India's surprising economic miracle
The country’s state may be weak, but its private companies are strong
Sep 30th 2010
HORRIBLE toilets. Stagnant puddles buzzing with dengue-spreading mosquitoes. Collapsing masonry. Lax security. A terrorist attack. India’s preparations for the 72-nation Commonwealth games, which are scheduled to open in Delhi on October 3rd, have not won favourable reviews. “Commonfilth”, was one of the kinder British tabloid headlines. At best—assuming that the organisers make a last-minute dash to spruce things up—the Delhi games will be remembered as a shambles. The contrast with China’s practically flawless hosting of the Olympic games in 2008 could hardly be starker. Many people will draw the wrong lesson from this.
A big sporting event, some people believe, tells you something important about the nation that hosts it. Efficient countries build tip-top stadiums and make the shuttle buses run on time. That India cannot seem to do any of these things suggests that it will always be a second-rate power.
Or does it? Despite the headlines, India is doing rather well. Its economy is expected to expand by 8.5% this year. It has a long way to go before it is as rich as China—the Chinese economy is four times bigger—but its growth rate could overtake China’s by 2013, if not before (see article). Some economists think India will grow faster than any other large country over the next 25 years. Rapid growth in a country of 1.2 billion people is exciting, to put it mildly.
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* Business in India: A bumpier but freer roadSep 30th 2010
People power
There are two reasons why India will soon start to outpace China. One is demography. China’s workforce will shortly start ageing; in a few years’ time, it will start shrinking. That’s because of its one-child policy—an oppressive measure that no Indian government would get away with. Indira Gandhi tried something similar in the 1970s, when she called a state of emergency and introduced a forced-sterilisation programme. There was an uproar of protest. Democracy was restored and coercive population policies were abandoned. India is now blessed with a young and growing workforce. Its dependency ratio—the proportion of children and old people to working-age adults—is one of the best in the world and will remain so for a generation. India’s economy will benefit from this “demographic dividend”, which has powered many of Asia’s economic miracles.
The second reason for optimism is India’s much-derided democracy. The notion that democracy retards development in poor countries has gained currency in recent years. Certainly, it has its disadvantages. Elected governments bow to the demands of selfish factions and interest groups. Even the most urgent decisions are endlessly debated and delayed.
China does not have this problem. When its technocrats decide to dam a river, build a road or move a village, the dam goes up, the road goes down and the village disappears. The displaced villagers may be compensated, but they are not allowed to stand in the way of progress. China’s leaders make rational decisions that balance the needs of all citizens over the long term. This has led to rapid, sustained growth that has lifted hundreds of millions of people out of poverty. Small wonder that authoritarians everywhere cite China as their best excuse not to allow democracy just yet.
No doubt a strong central government would have given India a less chaotic Commonwealth games, but there is more to life than badminton and rhythmic gymnastics. India’s state may be weak, but its private companies are strong. Indian capitalism is driven by millions of entrepreneurs all furiously doing their own thing. Since the early 1990s, when India dismantled the “licence raj” and opened up to foreign trade, Indian business has boomed. The country now boasts legions of thriving small businesses and a fair number of world-class ones whose English-speaking bosses network confidently with the global elite. They are less dependent on state patronage than Chinese firms, and often more innovative: they have pioneered the $2,000 car, the ultra-cheap heart operation and some novel ways to make management more responsive to customers. Ideas flow easily around India, since it lacks China’s culture of secrecy and censorship. That, plus China’s rampant piracy, is why knowledge-based industries such as software love India but shun the Middle Kingdom.
India’s individualistic brand of capitalism may also be more robust than China’s state-directed sort. Chinese firms prosper under wise government, but bad rulers can cause far more damage in China than in India, because their powers are so much greater. If, God forbid, another Mao were to seize the reins, there would be no mechanism for getting rid of him.
