Bankruptcy

Westpac reported a 40% increase in home repossessions

Mortgages Westpac

Don’t get CM wrong – this is still the law of small numbers.  Westpac reported this week that it repossessed another 162 properties in the latest fiscal year.  That is a 40% increase. While it is but a dribble compared to the 100,000s of total loans outstanding it is none-the-less a harbinger of things to come. Westpac made clear, “the main driver of the increase has been the softening economic conditions and low wages growth.”

The current status of 90-day+ delinquencies has been rising over time. As have 30-day +. While nothing alarming, the current economic backdrop should give absolutely no confidence that an improvement in conditions is around the corner. We are not at the beginning of the end, but at the end of the beginning.

Former President Ronald Reagan once said of the three phases of government, “if it moves, tax it. If it keeps moving regulate it. If it stops moving, subsidize it.” How is that relevant to the banks?

We have already had the government fold and attach a special bank tax on the Big 4. Phase 1 done. Now we are in the middle of phase 2 which is where knee-jerk responses to the Hayne Banking Royal Commission (HBRC) where banks will be on the hook for the loans they make. That is a recipe for disaster that could bring on phase 3 – bailouts.

Sound extreme? How is a bank supposed to make a proper risk assessment of a customer’s employability in years to come? Can they predict with any degree of accuracy on the stability of candidates who come for loans? The only outcome is to cut the loan amount to such conservative levels that the underlying purpose gets diluted in the process and prospective home buyers have to lower expectations. Not many banks will look positively at taking several loans on the same property with different institutions. That won’t work. SO loan growth will shrink, putting pressure on the property market.

What is the flip side? Given property prices in Sydney hover at 13x income (by the way, Tokyo Metro was 15x income at the peak of its property bubble), restrictions on further lending against loan books that are on average 63% stuffed with mortgages (Japan was 41.2% at the peak) won’t be helpful. A property slowdown is the last thing mortgage holders and banks need.

While equity continues to rise at Aussie banks, the equity to outstanding mortgages has gone down since 2007 i.e. leverage is up. If banks saw their average property portfolios drop by more than 20% many would be staring at a negative equity scenario. Yet, it won’t be just mortgage owners that we need to worry about. Business loans could well go pear-shaped as the onset of higher unemployment could see a sharp increase in delinquencies through a business slowdown. A concertina effect occurs. More people lose their job and a vicious circle ensues. It isn’t rocket science.

Of course, Australia possesses the ‘boy who cried wolf‘ mentality over the housing market. Yet it is exactly this type of complacency that paves a dangerous path to poor policy prescriptions.

In Japan’s property bubble aftermath, 40% of the value of loans went bang. 17% of GDP. $1.1 trillion went up in smoke. It took more than 10 years to clean up the mess and the aftershocks remain. Accounting trickery around the real value of loans on the balance sheet can hide the problems for a period but revenue tends to unravel such tales. 181 banks and building societies went bust. The rest were forced into mergers, received bailouts or were nationalised. Now the Japanese government is a perpetual debt slave, having to raise $400bn per annum in debt just to fill the portion of the $1 trillion budget that tax collections can’t fill.

The problem  Japan’s banks faced was simple.  If a neighbour’s $2m home was repossessed through mortgage stress and the bank fire sold it for $1.4m, the bank needed to mark to market the value of the loan portfolio for that area by similar amounts. In doing so, a once healthy balance sheet started to look anything but. Extrapolate that across multiple suburbs and things look nauseating quickly.

This is where Aussie banks are headed. This time there is no China to save us like in 2009. Unemployment rates in Australia never went above 6% after the GFC in 2008/9, unlike the US which went to 10%. We weathered that storm thanks to a monster surplus left by the Howard government, which we no longer have.

Sadly China has had 18 months of consecutive double-digit car sales decline. Two regional Chinese banks have folded in the last 3-4 months. China isn’t a saviour.

Nor is the US. While the S&P500 might celebrate new highs, aggregate corporate profitability hasn’t risen since 2012. The market has been fuelled by debt-driven buybacks. We now have 50% of US corporates rated BBB because of the distortions created by crazed central bank monetary policy, up from 30%. Parker Hannifin’s latest order book shows that customer activity is falling at a faster pace.

