As reported by Businessweek, the first yellow flag was Fitch putting China’s debt rating on negative watch for the first time in 12 years after a record jump in total formal banking sector and other lending is presenting a growing risk that bad loans will overwhelm China's banks within three years.
According to Fitch, bad loans could rise from 15% to 30% of the total given the sharp growth in off-balance-sheet credit as the Chinese government has no control over the off-balance sheet credit being extended, thereby significantly diluting the effectiveness of China's inflation fighting monetary policy.
A downgrade by Fitch would be the first on China’s debt since Standard & Poor’s cut its foreign and local currency long- term ranking one level in July 1999 to BBB. Fitch has never cut China’s credit rating, according to Bloomberg. Other analysts like BoA Merrill Lynch play down the possibility of a systemic banking crisis in China, although the increase in loans to companies and households in China to 140% of GDP in 2010 would make anyone nervous as the loans were going into property lending and local government financing. Administrative controls on lending, instead of allowing interest rates to rise, are apparently encouraging banks to meet excess credit demand with off-balance-sheet vehicles.
That said, China does have plenty of resources including $2.8 trillion of forex reserves to again bail out the state banks if need be.
The other yellow flag however was HSBC's China Flash PMI for July, which dropped atits fastest pace since March 2009 and is pointing to a monthly contraction in the country's vast manufacturing sector for the first time in 12 months, and a price sub-index signalled rebounding inflation.
For copper prices, which had just broken to the upside, the yellow flags were a dash of cold water, as everyone knows that China demand is what is driving global demand for copper and other industrial metals. A serious slowdown in China's GDP growth would also be bad news for Japan's exports, as China is now by far Japan's largest trading partner.
Friday, July 22, 2011
Thursday, July 21, 2011
Domestic Demand Stocks Are Japan's New Multinationals
Japanese companies that provide daily necessities, cosmetics, seasonings and alcoholic beverages were once considered "terminally mature" because of shrinking domestic consumption in Japan. Over the past five years, however, a growing number of these companies have quietly become Japan's new multinationals, as faster overseas sales growth has now expanded to the point that overseas sales will exceed sales in Japan within the next few years.
Uni Charm (8113), a maker of disposable diapers, will be investing JPY60 billion over the next three years to increase production in Asia and its management gets high marks for its global approach. The firm already has a China sales network covering 500 cities and the world's largest share in disposable diapers. Shiseido (4911) now has only three global cosmetic brands, but will be expanding this to six. The company's SHISEIDO cosmetics brand is gaining traction among newly urbanizing Asian consumers. Both companies foresee overseas sales exceeding domestic sales within the next two years.
Any non-Japanese who has worked in a Japanese company, particularly headquarters, has horror stories of what went wrong, and Japanese companies in the main have a very poor track record of absorbing overseas takeovers. The main issue for Japanese companies to date has been the lack of a global approach among their senior managers, but this is changing in such companies.
But the road to globalization has not been smooth. Five years have passed sinceKirin Holdings (2503) shifted from a conservative, domestic-only mode to a more growth-focuse aggressive mode. Kirin's long-term business plan aims for sales of JPY3 trillion yen and an overseas sales ratio of 30% by 2015. It has already reached 70% of its sales target with a quarter of sales coming from overseas, but profitability has lagged and it has been slow to integrate Australian National Foods and Lion Nathan acquisitions. Consequently, operating profit is just 60% of the 2015 target, raising questions over whether the company will be able to meet its goal. It has also had to amend its original strategy of direct ownership in China and switch to a joint venture strategy.
To globalize its operations, Kirin set up a company in Singapore in April to oversee its operations in Southeast Asia. Workers who had completed a training program in Japan to foster a globally minded workforce were assigned to the Singapore operations, and Kirin plans to transfer planning and M&A in the region to the Singapore company, which will eventually take over such roles as promoting local employees and developing new products jointly with its Southeast Asian acquisitions. Further, Kirin is studying international personnel management standards, including a pay system, to smooth the cross-border transfer and promotion of employees.
Bold strategic thinking will be crucial for Japanese companies to remain viable longer term amid shrinking domestic demand and stronger global competition. For Kirin, this included considering a merger with unlisted rival, Suntory Holdings, but this proved to be too big a bite as the deal was called off at the negotiating phase. That said, domestic-oriented firms without hope of organic growth either need to a) consolidate the domestic industry through mergers with rivals, b) use the abundant cash they have on hand to acquire a presence in growing emerging markets, or c) find overseas strategic development partners.
