GFC

Kobe Steel 5yr CDS not showing much fear vs history

7BF1DD0E-A593-480C-8D83-BA7EC5CDF598.jpeg

Kobe Steel’s 5yr CDS rate showing a 271bps premium above the risk free rate from around 50bps before the scandal broke. During GFC it was around 600bps+.

US unemployed since 1948 – trend is our friend?

240DDF56-FAF8-40FC-AC9C-D5D1AD17AC7D.jpeg

This is a chart of unemployed persons in the US since 1948 published by the St Louis Federal Reserve. The shaded sections denote recessions. Interesting to note that the we are skirting the red line at present, one that has seldom been breached in 70 years. Will history be bunk or will the trend confirm economic slowdown? An eerie looking chart.

Repossession by remote

IMG_0175

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

IMG_0176.PNG

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.

Not capitalism with warts but socialism with beauty spots

IMG_9700.JPG

I was fortunate enough to attend an LDP function last night where Deputy PM and Minister of Finance Taro Aso spoke. The audience was largely retirees in their 60s-80s in the Yokohama area who in part likely came for the hotel buffet. I was the only foreigner to attend among 1,000 guests. Aso truthfully described the difference between Japan and the West. Talking of how many foreign politicians can’t understand how Japan can have so many vending machines because in their countries they’d be vandalized  for their cash. Aso’s bigger point was made around deflation and how Japan is coping far better than most of the West, especially the EU. While there is a sense of celebrating an own goal, the biggest mistake made by the West in its analysis of the ‘lost two decades’ in Japan has been its unique society. Only in Japan could a population withstand two decades of hardship. Shared grief.

In the West, when it all goes to the dogs people will run as far away from the implosion as they can. Moral hazard is the order of the day. Make someone else pay. I recall the tale of a friend who had bought a condo in a ski resort in Yuzawa, Niigata Prefecture for around $20,000 off a family who had paid $800,000 for it during the bubble. They religiously paid off the loan as a form of moral obligation. In Japan, bankruptcy is seen as failure. A bankruptcy record is hung around one’s neck forever. In America, bankruptcy is seen as a badge of honor in some circles for someone pursuing the American Dream and in the next credit cycle, financial institutions will forgive the infraction, albeit at a slightly higher risk premium.

The point Aso was making was on the money. Japan is different. It is a society based on values. While the West may frown on the Japanese taking on a 250% debt: GDP ratio to allow the air to slowly leak out of a balloon, the society demands it. Despite all of the studies I’ve read on financial resurrection from deflation in the West I can safely say ‘society’ is the seemingly most overlooked yet most relevant part of the equation. As the game of convenient lies mount up from the mouths of politicians, a growing number of people are realizing that failure to act will lead to unpleasant truths. Economic cycles can only be toyed with to a point until trust leaves the system. The Japanese are indeed the most capable people on the planet to embrace change. It may take a tragedy, shock or disaster to force true action but one can be rest assured the people will unite in common purpose while the West go out of their way to look after themselves at the expense of all others.

Japan is not capitalism with warts but socialism with beauty spots. With the coming global financial train wreck approaching Japan is the best place to be.

IMG_9694.JPG

New cars for 40% off

IMG_9620.PNG

Looking for a new car? This maybe last year’s model but it’s new and 40% off. I recall seeing such lunatic deals the last time we headed for a collapse in auto sales. Mac Haik Ford in Houston is practically giving it away.  Even some of the 2017 models are getting chunky discounts.

Jim Glover Chevy near Arkansas River is also trying to shift 2016 metal. Why buy used when a 2016 new Malibu is $7,000 off?

IMG_9621.PNG

Chrysler is also chucking discounts left, right and centre. Northwest Dodge Houston is taking $14,000 off new Rams.

IMG_9622.PNG

ZeroHedge wrote:

If GM piles on incentives at this rate three months in a row, it would spend nearly $4 billion on incentives, in just that quarter, just in the US alone. How much dough is that for GM? In Q1 2015, GM reported global net income of $2.0 billion. In Q1 2015, it reported global net income of $0.9 billion. These incentives can eat an automaker’s lunch in no time. And they did in the years before the industry collapsed during the Great Recession.”

