Kobe Steel’s White Samurai – who might be forced into national service?


While we are some way off understanding the extent of damage to Kobe Steel, we shouldn’t rule out the inevitable action which could involve a structured rescue of it, a white samurai if you will. Japan’s largest steel company NSSMC (5401) owns 2.95% of the outstanding shares of Kobe Steel. Will we see a motion in several months time as more facts become known for a consortium like the INCJ to team up with NSSMC to turn it into another Hinomaru sunset business? We saw the dying semiconductor industry in Japan get rolled into Elpida (which went bust) and cell phone screen players get merged into Japan Display (still listed) so why would anyone doubt a Hinomaru Steel consortium which would be a forced sense of national duty. While still way too early to surmise we should not ignore such a scenario should Kobe really find itself hoisted by its own petard. Corporate harakiri is the last thing Nippon Sumitomo Steel holders want from a governance perspective

Repossession by remote


A growing number of car loans in the US are being pushed further down the repayment line as much as 84 months. In the new car market the percentage of 73-84-month loans is 33.8%, triple the level of 2009. Even 10% of 2010 model year bangers are being bought on 84 month term loans. The US ended 2016 with c.$1.2 trillion in outstanding auto loan debt, up 9%YoY and 13% above the pre-crisis peak in 2005.

Why is this happening? Mortgage regulations tightened after 2008 to prevent financial lenders from writing predatory loans, especially sub prime. Auto lending attracts far less scrutiny. Hence the following table looks like it does with respect to outstanding accounts on loans


Sub Prime auto loans, at all time records, make up 25% of the total. Devices installed in cars let collection agencies repossess vehicles by remote when the borrower falls behind on repayment. This lowers risk and allows these long dated loan products to thrive. Average subprime auto loans carry 10% p.a. interest rates. More than 6 million American consumers are at least 90 days late on their car loan repayments, according to the Federal Reserve Bank of New York.

While it is true that $1.2 trillion auto loan book pales into insignificance versus the $10 trillion in mortgage debt at the time of the GFC, a slowdown in auto sales (happening now) isn’t helpful. The auto industry directly and indirectly employs c. 10% of the workforce and slowing new and used car sales will just put more pressure on prices further lifting the risk of repossessions

It is worth reminding ourselves the following.

Last month the Fed published its 2016 update on household financial wellbeing. To sum up:

“44%. This is actually an improvement on the 2015 survey that said 47% of Americans can’t raise $400 in an emergency without selling something. The consistency is the frightening part. The survey in 2013 showed 50% were under the $400 pressure line. Of the group that could not raise the cash, 45% said they would go further in debt and use a credit card to pay It off over time. while 25% would borrow from friends or family, 27% would forgo the emergency while the balance would turn to selling items or using a payday loan to get by. The report also noted just under a quarter of adults are not able to pay all of their current month’s bills in full while 25% reported skipping medical treatments due to the high cost in the prior year. Additionally, 28% of adults who haven’t retired yet reported to being largely unprepared, indicating no retirement savings or pension whatsoever. Welcome to a gigantic problem ahead. Not to mention the massive unfunded liabilities in the public pension system which in certain cases has seen staff retire early so they can get a lump sum before it folds.”

If only this perpetual debt cycle could be stopped via remote. Someone else’s problem one would suggest.

A reminder of credit ratings and ability to pay – both awful


An astute market’s person sent me an interesting chart (above) from the IMF highlighting that US companies have added $7.8t in debt & other liabilities since 2010. The ability to cover interest payments is now at the weakest level since 2008 crisis. When looking at credit ratings for US companies over the last decade, the deterioration has been marked. For all of the turbo charged low interest rate environment set by central banks, the ‘real’ state of corporate financial health on aggregate continues to worsen despite near full employment, record level equity markets and every other word of encouragement from our politicians. However if this is the state of the corporate sector at arguably the sweet spot of the economic cycle I shudder to think the state of potential bankruptcies that will come when the cycle takes a turn for the worse. This is a very bad sign.


Dan Andrews plays his hand as a property tycoon


Victorian Premier Daniel Andrews is now turning the government into a property tycoon using taxpayer dollars to pour gasoline on the 6th most expensive property market in the world. His latest plan to push the greater fool theory in a country that has a 180% private debt to GDP is to encourage those who can least afford to climb on the property ladder to spend even more. While a 25% interest free loan looks exceptionally generous, rational thought for a first time buyer is to spend closer to 125% of what they would originally looked to fork out. While the government gets its 25% back simple economics tells us this is a bubble waiting to pop. To think people will stick to financing 75% of the median house price is bonkers.

If the mortgage borrower defaults, will the government accept NAB, CBA, ANZ or Westpac et al wish to do a fire sale because their balance sheet may not sustain unrealized losses in their balance sheet? Sure it is only 400 people to start with (unfair in itself because 401 onwards will face a steeper wall) but this stinks of the antics pre GFC. People then were lured into borrowing more because appraisals were massaged higher and without knowing it buyers were actually $100,000s in the hole before they started.