Uni Charm (8113), a maker of disposable diapers, will be investing JPY60 billion over the next three years to increase production in Asia and its management gets high marks for its global approach. The firm already has a China sales network covering 500 cities and the world's largest share in disposable diapers. Shiseido (4911) now has only three global cosmetic brands, but will be expanding this to six. The company's SHISEIDO cosmetics brand is gaining traction among newly urbanizing Asian consumers. Both companies foresee overseas sales exceeding domestic sales within the next two years.
Any non-Japanese who has worked in a Japanese company, particularly headquarters, has horror stories of what went wrong, and Japanese companies in the main have a very poor track record of absorbing overseas takeovers. The main issue for Japanese companies to date has been the lack of a global approach among their senior managers, but this is changing in such companies.
But the road to globalization has not been smooth. Five years have passed sinceKirin Holdings (2503) shifted from a conservative, domestic-only mode to a more growth-focuse aggressive mode. Kirin's long-term business plan aims for sales of JPY3 trillion yen and an overseas sales ratio of 30% by 2015. It has already reached 70% of its sales target with a quarter of sales coming from overseas, but profitability has lagged and it has been slow to integrate Australian National Foods and Lion Nathan acquisitions. Consequently, operating profit is just 60% of the 2015 target, raising questions over whether the company will be able to meet its goal. It has also had to amend its original strategy of direct ownership in China and switch to a joint venture strategy.
To globalize its operations, Kirin set up a company in Singapore in April to oversee its operations in Southeast Asia. Workers who had completed a training program in Japan to foster a globally minded workforce were assigned to the Singapore operations, and Kirin plans to transfer planning and M&A in the region to the Singapore company, which will eventually take over such roles as promoting local employees and developing new products jointly with its Southeast Asian acquisitions. Further, Kirin is studying international personnel management standards, including a pay system, to smooth the cross-border transfer and promotion of employees.
Bold strategic thinking will be crucial for Japanese companies to remain viable longer term amid shrinking domestic demand and stronger global competition. For Kirin, this included considering a merger with unlisted rival, Suntory Holdings, but this proved to be too big a bite as the deal was called off at the negotiating phase. That said, domestic-oriented firms without hope of organic growth either need to a) consolidate the domestic industry through mergers with rivals, b) use the abundant cash they have on hand to acquire a presence in growing emerging markets, or c) find overseas strategic development partners.
Tuesday, July 19, 2011
A 4.3% Depreciation in the ECB's Assets Would Make it Insolvent
Not only are the periphery Euro countries governments highly leveraged, so are the weaker Euro banks. But the ECB (European Central Bank) could be the most leveraged of them all, as a mere 4.3% impairment of assets could mean a technical default, whereas investors worry that Euro banks would not be able to absorb a 20%~30% haircut on sovereign debt held as assets.
As of end December 2010, the ECB posted EUR82 billion in capital and reserves versus EUR1.9 trillion ($2.6 trillion) of assets,implying a leverage ratio of 23:1. Assets consist of EUR 480 billion of ABS (asset-backed securities)and EUR360 billion of "non-marketable financial instruments"--or a combined 44% of assets.These asset backed securities are 2010 securitizations, where the ECB permitted European banks to bundle their bad mortgages and mortgage securities and sell them at par value to the ECB, who paid the banks with freshly minted EUR. In other words, the banks unloaded EUR480 billion of their worst mistakes to the ECB and still are in bad shape.
Also included in assets under“non-marketable financial instruments” are the “own-use” bonds issued by the Irish banks to themselves and then sold to the ECB for EUR. “Own-use’ bonds are popular with banks because they can continue to access funding at the ECB's 1% interest rate even when they have run out of the high-quality collateral. For its part, the ECB insists all of these loans are properly collateralized.
Who foots the bill for an ECB default? All of the 17 Euro states, who would have to pony up any losses incurred. This further underscores the motivations behind Euro politician and regulator statements that "we are willing do virtually anything humanly possible”to avoid crisis-creating defaults,including some very questionable accounting.This makes the fudges made by Japanese authorities to understate the true extent of balance sheet impairment during Japan's financial crisis in the 1990s look like a mere "oversight".
(Hat Tip: The Big Picture)
As of end December 2010, the ECB posted EUR82 billion in capital and reserves versus EUR1.9 trillion ($2.6 trillion) of assets,implying a leverage ratio of 23:1. Assets consist of EUR 480 billion of ABS (asset-backed securities)and EUR360 billion of "non-marketable financial instruments"--or a combined 44% of assets.These asset backed securities are 2010 securitizations, where the ECB permitted European banks to bundle their bad mortgages and mortgage securities and sell them at par value to the ECB, who paid the banks with freshly minted EUR. In other words, the banks unloaded EUR480 billion of their worst mistakes to the ECB and still are in bad shape.
