Almost 3 years ago, in our post Credit Entropy and the China Credit Syndrome (
https://crediteye.wordpress.com/2011/05/11/credit-entropy-and-the-china-credit-syndrome/), we had asserted that most of China’s big companies were unviable and the banking system was headed for a one way ticket to the zoo. That scenario is now being played out in front of our eyes. The interbank rate has shot through the roof on the news of big defaults. It is now time to worry about the creditworthiness of the world’s big mining companies, whose credit story has been closely correlated to China’s.
I invite you to publish credit analysis notes at this blog site under your names. They must conform to this site’s motto of “No Bullshit Credit Analysis and Research”.
The Notes could be on
1) Credit Analysis of Sovereign Countries/ sub-sovereign entities
2) Credit Analysis of Companies
3) Developments that Creditors everywhere need to pay heed to.
Looking forward to receiving your contributions.
In India, this question would be regarded as sacrilegious. But the time has come to tot up the group’s assets and liabilities. This is a must for any sensible investor before he plunges into the perpetual debt of Tata Steel and the Tier I and Tier II capital instruments of Tata Capital or Tata Motors Finance. On the asset side, there is only the group’s holdings in TCS. All the rest is liability. No one wants to be seen dead in the ghastly cars that Tata Motors makes (the JLR bit alone cant bail out this company). God only knows for how long Tata Steel can carry its leveraged capital structure before the edifice collapses. Tata Communications requires Rs 1500 crores of annual bailout (the joint venture partner DoCoMo wants to get out- if the Tatas buy out the Japanese company, the bad situation would only get worse). Though Indian Hotels has made losses recently, that company should survive once the economy turns. The same cant be said with certainty about Tata Chemicals or the Tata group’s retail adventures. Tata Power is a bottomless pit, guzzling cash faster than Ford’s Model T guzzled petrol. Many of the group’s companies have not been shy about borrowing in foreign currency. The recent fall in the INR is going to make things worse. Credit investors who are investing in the debt instruments of the Tata group companies based on the AAA rating of Tata Sons assigned by the Indian arms of S&P and Moody’s should not look to those agencies for solace when the shit hits the fan.
It has been almost two and half years since we had mentioned that Deutsche Bank was under reserving for litigation expenses (In our piece Deutsche Bank Creditor Concerns, March 2011). Among the many reasons we had listed for asserting that the bank was woefully undercapitalized was
It is doubtful that Deutsche Bank has sufficiently provisioned for the litigations it is exposed to. Only last week it lost a case in Germany for failing to advice a client properly on the true risk of a complex swap transaction. This litigation was not even mentioned in the 2010 Annual report. In the US, the bank has $ 588 million of outstanding mortgage repurchase demands on mortgages that were allegedly fraudulently securitized. More such demands could come up this year. The bank is also exposed to risk from the Auction Rate class action as well as the Trust Preferred Securities class action. It is unlikely that the bank will emerge unscathed from these lawsuits as the management wishfully claims.
Finally, the chickens have come home to roost. The Bank, in the second-quarter, has set aside about 600 million euros ($796 million) to cover legal costs. Wishful thinking can only go so far.
About 3 years ago we had said that while the great investor Jim Chanos is usually right, he is wrong being pessimistic about the prospects of the Chinese real estate sector- particularly the high end real estate sector (See https://crediteye.wordpress.com/2010/12/14/investor-jim-chanos-almost-always-right/). We reaffirmed this conviction about a year ago (https://crediteye.wordpress.com/2012/11/06/china-corruption-good-for-high-end-real-estate-credit/).
It seems that our expectation has turned out right. Despite a sharply slowing economy, China’s June new home prices rose in all but one city, led by the biggest metropolitan centers. Prices climbed in 69 of the 70 big cities last month from a year earlier, matching the data in May. The city of Guangzhou posted the biggest increase with a 16 percent advance from a year earlier. Prices climbed 13 percent in Beijing and 12 percent in Shanghai. The Chinese real estate market bears no similarity to the US sub-prime market. The US real estate market continues to be driven by leveraged investors using cheap credit provided by Bernanke. The debt involved in real estate purchase in China is far lower than the US, and hence it is less likely there will be a panic in the sector.
