18

Business Insider – Hong Kong is ‘stuck between a rock and a hard place’ 7/23

FT – Brazil sees strong demand for bonds as market rallies 7/22

FT – Moscow’s building boom belies recession 7/22

FT – Thermal coal bears gripped by Chinese capacity squeeze 7/24

FT – Balance of power tilts from fossil fuels to renewable energy 7/25

FT – Chinese default exposes creditor anger at political interference 7/26

FT – Fossil fuels have had an aeon’s head start 7/26

NYT – Justice Dept. Rejects Account of How Malaysia’s Leader Acquired Millions 7/22

NYT – Uncle Sam Wants You – Or at Least Your Genetic and Lifestyle Information 7/23

NYT – Delusions of Chaos (Paul Krugman) 7/25

May 13, 2016May 13, 2016

May 6 – May 12, 2016

China’s coming debt bust.

It’s a short one this week – traveling with the family. Enjoy!

Headlines

FT – Chinese retail investors throw global commodities into a tailspin 5/6. Without a better outlet, money from Chinese retail investors has found its way to the commodity markets.
FT – Canada’s wildfires could blaze for months 5/8. So far more than 1,500 square km have been consumed and the fire is at the footsteps of neighboring province, Saskatchewan.
NYT – Anger Overflows in Nigeria as Economy Dives 5/9. The country is reaching a boiling point.
FT – China party mouthpiece echoes Soros’ debt fears 5/10. Basically an unnamed ‘authoritative’ figure within the country acknowledged that the country’s debt levels pose a systemic risk.
NYT – Brazil’s Senate Votes to Begin Impeachment Trial of Dilma Rousseff 5/12. VP Michel Temer will take charge now while the trial gets underway.

Briefs

Adding to this week’s feature is Ben Bennett’s piece in the Financial Times basically saying that by pushing out the problem (China’s growing debt imbalance), it will only make the remedy worse.
- “Estimating the amount of debt that needs to be written off by China is not an exact science. It boils down to how much excess capacity has been built with little chance of making an economic return. Julien Garran at MacroStrategy estimates there has been around $8tn of excess fixed capital formation in China since 2008, which, assuming that 60% turn into non-performing loans and a 40% recovery rate, suggests losses of $3tn. This is about 30% of Chinese GDP. Autonomous Research gets to a similarly large number by looking at losses realized by other countries following their own credit bubbles. This far outstrips the loss-absorbing capacity of the financial system, and would therefore require significant state support to resolve.”
Shifting our attention further West (if the reference point is China), Anna Andrianova and Andrey Biryukov of Bloomberg highlight that Russia is grappling with deflation as its economic sickness gets worse.
- “Russia’s longest recession in two decades has obliterated consumer demand. Price growth has slowed for a seventh month. Goldman Sachs predicts Russia’s annual inflation, now 7.3%, will slip below 6% in the third quarter and finish the year at 4.5%. In March of last year inflation was 16.9%. It’s enough for Bank of America to warn that the country faces a ‘sharply rising’ risk of deflation.”
- “After President Vladimir Putin came to power in 2000, the poverty level fell until 2014, when oil prices collapsed. Now millions are sinking into poverty and wages are rising minimally.”
- “Savings rose to 14.1% of disposable income last year, up from 5.4% in 2008, according to the Federal State Statistics Service.”
- “Poor demographics add another wrinkle. The working-age population has shrunk by 5 million since its peak in 2006 and will continue to contract, cutting Russia’s potential economic growth to near zero in 2016-2017, according to BofA economists.”
Back to the U.S., Sam Fleming and Shawn Donnan point out in the Financial Times that the middle class in most US cities have taken a financial hit so far this century.
- “The research on urban centers that are home to three-quarters of the US population shows that median household incomes, adjusted for the cost of living in the area, grew in just 39 out of 229 metro areas between 1999 and 2014.”

Graphics

FT – The biggest problem with China’s latest credit boom, charted 5/4

FT – China companies borrow to repay debts in latest credit binge – James Kynge 5/9

Economist – Shadow banks: Dark and stormy

FT – EM millennials out-earn their elders 5/11

FT – Air pollution hits ‘catastrophic’ levels 5/11

Featured

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

The coming debt bust: It is a question of when, not if, real trouble will hit in China. Economist. 7 May 2016.

“The country’s debt has increased just as quickly over the past two years as in the two years after the 2008 crunch. It’s debt-to-GDP ratio has soared from 150% to nearly 260% over a decade, the kind of surge that is usually followed by a financial bust or an abrupt slowdown.”