Also included in assets under“non-marketable financial instruments” are the “own-use” bonds issued by the Irish banks to themselves and then sold to the ECB for EUR. “Own-use’ bonds are popular with banks because they can continue to access funding at the ECB's 1% interest rate even when they have run out of the high-quality collateral. For its part, the ECB insists all of these loans are properly collateralized.
Who foots the bill for an ECB default? All of the 17 Euro states, who would have to pony up any losses incurred. This further underscores the motivations behind Euro politician and regulator statements that "we are willing do virtually anything humanly possible”to avoid crisis-creating defaults,including some very questionable accounting.This makes the fudges made by Japanese authorities to understate the true extent of balance sheet impairment during Japan's financial crisis in the 1990s look like a mere "oversight".
(Hat Tip: The Big Picture)
Paul Krugman: Italy vs Japan
Paul Krugman asks the question, "Why are the interest rates on Italian 10-year bonds (5.76%) so different than Japan 10-year bonds (1.09%), (to which we add), and why are Italian sovereign bond yields soaring while Japan's are falling? The similarities include high debt-to-GDP ratios--Italy's debt-to-GDP is 119%, while Japan's is 228% for 2011 and awful demographics.Like Japan, Italy's deficit is largely self-financed and personal savings rate is high. Under the common Euro, Italy must make its adjustments with austerity and grinding deflation to restore competitiveness, while Japan can inflate through a weaker JPY but is seeing JPY near historical highs and has been seeing mild deflation for essentially a decade.
o One factor could be investor psychology, i.e., the disaster feared by investors in Italian bonds is much scarier than the disaster feared by JGB investors.
o A second factor is that Japan has a floating currency, whereas Italy is married to the Euro, meaning adjustments have to come through fiscal and monetary policy. However, Japan has a chronically strong JPY ostensibly because the BOJ (Bank of Japan) has been too cautious about reflating Japan's economy.
o Italian banks have much higher balance sheet impairment risk compared to Japan's megabanks and thus there is more risk in the Italian financial system than in the Japanese financial system.
o Italian bonds are being used as a liquid proxy for Euro breakup scenario risk, i.e., investors are trying to send a strong signal to Euro politicians and investors, which is, a) kicking the can down the road is no longer enough to stave off a selloff, b) investors want to see enduring solutions, fast.
Because Italy was already the fifth PIIGS and has been tarred with the same "the Euro is doomed" brush, the big money is leaving EUR for JPY, where there is little balance sheet risk among the megabanks and foreign central banks as well as SWFs are incrementally diversifying holdings away from EUR and USD into JPY-denominated assets.Thus net buying by cash-rich domestic institutions as well as net buying by cash-rich, increasingly ALM-driven domestic financial institutions are buying JGBs instead of expanding their underlying businesses.
Source: Hat Tip; FT Alphaville.com
o One factor could be investor psychology, i.e., the disaster feared by investors in Italian bonds is much scarier than the disaster feared by JGB investors.
o A second factor is that Japan has a floating currency, whereas Italy is married to the Euro, meaning adjustments have to come through fiscal and monetary policy. However, Japan has a chronically strong JPY ostensibly because the BOJ (Bank of Japan) has been too cautious about reflating Japan's economy.
o Italian banks have much higher balance sheet impairment risk compared to Japan's megabanks and thus there is more risk in the Italian financial system than in the Japanese financial system.
o Italian bonds are being used as a liquid proxy for Euro breakup scenario risk, i.e., investors are trying to send a strong signal to Euro politicians and investors, which is, a) kicking the can down the road is no longer enough to stave off a selloff, b) investors want to see enduring solutions, fast.
Because Italy was already the fifth PIIGS and has been tarred with the same "the Euro is doomed" brush, the big money is leaving EUR for JPY, where there is little balance sheet risk among the megabanks and foreign central banks as well as SWFs are incrementally diversifying holdings away from EUR and USD into JPY-denominated assets.Thus net buying by cash-rich domestic institutions as well as net buying by cash-rich, increasingly ALM-driven domestic financial institutions are buying JGBs instead of expanding their underlying businesses.
Source: Hat Tip; FT Alphaville.com
Investors Give European Bank Stress Tests A Big Thumbs Down
We believe the Euro PIIGS sovereign debt issue presents a more immediate and serious systemic risk to global financial markets than the juvenile fight between the U.S. Republicans and Democrats regarding the U.S. debt ceiling. As Winston Churchill once said, "America will always do the right thing, but only after exhausting all other options", while we are not so sure that Euro politicians know what the right thing to do is.