So let’s assume that Andrews lends $162,500 to the first 400 on average (median home price $650k). $65mn. Victoria’s tax receipts are around $20bn. Not a huge dent but you’d only need 12,300 people on a scheme to speak for 10% of the budget. There are 25,000 people wanting to climb the property ladder. If all stepped up for that, Victoria’s taxpayers would be stung for $4bn or 20% of the budget. Property-based taxes including stamp duty, land tax, the congestion levy and the Growth Areas Infrastructure Contribution are projected to contribute more than 42% of Victoria’s tax revenue base in 2016-17. That could drop like a stone.

Andrews would be better off addressing supply issues. Aussie property prices are a function of restricted supply. By subsidizing the first home buyer he inadvertently supports investment property owners by inflating the value of their properties even further exacerbating the problem he’s trying to fix.

Andrews is also copying  the South Australian playbook on renewables which could have a reverse effect on the economy. Note South Australia was the only state which recorded negative tax revenue growth no thanks to making it a less attractive place to invest . It has the highest unemployment rate, the highest energy costs, slowest growth and is now forced to spend 13% of its revenues on a hairbrained emergency energy plan.

In any event if the private sector is unwilling to lend to these people it is a signal they’re concerned about levering already overstretched balance sheets. NAB just raised variable rates not because the RBA ticked cash rates higher, they’re facing higher funding costs via the wholesale markets where they source 40% of the cash they lend. Don’t kid yourself that already overinflated asset bubbles aren’t being recognized. Australia’s increasingly destabilized political scene and pending sovereign credit rating cut aren’t lost on investors. Take a look at US bond markets readjust in the last 4-5 months.

While as well intentioned as this plan of Premier Andrews may indeed be, shoveling the desperate into a property market using taxpayer funds will likely end up hurting them over the long term. Listen to the market. The invisible hand is about to grab many by the throat.

Oh lord won’t you buy me a Mercedes-Benz my friends all have Porsches & I must make amends


It really helps an economy to have a robust car market. In the US car companies employ around 9% of the workforce which includes the businesses that feed off suppliers. The amount of people employed in a factory means those people need to buy groceries, get the dry-cleaning done and send the kids to daycare. Car factories are mini-cities. States fork out $100 millions in tax breaks for auto companies to set up facilities because of all the benefits that accrue  and the likelihood that after the plant has been built the economics means they’re stuck for decades.


US auto inventories on the way up

Even with borrowing rates at ridiculously low levels, inventories are back to the 1.2mn unit level  just shy of the peak we saw at the same trough of GFC. Although inventories are at 2.82x sales right now (peaked at 4.7x during GFC) it is heading back up.


The big weakness in car sales is more an issue with companies than consumers. In order to shift metal deals got better and better. However many car makers fell into the trap of offering residual value guarantees on cars after 3 years. So as they were sweetening deals today, cars of three years ago were coming back onto their books but the car maker was losing money on 90% of the returns with average losses of $3,000 per car. All of this was bringing forward consumption.

Now we have a predicament of auto companies having to reevaluate who they finance. We’ve seen default rates from sub-prime borrowers jump 20% or more in recent months. When I was in Sydney a last month BMW was raked over the coals for offering a mother of 10 kids a car loan.

BMW Australia Finance was found to have loaned $27,000 to a single mother of 10 children even though she was in casual employment and had negative disposable income. It gave $23,300 to a refugee aged 21 who had been employed for just one month and whose income was overstated. And it loaned nearly $50,000 to a 76-year-old man based on earning projections rather than real income. The loan was almost twice the value of the car. I call that desperation and coming from a luxury maker speaks volumes how bad it must be among volume makers.

Car makers are desperate. Even my old man got a brand spanking new 7-series for $50,000 off list price that when he told me I thought he’d bought the outgoing model. It is not healthy in the auto space. Perhaps they’re singing Janis Joplin tunes in the hope that profitability is miracle restored. Forget it. We’ve already seen how heavily Class-8 highway truck orders have plunged for the last year. Now expect to see mass firings, plant line closures and losses moun in passenger cars.

This will be another blow to the gullible masses who think Central banks have steered us down the path to prosperity. They haven’t and once again the end of Obama’s presidency will earmark the state in which he left the economy. In a horrid state.


Poverty in America – tales from the dollar stores


I’ve made the point countless times that the US election is increasingly one about poverty – the haves vs the have nots. The US dollar store chains are telling us the level of poverty is growing

In my former career as an analyst I used to cover a company called Seria, a ¥100 store chain which was booming as cash strapped Japanese took advantage of its offering. Poverty in Japan continues to grow and crime rates are soaring

It appears that the US Dollar General  and Dollar Tree discount chains are suffering from further pressures on their low income customers. They cite rising health costs, rental costs and stagnant or falling income crimping purchasing power.