“China will not be an exception to that rule. Problem loans have doubled in two years and, officially, are already 5.5% of banks’ total lending. The reality is grimmer. Roughly two-fifths of new debt is swallowed by interest on existing loans; in 2014, 16% of the 1,000 biggest Chinese firms owed more in interest than they earned before tax. China requires more and more credit to generate less and less growth: it now takes nearly four yuan of new borrowing to generate one yuan of additional GDP, up from just over one yuan of credit before the financial crisis.”

“It is true that China has been fastidious in capping its external liabilities (it is a net creditor)… But the damage from a big Chinese credit blow-up would still be immense. China is the world’s second-biggest economy; its banking sector is the biggest, with assets equivalent to 40% of global GDP.“

“Optimists have drawn comfort from two ideas. First, over three-plus decades of reform, China’s officials have consistently shown that once they have identified problems, they had the will and skill to fix them. Second, control of the financial system – the state owns the major banks and most of the biggest debtors – gave them time to clean things up.”

“Both these sources of comfort are fading away. This is a government not so much guiding events as struggling to keep up with them. In the past year alone, China has spent nearly $200 billion to prop up the stock market; $65 billion of bank loans have gone bad; financial frauds have cost investors at least $20 billion; and $600 billion of capital has left the country. To help pump up growth, officials have inflated a property bubble. Debt is still expanding twice as fast as the economy.”

Further, “despite repeated efforts to restrain them, loosely regulated forms of lending are growing quickly: such “shadow assets” have increased by more than 30% annually over the past three years.”

The risks are first “higher-than-expected losses for the banks. Hungry for profits in a slowing economy, plenty of Chinese banks have mis-categorized risky loans as investments to dodge scrutiny and lessen capital requirements. These shadow loans were worth roughly 16% of standard loans in mid-2015, up from just 4% in 2012. The second risk is liquidity. The banks have become ever more reliant on ‘wealth management products,’ whereby they pay higher rates for what are, in effect, short-term deposits and put them into longer-term assets. For years China restricted bank loans to less than 75% of their deposit base, ensuring that they had plenty of cash in reserve. Now the real level is nearing 100%, a threshold where a sudden shortage in funding – the classic precursor to a banking crises – is well within the realm of possibility. Midsized banks have been the most active in expanding; they are the place to look for sudden trouble.”

“…it is too late for China to avoid pain. The task now is to avert something far worse.”

Other Interesting Articles

Bloomberg Businessweek

The Bank of Japan Buys Blue Chips

The Economist

Bloomberg – Manhattan’s Latest Tower Heats Up Hudson Yards Race for Tenants 5/9

FT – MetLife takes axe to hedge fund portfolio 5/5

FT – Alarm bells ring over negative interest rates 5/5

FT – Buffett and Bogle unite against hedge funds 5/7

FT – The real cost of big tech’s accounting games 5/8

FT – PwC to deploy drone army 5/8

FT – Alarm grows as investors get bulk of listed groups’ profits 5/9

FT – China capital outflows persist despite FX reserves rebound 5/9

FT – Rosneft head: Opec no longer united organization 5/10

FT – China insurance regulator sends inspectors to Anbang 5/11

FT – Linn Energy files for bankruptcy protection 5/11

FT – Macy’s joins American retail descent into the doldrums 5/11

FT – Grantham on the paradigm shift that never was 5/11

FT – Abu Dhabi raises stakes in 1MDB dispute with $1.2bn demand 5/11

WSJ – Stuck at Zero: The Long-Term Challenge for Investors 5/6

WSJ – Opportunity to Squeeze More From China’s Biggest Mall Developer 5/9

WSJ – What a China U-Turn Would Mean for Global Growth 5/10

WSJ – Luxury Condo Boom Is Ending in Manhattan 5/10

WSJ – Mall Landlords Go for Novelty in China 5/10

WSJ – Malaysian Leader Najib’s Stepson Allegedly Funded U.S. Property Deals With 1MDB Money 5/12

May 6, 2016May 6, 2016

April 29 – May 5, 2016

Beware of ‘investments’ being peddled by Chinese banks. China no longer getting the same bang for the buck. Industry concentration tends to result less money going to employees.