A case in point is the Euro bank stress tests just released by the European Bank Authority. Instead of having the intended effect of calming increasingly nervous investors, it had the opposite effect.
1) The recent Euro bank stress tests avoided the key issue entirely, which was sovereign debt default risk, a metric not even measured in the stress test, as sovereign debt is not subject to BIS (Bank of International Settlements) rules have government loans (sovereigns) in a special category that has a 0% risk requirement. That means European banks do not have to hold any reserves against loans they make to European governments.
2) Instead, the test results gave a complete analysis of each bank’s exposure to troubled countries, including corporate lending, retail lending, financial institution exposure as well as sovereign exposure, thereby revealing a clearer picture of the potential risk. In addition, some banks that would certainly have failed the stress test such as Germany's Landesbank Hessen-Thueringen (Helaba) simply refused to participate because what they count as capital would not be counted in the tests.
As a result, investors gave no credibility to the stress tests,and promptly sold the 49-member Stoxx 600 Euro Banks Index, which fell 3.2% on Monday July 18. The index has fallen some 27% from its February 2011 high and is trading below (0.97X) book value for the first time since it traded below book value between October 2008 and April 2009. In other words, investors do not believe that stated book value is a fair reflection of balance sheet impairment at these banks. European banks are believed to need around $112 billion or 80 billion Euros of additional capital, implying the discount to stated book value should be more like 20% or 30% instead of just 3% as indicated by a 0.097 book valuation. Given the uncertainties about the future value of sovereign bond holdings and mortgages, the stocks have become impossible to value.
Basically, by pounding Italy (which is the third largest economy in Euroland) sovereign debt as well as the stock prices of some of the largest banks in Euroland, investors are sending Euro politicians and regulators a strong message that, a)kicking the can down the road is no longer enough and b) both the politicians and regulators need to come up with enduring solutions fast.In response, the EU's financial services chief is set to propose a law to implement global rules approved by the Basel CommitteeThe Basel Committee on Banking Supervision, which is unrelated to the European Bank Authority. If implemented European banks will need to raise $596 billion (423 Euros) or some $470 billion more than indicated in the stress tests by 2019 to comply with the Euro version of the Basel III rules, according to the draft proposal as reported by Bloomberg.
Stock price movements of some of Euroland's biggest banks already reflect a clear differentiation of who investors perceive have the stronger balance sheets.
1) Comerzbank AG (CBK.DE, Yahoo): second-largest bank in Germany, the strongest country in Euroland: -66% since August 2010.
2) UniCredit SpA (CRI.DE): was the second-largest bank in Europe when it merged Capitalia in 2007:
-45% since August 2010.
3) Deutsche Bank AG (DBK.DE): fourth largest bank in the world in assets: -33% since August 2010.
3) Societe Generale Group (SGE.DE): second-largest bank in France, a core Euro country: -33% since February 2011.
4) JP Morgan Chase (JPM.NYSE): 9th largest bank in the world in assets and best in class in the US: -17% since February 2011.
A case in point is the Euro bank stress tests just released by the European Bank Authority. Instead of having the intended effect of calming increasingly nervous investors, it had the opposite effect.
1) The recent Euro bank stress tests avoided the key issue entirely, which was sovereign debt default risk, a metric not even measured in the stress test, as sovereign debt is not subject to BIS (Bank of International Settlements) rules have government loans (sovereigns) in a special category that has a 0% risk requirement. That means European banks do not have to hold any reserves against loans they make to European governments.
2) Instead, the test results gave a complete analysis of each bank’s exposure to troubled countries, including corporate lending, retail lending, financial institution exposure as well as sovereign exposure, thereby revealing a clearer picture of the potential risk. In addition, some banks that would certainly have failed the stress test such as Germany's Landesbank Hessen-Thueringen (Helaba) simply refused to participate because what they count as capital would not be counted in the tests.
As a result, investors gave no credibility to the stress tests,and promptly sold the 49-member Stoxx 600 Euro Banks Index, which fell 3.2% on Monday July 18. The index has fallen some 27% from its February 2011 high and is trading below (0.97X) book value for the first time since it traded below book value between October 2008 and April 2009. In other words, investors do not believe that stated book value is a fair reflection of balance sheet impairment at these banks. European banks are believed to need around $112 billion or 80 billion Euros of additional capital, implying the discount to stated book value should be more like 20% or 30% instead of just 3% as indicated by a 0.097 book valuation. Given the uncertainties about the future value of sovereign bond holdings and mortgages, the stocks have become impossible to value.