The National Automotive Dealer Association (NADA), a division of JD Power wrote,

Manufacturers dialed up incentive spending 18% last month to help reduce new vehicle inventory levels that are at a decade-plus high.”

IMG_0474.PNG

The NADA Used Car Guide’s “seasonally adjusted used vehicle price index fell for the eighth straight month, declining 3.8% from January to 110.1. The drop was by far the worst recorded for any month since November 2008 as the result of a recession-related 5.6% tumble. February’s index gure was also 8% below February 2016’s 119.4 result and marked the index’s lowest level since September 2010.”

WolfStreet noted “Used vehicle wholesale prices determine the value of the collateral for $1.11 trillion in auto loans that have boomed on higher prices, higher unit sales, longer maturities (the average hit a new record of 66.5 months in Q4), and higher loan-to-value ratios (negative equity)”

IMG_0475.PNG

It doesn’t bode well.

Intriguing quote in Deutsche Bank’s funding sheet. What if all of a sudden there is a run?

db-funding

By now most people know that Germany’s once gargantuan Deutsche Bank is trading at all time lows. Over the weekend Angela Merkel said the German government saw no grounds to bail it out although I’m sure if it comes to it Germany will be under so much international pressure to save it because of the systemic risks that a failure would pose to global financial markets. Europe’s fashionable bail-in concept means the ultimate victims are those that have lent to it – whether individual depositors or wholesale lenders. Is it any wonder Italian PM Renzi is ignoring the EU rules and likely to bail out the world’s oldest bank?

Deutsche’s most recent funding blurb says the following:

“Diversification of our funding profile in terms of investor types, regions, products and instruments is an important element of our liquidity risk management framework. Our most stable funding sources come from capital markets and equity, retail, and transaction banking clients. Other customer deposits and secured funding and shorts are additional sources of funding. Unsecured wholesale funding represents unsecured wholesale liabilities sourced primarily by our Treasury Pool division. Given the relatively short-term nature of these liabilities, they are primarily used to fund cash and liquid trading assets…

…Credit markets in 2015 were affected by continued political uncertainties in the euro zone, the ongoing low interest rate environment as well as the implementation in a number of jurisdictions, including Germany, of measures intended to reduce the levels of implicit sovereign support for banks, with a consequential impact on bank senior ratings. Our 5 year CDS traded within a range of 61 to 110 bps [trading at 247bps today], peaking in July. Since then, the spread has slightly declined and as of year-end was trading at the higher end of the range for the year…

…In 2016, our base case funding plan is up to € 35 billion which we plan to cover by accessing the above sources, without being overly dependent on any one source. We also plan to raise a portion of this funding in U.S. dollar and may enter into cross currency swaps to manage any residual requirements. We have total capital markets maturities, excluding legally exercisable calls of approximately € 22.4 billion in 2016.”

Naturally it presents an interesting question. If you are lending to DB how much faith do you put in the government to bail it out? Even if you weight the chances as high on a “too big to fail” argument (which is becoming somewhat hard to justify on grounds of market cap) premiums have to go up to compensate which at the ridiculous rates we are at has a far greater relative impact on profitability. I’m not sure how much of the € 22.4 billion in 2016 has been funded already but I’m sure those with money due in 2017 will have to take a longer look.

But we shouldn’t worry. Deutsche’s CEO is on record as saying “funding is not on the agenda”. I always love the way banks talk about their risks. Who could forget former Goldman Sachs CEO and Treasury Secretary Hank Paulson in March 2008 before GFC:

“We’ve got strong financial institutions . . . Our markets are the envy of the world. They’re resilient, they’re…innovative, they’re flexible.”

Of course banks always push the denial line when in trouble. They have no choice. No doubt the internal emails at DB have a”message” to staff – where what is written doesn’t resemble anything like the reality faced everyday by the minions. That is the folly of working in an investment bank – the internal politics get ever nastier until there are no more lifeboat passes left and no life jackets to give.

Throw in a good Trump performance tonight and global markets will be even more skittish – then again it might be they are finally waking up to the reality of the disaster central banks have put the world into.

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

image

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.

image

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.

image.jpeg

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.

image.jpeg