Nor is Europe. German industrial production is at 10-year lows. The prospects for any EU recovery is looking glib. Risk mispricing is insane with Greek bond spreads only 1.8% higher than German bunds.

What this means is that 28 years of unfettered economic growth in Australia is coming to an end and the excesses built in an economy that believes its own BS is going to leave a lot of people naked when the tide goes out.

The Australian government needs to focus on more deregulation, tax and structural reforms. Our record-high energy prices, ridiculous labour costs and overbearing red-tape are absolutely none of the ingredients that will help us in a downturn. We need to be competitive and we simply aren’t. Virtue signalling won’t help voters when the whole edifice crumbles.

All a low-interest rate environment has done is pull forward consumption. It seems the RBA only possesses a hammer in the tool kit which is why it treats everything as a nail. It is time to come to terms with the fact that further cuts to the official cash rate and the prospect of QE will do nothing to ward off the inevitable.

Pain is coming, but the prospects of an orderly exit are so far off the mark they are in another postcode. Roll your eyes at the stress tests. Stress tests are put together on the presumption that all of the stars align. Sadly, in times of panic, human nature causes knee-jerk responses which put even more pressure.

Banks.png

The Aussie banks have passed their best period. While short term news flow, such as a China trade deal, might give a short term boost, the structural time bomb sits on the balance sheet and while we may not get a carbon copy of the Japanese crisis, our Big 4 should start to look far more like the rest of the global banks – truly sick. The HBRC will see that it becomes way worse than it ever needed to be.

Complacency kills.

Forget the return “ON” your money. Just look to the return “OF” it

CM knew a lot of passive indices existed but not to this crazy extent. Probably explains why there is so much stupid money tied up in me too commoditised investment products. 4 years ago CM wrote a piece on the dangers of ETFs (especially leveraged)  and passive products in a downturn. These products predominantly follow the market, not lead it. So if these products end up stampeding toward the exits in a market meltdown, the extent will be amplified, especially those levered funds potentially making market panic look worse than it really might otherwise be. Don’t be surprised to see the mainstream media sensationalise the size of any falls in the market.

According to Bloomberg, 770,000 benchmark indexes were scrapped globally in 2019…however  2.96 million indexes remain around the world, according to a new report from the Index Industry Association…There are an estimated 630,000 stocks that trade globally, including c.2,800 stocks on the NYSE and c. 3,330 on NASDAQ or 5x as many indices as there are securities globally.

CM wrote back in October 2015,

ETFs are hitting the market faster than the dim-sum trolley can circle the banquet hall. Charles Schwab, in the 12 months to July 2015, saw a 130-fold preference of ETF over mutual funds given their relative simplicity, cost and transparency….

…ETFs, despite increasing levels of sophistication, have brought about higher levels of market volatility. Studies have shown that a one standard deviation move of S&P500 ETF ownership as a percentage of total outstanding shares carries 21% excess intraday volatility. Regulators are also realising that limit up/down rules are exacerbating risk pricing and are seeking to revise as early as October 2015. In less liquid markets excess volatility has proved to be 54% higher with ETFs than the actual underlying indices. As more bearish market activity has arrived since August 2015 we investigate how ETFs may impact given a large part of recent existence has been under more favourable conditions…

CEO Larry Fink of Blackrock, the world’s largest ETF creator, has made it clear that
leveraged ETFs (at present 1.2% of total ETF AUM) have the potential to “blow up the whole industry one day.” The argument is that the underlying assets that provide the leverage (which tend to have less liquidity) could cause losses very quickly in volatile markets. To put this in perspective we looked at the Direxion Daily Fin Bull 3x (FAS) 3x leverage of the Russell 1000 Financial Services Index. As illustrated in the following chart FAS in volatile markets tends to overshoot aggressively

…The point Mr Fink is driving at is more obvious with the following chart which shows in volatile markets, the average daily return is closer to 10x (in both directions) than the 3x it is seeking to offer. This is post any market meltdown. On a daily basis, the minimum and maximum has ended up being -1756x to 1483x of the index return, albeit those extremes driven by the law of small numbers of the return of the underlying index. Which suggests that in a nasty downturn the ETF performance of the leveraged plays could be well outside the expectations of the holders.”