Headlines

FT – Will duration risk rear its head for bond investors? 4/28. “The duration on the Barclays global aggregate bond index hit a record high of 6.8 years this month. At the same time, the yield on the index has crumbled to 1.44% from 4.24% a decade ago.
NYT – China Lending Inflates Real Estate, Stocks, Even Egg Futures 5/1. Bottom line, money finds a home.
FT – Puerto Rico suffers most significant default in debt crisis 5/2. Puerto Rico just declared a moratorium on the Government Development Bank obligations, next up general obligation bond payment due July 1, will they make it?
NYT – American Pharoah Is Already a Champion at the Stud Life, Too 5/3. Some of you may recall the Bloomberg article about the concerns and hope about American Pharoah’s next act, well turns out he’s doing just fine.

Briefs

Lucy Hornby of the Financial Times drew attention to the reality that not all Chinese provinces are posting growth, in fact some are experiencing outright decline.

“The economy in China’s industrial province of Liaoning contracted in the first quarter, making it the first region to register negative growth in seven years as a severe downturn in energy and heavy industry sectors hits hard in the country’s north-east.”
“China’s national growth clocked in at an annual rate of 6.7% in the first quarter, but that headline figure masks sharp discrepancies between provinces reliant on heavy industry, mining or oil, and the southern and eastern regions with more diversified economies.”
“Chinese newspaper 21st Century Business Herald reported this week that Liaoning would book a 1.3% contraction in real GDP for the quarter…”

Daniel Thomas of the Financial Times covered that Global smartphone sales fell for the first time. It was bound to happen eventually.
- “Global smartphone shipments fell for the first time as “iPhone fatigue” dragged down sales for Apple’s once-unstoppable franchise amid a general weakening in the market for new devices.”
- “After close to a decade of stellar growth, analysts say a tipping point in the smartphone market has been reached as most people already have a phone, phablet or tablet device.”
- “Apple popularized the smartphone market with the launch of the first iPhone in 2007. The US group said this week that it had suffered a 16% fall in unit sales in the first quarter and warned that the next quarter could be even worse…”
- “Apple was not totally to blame, however, as global smartphone shipments fell 3% in the first quarter of 2016 to 334.6m, down from 345m units in the same quarter of 2015. The quarter was the ‘first time ever since the modern smartphone market began in 1996 that global shipments have shrunk on an annualized basis.'”
- “As the China market matures, the appetite for smartphones has slowed dramatically as the explosion of uptake has passed its peak.” – IDC, a research firm.
For those of us in Hawaii, we’re quite familiar with the concept of leasehold property, and generally if you can avoid it for your primary residence you do. Well in China all residential property is leasehold and some of those lease terms are rolling over in short order. Lucy Hornby of the Financial Times discusses the angst this is causing.
- “The simmering issue of property rights in China has burst into the open with the upcoming expiry of residential leases in several wealthy cities and a contentious plan to charge homeowners to renew them.”
- When the Communist party entered into power in 1949 property ownership was abolished only to be renewed via a mixed bag of leasehold rights in the 1980s and 1990s. Now these rights are “…in the spotlight with the upcoming expiry of 20-year residential land use rights in Wenzhou in eastern China… Leases granted in the 1990s will also soon come due in Shenzhen and other coastal cities, although the more common tenure of 70 years means most of the current generation of urban homeowners will hand the problem on to their heirs.”
- “Wenzhou has asked homeowners to pay up to a third of their homes’ value to renew their rights, according to a city government document, sparking an outcry across China. The Property Law of 2007 says land-use rights can be renewed but does not specify the criteria for doing so.”
- “Many Chinese bought their homes under the expectations that the long leases would be transformed into full ownership.”
Enough with all this bad news. No really, as Lingling Wei reports in the Wall Street Journal, China is pressing Economists to brighten their outlooks.
- “Securities regulators, media censors and other government officials have issued verbal warnings to commentators whose public remarks on the economy are out of step with the government’s upbeat statements, according to government officials and economic commentators with knowledge of the matter.”
- As Scott Kennedy, a deputy director at the Center for Strategic and International Studies (a Washington think tank), puts it “vigorous debate among economists and public confidence in this conversation is critical if China is to successfully navigate the choppy economic waters. If the party and government only want to hear good news, then they’d be better off hearing nothing because the value of the words would be less than zero.”
- “While restrictions on foreign media have always been tight, they are becoming tighter, with a growing list of foreign publications having their websites blocked from view within China, including The Wall Street Journal.”

Special Reports

FT – China’s robot revolution – Ben Bland 4/28
FT – Rise of the robots is sparking an investment boom – Richard Waters and Tim Bradshaw 5/2
Mauldin Economics – Where’s the Beef? “Lies, Damned Lies, and Statistics” – Rob Arnott and Lillian Wu 5/4
Washington Post – America’s great housing divide: Are you a winner or loser? 4/28
- Interesting interactive graphic to see how much home values have changed in your neighborhood since 2004.