Basically, by pounding Italy (which is the third largest economy in Euroland) sovereign debt as well as the stock prices of some of the largest banks in Euroland, investors are sending Euro politicians and regulators a strong message that, a)kicking the can down the road is no longer enough and b) both the politicians and regulators need to come up with enduring solutions fast.In response, the EU's financial services chief is set to propose a law to implement global rules approved by the Basel CommitteeThe Basel Committee on Banking Supervision, which is unrelated to the European Bank Authority. If implemented European banks will need to raise $596 billion (423 Euros) or some $470 billion more than indicated in the stress tests by 2019 to comply with the Euro version of the Basel III rules, according to the draft proposal as reported by Bloomberg.
Stock price movements of some of Euroland's biggest banks already reflect a clear differentiation of who investors perceive have the stronger balance sheets.
1) Comerzbank AG (CBK.DE, Yahoo): second-largest bank in Germany, the strongest country in Euroland: -66% since August 2010.
2) UniCredit SpA (CRI.DE): was the second-largest bank in Europe when it merged Capitalia in 2007:
-45% since August 2010.
3) Deutsche Bank AG (DBK.DE): fourth largest bank in the world in assets: -33% since August 2010.
3) Societe Generale Group (SGE.DE): second-largest bank in France, a core Euro country: -33% since February 2011.
4) JP Morgan Chase (JPM.NYSE): 9th largest bank in the world in assets and best in class in the US: -17% since February 2011.
Monday, July 18, 2011
Japan Retail Chains Rush to Build Stores in Tohoku
The triple Tohoku disasters, i.e., earthquake, tsunami and Fukushima Daiichi nuclear plant meltdown took a big toll on local retailers without the capital to rebuild. This has created a rush by major convenience store, drug store and home center chains to expand their store networks in Tohoku. The Aeon Group's Ministop (9946) convenience chain now plans to open three times as many store compared to plans before the disaster while FamilyMart (8028) is planning a five-fold increase and Yamada Denki (9831, consumer electric retailer) plans to open 15~20 stores, or about two time more than previously planned. These investments are in addition to other needed refurbishing and repair capex for existing stores.
These retailers are counting on the fact that demand for rebuilding destroyed households and other consumption will continue to be strong for the foreseeable future. May department and super store sales in the six prefectures of the Tohoku region were up 1.5% YoY versus a 1.3% decline for nationwide sales, while convenience store sales in the region were up 10.9% versus 7.3% growth nationwide.
Aeon's Ministop plans 100 new shops, particularly in Miyagi prefecture. Family Mart plans a five-fold increase to 85 stores, including temporary stores in Iwate, Miyagi and Fukushima prefectures. Seven-Eleven and Lawson have similarly bullish plans to increase their store network in the region. Consumer electronic retailers like Yamada Denki and K's Holdings also plan big expansions. K's Holdings (8282) saw a 50% YoY increase in sales for June in the six Tohoku prefectures, versus a 40% nationwide increase, and believes the demand uptick will continue for the next 2~3 years. As a result, the new plan 4 new store openings versus just one in prior plans. Yamada Denki plans to build 15~20 smaller stores in the region this fiscal year.
Over the past six months,the best performer of these has been K's Holdings, which has essentially doubled, whle Yamada Denki, a previous foreign favorite is bascially flat, as is FamilyMart's stock price. MiniStop's recent performance is better than FamilyMart's, but it is coming from a lower base.
These retailers are counting on the fact that demand for rebuilding destroyed households and other consumption will continue to be strong for the foreseeable future. May department and super store sales in the six prefectures of the Tohoku region were up 1.5% YoY versus a 1.3% decline for nationwide sales, while convenience store sales in the region were up 10.9% versus 7.3% growth nationwide.
Aeon's Ministop plans 100 new shops, particularly in Miyagi prefecture. Family Mart plans a five-fold increase to 85 stores, including temporary stores in Iwate, Miyagi and Fukushima prefectures. Seven-Eleven and Lawson have similarly bullish plans to increase their store network in the region. Consumer electronic retailers like Yamada Denki and K's Holdings also plan big expansions. K's Holdings (8282) saw a 50% YoY increase in sales for June in the six Tohoku prefectures, versus a 40% nationwide increase, and believes the demand uptick will continue for the next 2~3 years. As a result, the new plan 4 new store openings versus just one in prior plans. Yamada Denki plans to build 15~20 smaller stores in the region this fiscal year.
Over the past six months,the best performer of these has been K's Holdings, which has essentially doubled, whle Yamada Denki, a previous foreign favorite is bascially flat, as is FamilyMart's stock price. MiniStop's recent performance is better than FamilyMart's, but it is coming from a lower base.
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