Yesterday S&P downgraded the credit rating of leading Chinese Steel producer Baosteel to BBB-. Two years ago, in our piece Credit Entropy and the China Credit Syndrome (https://crediteye.wordpress.com/2011/05/11/credit-entropy-and-the-china-credit-syndrome/) we said the following about Baosteel:
God help any company competing with Baoshan Iron and Steel (Baosteel). Untrammelled by petty thoughts such as return on capital employed, and sustaining thanks to access to unlimited cheap credit, the only people who had the right to complain were the long suffering minority shareholders- the stock was at the same level that it was 7 years ago. Inner Mongolia Baosteel Union, a subsidiary of Baosteel, had negative return on capital employed in 2009 after a terrible performance in the previous few years. After a merger in 2008, Handan Iron and Steel overtook Baosteel to become the second largest Chinese steel producer. Like its other compatriots, the company is not overly fanatical about ROCE metrics.
Unlike S&P, we continue to assert that a creditor to Baosteel, particularly its Dim Sum bonds, has no cause to worry. The Chinese state is not going to allow this entity to default.
The population of the US city of Detroit peaked in 1950 at 1.8 million. In the census of 2010, the population, at 700,000, was barely 40% of the 1950 population. Skilled labour, which helped in causing the debt load of Detroit to zoom, had moved out, leaving the poorer and unskilled lot to face the music of debt servicing. The city is now on the verge of defaulting on its debt and its pension obligations to poorer citizens.
About a year ago, in a piece The Moral Hazard of Open Borders On Sovereign Creditworthiness (https://crediteye.wordpress.com/2012/06/18/the-moral-hazard-of-open-borders-on-sovereign-creditworthiness/), we had predicted that skilled labour will flee the indebted countries of Europe into the welcoming arms of Germany. That is precisely what is happening. Spain’s engineers are fleeing to Germany to escape unemployment at home. This benefits German companies while hurting the ability of the government of Spain to repay its debt.
Over the next few years, we will see more and more sovereign/sub sovereign debt that will have to be written off as skilled labour flees those debt holes into oasis’ that welcome them. They would have helped create the debt, but will not be involved in debt servicing- leaving that task to poorer citizens who do not have the skills to emigrate.
Late last week, the Vice Chairman of the US’ deposit insurance agency, the FDIC, said that Deutsche Bank is “horribly undercapitalised” . That should not be news to readers of this blog. However, when the regulator made this claim, he did not take into account the issues given below- else he would have added one more adjective to the description (awfully, horribly, undercapitalised?).
1) The Vice Chairman assumes that the value of assets, as stated in the balance sheet, is true. This is being too generous- particularly concerning its Level III assets which the bank is valuing in a “mark to myth” fashion. Fiddling with accounts is not new to Deutsche. At the height of the credit crisis, Deutsche misplaced $12 billion of asset valuation, for which it is being investigated by the Bundesbank. Again, in 2010, the bank is alleged to have fiddled with its computer models.
2) It is understating its legal liabilities in the US from the sub prime crisis.
3) It is understating the volatility of its trading book. After all, capital is necessary to cover unexpected losses in its trading book too.
Just when we were beginning to fear that CARE Ratings was losing the ability to amuse and amaze the Indian debt markets, CARE has struck again. The reason for our fear was simple- it has been almost a month since CARE published a truly idiotic rating. Today CARE downgraded Educomp, a company on which CARE had a high single A rating until recently, to D. As usual, CARE was late to the party- the default had occurred sometime back. But have no fear- CARE has several tricks up its sleeves to amuse and amaze us!
Lenders who have given out loans collateralised with gold must have experienced some heart stopping moments during the last few months as gold prices sharply cracked. We would not be too concerned about taking credit exposures to gold loan companies (provided the LTV of the loans is 60% or below).
Gold is passing from weak hands (leveraged players, speculators and hedge funds) to strong hands (Indian, Chinese and Vietnamese housewives etc). The speculator such as Soros has to close out his position at some point. The gold that goes to an Asian housewife is forever removed from the market unless there is a deep financial crisis in the family.
Gold demand in India, the world’s largest buyer, is heading for a quarterly record after prices slumped to a two-year low in April, the World Gold Council said. India’s gold imports will be 300 to 400 tonne in the second quarter, almost half total shipments for all of last year. Gold auctions run by the State Bank of Vietnam were fully subscribed and some retailers in Japan ran out of stock. Weak hands sold 477.7 tonne valued at about $21 billion from exchange-traded products this year. The buyer was the strong hand. Throw in the demand from central banks of countries running current account surpluses (again strong hands, as opposed to weak hands running current account deficits), we would be sanguine about gold’s long term prospects. And the creditworthiness of lenders whose business model is built around lending against gold.