CM has said for many years, where CDOs and CDSs required the intelligence of a mystical hermit atop a mountain in the Himalayas to understand the complexities, ETFs are the complete opposite. Super easy to understand which inadvertently causes complacency. Unfortunately, as much as they might try to do as written on the tin, the reality could well turn out to be the exact opposite.

Hence CM continues to believe that stocks with low levels of corporate social responsibility (CSR) scores like tobacco companies such s Philip Morris, JT and Imperial Tobacco, as well as gold/silver bullion,  look the places to be invested. Cash won’t necessarily be king because the banks are already in a world of pain that hasn’t even truly started yet. Aussie banks look like screaming shorts at these levels. The easiest way for the plebs – without access to a prime broker – to do this is to buy put options on individual bank names. Out of the money options are dirt cheap.

Banks

Forget the return ONyour money. Just look to the returnOFit.

NB, none of this constitutes investment advice. It is a reflection of where CM is invested only. 

 

Those selfish evil banks?

As is the case with nearly every rate cut, the media stirs up the fact that most of the major Aussie banks haven’t passed on the full 0.25% rate cut. As one can see from the RBA chart above, net interest margins are at the lowest level in 20 years. The banks, as much money as they might be making, are doing it very tough. What people often overlook is the fact that Aussie banks are 40% funded by the wholesale markets, meaning they need the benevolence of foreign and domestic institutions to buy their paper to lend. With a softening Aussie dollar that puts added pressure on funding margins.

Banks

We’ve written about this in previous dispatches. Aussie banks are in a far more precarious situation than we are often told. Global banks have already felt it. We are getting to the stage where we follow them into the morass.

As much as bashing banks has become a sport after the Royal Commission, bullying them into cutting rates by the full extent is actually making their position even weaker. The last thing Australia needs, on top of the ridiculous regulation set to follow the RC, is to force them to operate to the rule of the mob. Personal responsibility is what governments should be drumming home, not saddling the banks with more hoops. If people don’t like their bank that lent them millions for a home loan, switch banks! It is your choice.

Ding dong the switch is dead

Morgan Stanley has finally lowered its bearish scenario on Tesla from $97 to $10. CM wrote in October 2017 that the shares based on production of 500,000 vehicles was worth no more than $28 (refer to report page 5). That was based on rosy scenarios. Sadly CM thinks Tesla will be bought for a song by the Chinese. Maybe $4.20 a share instead of $420 “funding secured” levels.

The stock breached $200 yesterday for the first time since late 2016.

Morgan Stanley analyst, Adam Jonas, has still kept its base case scenario at $230 per share. His bull case is $391.

Where is the conviction? To drop a bear case target by 90% must surely mean the base case is far lower than presently assumed.

Jonas must assume the bear case is actually the base case. Sell side brokers love to hide behind scenario analysis to cop out having to get off the fence. His compliance department probably prevents him from realizing $10 is his true heart.

Tesla was always playing in a market that it had no prior experience. It is not to say the products didn’t have promise. The problem was the execution. Too much senior management turnover, missed targets, poor quality and too many Tweets from Musk.

The amount of bad press arising from a lack of service centers has driven customers to moan on social media at its amateur approach. The fragile dreams of being an early adopter are being shattered. Cash burn remains high and deliveries remain low. Some pundits think Tesla orders are under real pressure in 2Q 2019.

The recent all share deal with Maxwell Technologies has seen those holders -20% since the transaction a few weeks ago. CM argued how a company with such revolutionary technology could sell itself for all shares in a debt-ridden loss making like Tesla? If the technology was of real value PE funds would have snapped it up or at the very least made a bid in cash. That none was made speaks volumes about what was bought.

All of the arguments hold true in the above link, “Tesla – 30 reasons why Tesla will be a bug on a windshield

Tesla below $200 after a successful cap raise is not a good sign. It’s the faithful slowly tipping out. Await another imaginary Musk-inspired growth engine to be announced shortly to try prop up the stock price. Yet the momentum will continue to sink. The market is losing confidence in Musk. The 1Q results were diabolically bad.

Major holder T Rowe Price has stampeded out the door. The stock is too risky. Musk is a brilliant salesman but he has bitten off more than he can chew.

CM always thought that Toyota selling its Tesla stake was a major sign. Acknowledging that under the hood the company possessed no technology that Toyota didn’t already own.