Graphics

FT – Will duration risk rear its head for bond investors? 4/28

FT – Rise of the robots is sparking an investment boom – Richard Waters and Tim Bradshaw 5/2

FT – US producers Ultra and Midstates fall victim to low oil price 5/3

Featured

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

Chinese banks disguise risky loans as ‘investments’. Yuan Yang and Gabriel Wildau. Financial Times. 28 Apr. 2016.

“Chinese banks are using complex financial engineering to disguise risky loans as ‘investments,’ rendering traditional risk metrics such as non-performing loan ratios virtually useless.”

“Analyst say most of these assets are in effect loans but are structured to appear as holdings of investment products issued by a third party. Such financial alchemy allows banks to evade regulations designed to limit risk.”

“Banks are required to set aside fewer provisions against ‘investment’ assets than traditional loans.”

“Because the investments are not classified as loans, defaults are not reflected in these banks’ non-performing loan ratio. Many analysts believe China’s official NPL ratio of 1.67% is all but irrelevant in assessing banks’ overall asset quality.”

“Fitch, the rating agency, believes this practice, also known as channel lending is used to provide credit to the likes of ‘cash-strapped property developers and local governments’ that cannot obtain formal loans.”

“Now that overcapacity sectors such as steel and cement are facing restrictions on formal borrowing, channel lending could become even more important to zombie companies.”

“Banks classify the assets they hold in these third parties as ‘investment receivables’ or ‘debt receivables,’ not loans.”

“Shadow lending in debt receivables increased 63% to Rmb14tn ($2.16tn) last year, according to an analysis of 103 Chinese banks by Wigram Capital Advisors, equivalent to 16.5% of the formal loan book.”

“Aggressive balance sheet expansion by midsized lenders has also increased their systemic importance to China’s overall banking system. The big four’s share of total banking assets has fallen from 51% in 2009 to 38% at the end of 2015, according to Wigram’s calculations.”

China’s fizz goes flat, even with far bigger credit stimuli. James Kynge. Financial Times. 4 May 2016.

Bottom line: “money is losing the power to energize important economic muscles. Asset prices in the all-important property market – which drove China’s recovery from the 2008 financial crisis – are now so high relative to household incomes that it is hard to envisage another sustained rally.”

“On average, it would take 25 years, 33 years, 36 years and 19 years of household income in Beijing, Shanghai, Shenzhen and Guangzhou respectively for a family to buy a 90 sq m (969 sq ft) apartment, according to calculations by Mizuho Securities in Hong Kong. By contrast, London house prices are 9.2 times average earnings for first-time buyers, according to Nationwide data.”

“The International Monetary Fund estimates that $1.3tn in corporate debt – or almost one in six of the business loans on Chinese banks’ books – was owed by companies that brought in less in revenues than they owed in interest payments.”

“So unleashing a new tide of credit to ease debt problems is ‘like smoking opium to look healthy,’ said Professor Li Weisen of Fudan University, according to the South China Morning Post.”

“China expanded total domestic credit by Rmb12tn, or 34% of gross domestic product, in the year to November 2009 – significantly less than the Rmb27.9tn, or 40% of GDP, in the year to February this year, according to Bernstein Research.”

“But while the 2009 stimulus reinvigorated growth from 6.1% in the first quarter to a full-year GDP growth rate of 9.2%, the flood of credit seen in the year to February has been accompanied by a gentle decline in GDP headline numbers.”

Rising Profits Don’t Lift Workers’ Boats. Peter Coy. Bloomberg. 5 May 2016.

“Big business is getting bigger, and workers’ slice of the economic pie is getting smaller. Those trends have bred resentment toward large corporations. Now research shows a surprisingly tight link between the two phenomena: The share of the pie that goes to workers has been shrinking most in precisely those industries where ownership is becoming more concentrated.”

“Increasing industry concentration ‘may explain one of the transcendent issues confronting the U.S. economy,” namely labor’s declining share and profits’ rising share of the value a company creates, Michael Feroli, the chief U.S. economist at JPMorgan Chase, wrote in an April 25 research note.”

As an explanation of the trend, “Feroli says, is that industries with more concentrated ownership can charge higher prices. They pay out their extra profits to shareholders, or to the government in taxes, but not to workers.”

“One hopeful sign for workers: The share of national income going to wages and salaries has rebounded since 2012, erasing about 30% of its post-1997 decline.”

Other Interesting Articles

Bloomberg Businessweek

The Economist