On the Dollar General earnings call the other day management said,

“And when we’re out in stores and we drop prices like we do, I can tell you, I’ve been out in stores in the middle of the aisle and heard customers come up to our store manager in tears and thanking them for being there and thanking them for the prices that we offer in a real convenient nature for her, where she can walk to the store, because she can’t afford anything else. When you hear that, that really brings home where this core customer is.”

That is when I think to myself how a Trump could still do this. How the establishment has not bettered their lives. How sub-prime auto loan defaults jumped 17% in July.  How the gap between the rich and poor has continued to widen thanks to the reckless policies pursued by the Fed who are secretly admitting failure. The only thing left for those in destitution is the great equalizer – a vote.

Nightmare on Main Street


This will be a recurring nightmare for Main Street. Something that should make even Freddie Krueger cling onto his mother. We’ve already had some previews from the 2008 financial collapse. Small scale maybe but the lessons are real and this time round the effects are likely to be far larger and quantum levels more painful.

I wrote last month that the State of California’s pension fund (CalPERS) has unfunded pension liabilities of $412bn, or 3x the annual tax collection for the entire state. Rewind to 2008. The municipality of Vallejo, California filed for bankruptcy. It wasn’t just the evil banksters that caused financial markets to collapse that made tax revenues shrivel. Sadly the city of Vallejo was living high off the hog. Bloated pensions and fat cat salaries for public servants ruled by stubborn unions created a scenario where it couldn’t bail water fast enough when the crash hit.

The police captain was paid over US$300,000 while his lieutenants were on c.US$250,000. The average fire fighter took home US$170,000. The police and firefighters pay and conditions sucked up three-quarters of the budget much more than the 55-60% of most municipalities. That $80mn budget suddenly faced a $17mn black hole.

The city was forced to fire 40% of its 260 police officers and told its residents to be judicious with calling 911. Crime rates unsurprisingly jumped above the state average.

Vallejo didn’t sort its pension obligations to CalPERS during its bankruptcy negotiations which ended up becoming its largest budget hole by a considerable margin. Even in 2011 when the city came out of bankruptcy the pension time bomb ticked away. Moreover the declaration of bankruptcy prevented access to bond financing making budget gap filling even more complicated.

Scroll to 2016, the anaemic (and slowing) economic growth around the world is putting stress on pension funds ability to payout retirees and fund future pensions. Pensions funds set “return targets” which actuaries set to ensure the fund stays solvent. However pension funds need to be diversified with a mixture of cash, bonds and equities. With equities reaching more outlandish valuations and bonds moving further into negative yield territory (capital appreciating at least) pension fund returns are undershooting. When pension funds undershoot then the unfunded liabilities keep growing. As more baby boomers retire the more outflows are required putting more pressure on the unfunded portions.

Vallejo was small fry but the risk of more cities declaring bankruptcy in coming years is something that isn’t even on investor, national government or central bank radar screens. We’re fed more of the same tripe that all is ok and they’re in control.

San Bernadino, California also filed for bankruptcy after GFC carrying $140mn in unfunded pension liabilities including $50mn in debt it had raised to fill the pension hole. Yes! It was borrowing money to plug a pension hole. Sort of like buying groceries on the credit card you can’t pay off.

San Jose spends 20% of its $1bn budget on healthcare and pensions given the generous offer following 30 years service in police or firefighting. They net 90% of final salary every year to see out their retirement. Those sweet deals are now being contested in court giving people the option of the same deal with much higher contributions or accept a higher retirement age with a lower payment.

Take Detroit, Michigan. It declared bankruptcy around this time three years ago. It’s pension and healthcare obligations total north of US$10bn or 4x its annual budget. Accumulated deficits are 7x larger than collections. Dr. Wayne Winegarden of George Mason University wrote that in 2011 half of those occupying the city’s 305,000 properties didn’t pay tax. Almost 80,000 were unoccupied meaning no revenue in the door. Over the three years post the GFC Detroit’s population plunged from 1.8mn to 700,000 putting even more pressure on the shrinking tax base.

What we are likely to experience is more city and potentially state bankruptcies this time round. With over-inflated assets which aren’t producing returns and cash rates effectively zero or negative in the US, EU and Japan portfolio diversification gets more complicated pushing real returns lower and unfunded liabilities higher. There is no easy out. Printing more money will not help fill the hole. Even if it managed to keep nominal payments broadly unchanged the buying power would be severely diminished. What we can say is serious problems are being stored up and likely to arrive at the least opportune moment where realities will have to be faced and the blame game taken to new levels. It is truly a frightening prospect that once again Main Street will be left to carry the can!

This will not end well.