Watch the free fall. The Tesla stock will be below $100 by the year end.

(CM does not hold Tesla stock)

Greatest Corporate Showman on Earth

Tesla’s 1Q 2019 results were dreadful. CM has long held that Tesla is a basket case. The ever charismatic Elon Musk is trying to fan the flames of his company with dying embers. The question is where do we start on this diabolical 1Q report?

1. Musk started off with cash to speak to solvency. Tesla talks to $2.2bn in cash and equivalents. Down $1.5b, partly due to a $920m convertible repayment. Don’t forget Tesla has $6.5bn in recourse debt and $3.5bn in non-recourse debt. It has payables and accrued liabilities of another $5.5bn offset with receivables of just over $1bn.

2. Model S/X deliveries fell from 21,067 in 1Q 2018 to 12,091 in 1Q 2019. That’s -56% at the high margin premium car end. Musk claimed it was due to demand pull forward with a reduction in tax credits. Well he just proved that without credits, demand suffers appreciably.

Model 3 production was 3% higher on the quarter but deliveries were 20% lower. Note customer deposits total $768m, marginally down on the previous quarter. If Tesla starts to implode, customers have a right to get those credits back. Residual values aren’t holding as we discuss in pt.5.

3. Solar deployed -38% year on year

4. (Battery) Storage deployed -39%YoY

5. CM made it clear in point 11 of the 30 reasons why Tesla will be a bug on a windshield report,

The Tesla Residual Value Guarantee, while well intentioned carried risks that crucified the leasing arms of the Big 3. After the tech bubble collapsed at the turn of the century, do you remember the ‘Keep America Rolling’ programme, which was all about free financing for five years? While sales were helped along nicely, the reality was it stored up pain…Goldberg & Hegde’s Residual Value Risk and Insurance study in 2009 suggested on average 92% of cars returned to leasing companies recorded losses on return of up to 12%. Any company can guarantee the price of its used product in theory, the question is whether used car buyers will be willing to pay for it. Sadly Tesla does not get a say in what the consumer will be willing to pay.”

In the 1Q 2019 result, Musk admits that Tesla suffered $121m impairment on residual value guarantees (RVG). Is it any wonder they stopped this scheme. Now it’s payback time. There are $480mn worth of RVGs still on the balance sheet that are unlikely to have been marked to market values.

6. Level 5 autonomous driving is a pipe dream in the near term. 20+ years away. A fleet of Tesla taxis is an even bigger thought bubble. Regulation will put that on the back burner. The current level 2 systems have already shown significant short comings given the numerous beta testing deaths at the wheel of the Tesla auto pilot.

7. Musk is doing a stealth cash raise by putting a time limit on auto pilot upgrades. The question is when will the next cap raise come. His noise around Tesla taxis, Level 5 autonomous systems, Model Y all speak to the snake oil promises that he needs to distract investors from what is clearly going on.

8. His public spat with his biggest supplier, Panasonic, will not end well. Suppliers have to be on board with production expansion. Panasonic is cooling off its relationship. Musk publicly slapped the Japanese battery maker. It doesn’t augur well for the rest of the supply chain either to see these ructions

Peter DeLorenzo wrote the following with respect to Musk,

That this latest charade from Musk is yet another desperate act in an attempt at saving his floundering company is obvious. Where it differs from other Muskian braggadocio is the fact that he is insisting that his AV technology is safe for mass application and consumption. Sorry to disappoint all of the St. Elon acolytes out there, but this is the insane part…

…Unleashing a fleet of zombie Teslas on the streets of America curated by a notorious nanosecond-attention-span personality such as Musk is the quintessential definition of flat-out crazy. You can’t even squint hard enough to suggest that this is, in some way, shape, or form, rational thought. It’s a case of an intermittently brilliant mind that has wandered over the line into the Abyss of Darkness. A dangerous mind that is so obsessed with pushing his perpetually sinking car company into some sort of elevated stratosphere that he is willing to treat real people as so much collateral damage...

This country is 25 years away – at least – from widespread adoption of autonomous vehicles. Yes, there will be scaled deployment in limited, commercial applications primarily in urban centers over the next two decades, but driverless Teslas careening around less than two years from now? It is a recipe for disaster the likes of which simply defies calculation.”

All the reasons CM has disliked Tesla remain. It is so chronically overvalued. This stock will be lucky to be $100 by year end. Sadly the economy is slowing meaning it will be tougher to compete with more competition launching this year. China may give cause for some future hope but don’t bet on it.

The more Musk talks, the more desperate he is. Don’t forget he is not learning from SEC requests to lay off Twitter. His guidance in 1Q is lower than recent tweets suggesting appreciably higher targets. Tesla is a time bomb.

Almost half of Canadians on verge of bankruptcy-Ipsos

An Ipsos poll for bankruptcy specialist MNP Ltd has shown that 48% of Canadians have $200 or less of going bankrupt each month after meeting all obligations. The poll also revealed,

“35% of Canadians say an interest rate increase would move them towards bankruptcy, while 54% said they worry about their ability to repay debts.”

This is consistent with a ME Bank survey in Australia which found only 46% of households were able to save each month. Just 32% could raise $3000 in an emergency and 50% aren’t confident of meeting their obligations if unemployed for three months.

According to Digital Finance Analytics, “there are around 650,000 households in Australia experiencing some form of mortgage stress. If rates were to rise 150 basis points the number of Australians in mortgage stress would rise to approximately 930,000 and if rates rose 300 basis points the number would rise to 1.1 million – or more than a third of all mortgages. A 300 basis point rise would take the cash rate to 4.5 per cent, still lower than the 4.75 per cent for most of 2011.”

Do you know how many homes NAB has under repossession on its books at the latest filing? Around 277. Yes, Two hundred and seventy seven. Out of 100,000s of loans.

But we needn’t worry because we have to trust our central banks will keep rates low to avoid any economic shock. Remember the current and previous US Fed Chairmen have all but guaranteed there will be no more financial crises in their life time. Either they don’t hold much prospect for their longevity or they are clutching at straws.

That sinking feeling?

Clarksons.png

We are often told how robust the world economy is. Global trade tends to be a good indicator. Looking at the latest Clarkson’s December 2018 annual review, we can see that the number of shipyards that make the vessels (20,000dwt+) that look after global trade has slid from a peak of 306 in 2009 to 127. Newbuild orders have slid from 2,909 vessels to 708. Wärtsilä is anticipating a gradual recovery in contract new builds as high as 1,200 ships by 2022. Wishful thinking?

According to Clarksons, the global fleet of all types of commercial shipping is 50% larger than it was before the GFC despite the World Trade Organization saying growth in global trade for 2019 is expected to fall 2.9%. The WTO has fingers crossed for 2020. The charts in this WTO report show the sharp slowdown in freight in Q4 2018 and Jan 2019.

Germany’s five leading ship financiers reported outstanding ship-related loans of 59 billion euros at the end of 2016 with an average problem loan ratio of 37%. In recent years they have been busy reducing or selling off shipping portfolios. HSH Nordbank required a 10 billion euro bailout by its 85% owners, federal states Hamburg and Schleswig-Holstein. It ended up being swallowed by private equity and renamed Hamburg Commercial Bank. Nord LB was looking to bail in Bremer LB beyond the 54.8% it already owns. Bremer LB had to write off  €400m of its shipping portfolio.

China has been aggressive, filling the void left by the Germans with high leverage financing to support the longer-term objectives of the Belt & Road Initiative. One wonders whether China plans to spoil the market by squeezing a damaged sector further. It wasn’t so long ago that South Korea’s  Hanjin Shipping went bust.

BTIG reported that ship scrapping in Q1 2019 was up 35% to 107,000dwt. Ship owners tend to scrap ships if the cost of idling or operating them exceeds this. Note Capesize shipping rates have fallen to around $9,000/day well below the $25,000 breakeven rate. The bellwether Baltic Dry Index is 27% down year on year and 85% below the peak levels seen in 2009.

The shipping industry has been sick for a decade. The majors have been busy merging, cutting debt and right sizing. Unfortunately it is  still in a pickle. A global slowdown will only exacerbate the issues in the industry.

The one area that looks interesting is the scrubber makers (eg Alfa Laval, Valmet, Fuji Electric). There has been a sharp uptick in growth for retro-fitting pollution equipment to existing ships instead of buying new equipment. Sometimes the best investments come when industries that require massive consolidation hit breaking point.