That is a problem for the future. For now, India’s problems are painfully visible. The roads are atrocious. Public transport is a disgrace. Many of the country’s dynamic entrepreneurs waste hours each day stuck in traffic. Their firms are hobbled by the costs of building their own infrastructure: backup generators, water-treatment plants and fleets of buses to ferry staff to work. And India’s demographic dividend will not count for much if those new workers are unemployable. India’s literacy rate is rising, thanks in part to a surge in cheap private schools for the poor, but it is still far behind China’s.
Advantage India
The Indian government recognises the need to tackle the infrastructure crisis, and is getting better at persuading private firms to stump up the capital. But the process is slow and infected with corruption. It is hard to measure these things, but many observers think China has done a better job than India of curbing corruption, with its usual brutal methods, such as shooting people.
Given the choice between doing business in China or India, most foreign investors would probably pick China. The market is bigger, the government easier to deal with, and if your supply chain for manufactured goods does not pass through China your shareholders will demand to know why. But as the global economy becomes more knowledge-intensive, India’s advantage will grow. That is something to ponder while stuck in the Delhi traffic.
Thursday, September 30, 2010
Ireland's property hangover continues
The luck of the Irish
Ireland's property hangover continues
Sep 30th 2010
ON SEPTEMBER 30th, the Irish government revealed the full extent of its financial-sector bail-out. Anglo Irish Bank and other lenders that made bad commercial-property bets are to be provided with fresh capital to the tune of 20% of GDP this year. As a result, Ireland’s budget deficit is forecast to rise to 32% of GDP and its gross government debt to 96% of GDP. These huge costs contrast sharply with those in other countries that have had to rescue their banks. Ireland’s financial sector is so large relative to national income that, if it is not propped up, it has the ability to “bring down the sovereign”, according to Brian Lenihan, the finance minister. But Ireland does have some breathing space: it doesn't need to borrow from the bond markets until early next year as it has enough cash to cover immediate needs. The government will just have to hope that the public finances don't deliver any more nasty surprises in the intervening period.
U.S. Economy Expanded at 1.7% Rate in Second Quarter (Update1)
U.S. Economy Expanded at 1.7% Rate in Second Quarter (Update1)
By Shobhana Chandra
Sept. 30 (Bloomberg) -- The U.S. economy grew at a 1.7 percent annual rate in the second quarter, marking the start of a slowdown in growth that has concerned the Federal Reserve.
The revised increase in gross domestic product was more than the median forecast of economists surveyed by Bloomberg News and compares with a 1.6 percent estimate issued last month, figures from the Commerce Department showed today in Washington. The world’s largest economy grew 3.7 percent in the first three months of the year and 5 percent at the end of 2009.
Economists surveyed this month projected little pickup in growth for the rest of the year as a jobless rate hovering close to 10 percent hobbles consumer spending and housing languishes around record lows. Stocks and Treasury securities have rallied since Fed policy makers said Sept. 21 that they were prepared to do more to spur the economy and prevent prices from falling.
“The soft patch in the second quarter was pretty severe,” John Herrmann, senior fixed-income strategist at State Street Global Markets LLC in Boston, said before the report. “Unemployment will stay pretty close to where it is now as we’re moving at a slower pace of growth than we’d like to see. This is an economy that’s still healing and needs ongoing nurturing by the government and the Fed.”
Stock-index futures rose, erasing earlier losses, after a separate report showed first-time filings for jobless benefits declined. Futures on the Standard & Poor’s 500 Index expiring in December gained 0.3 percent to 1,143.90 at 8:36 a.m. in New York.
Jobless Claims
Initial jobless claims dropped by 16,000 to 453,000 last week, lower than the median forecast in a Bloomberg survey, Labor Department figures showed today.
GDP was forecast to grow at a 1.6 percent annual pace, according to the median estimate of 81 economists surveyed by Bloomberg. Projections ranged from gains of 1.3 percent to 2.2 percent. Today’s report is the third for the quarter.
The final revision to second-quarter growth reflected bigger gains in consumer spending and inventories.
The economy is among the top concerns for voters in the November congressional elections, and polls show the public is increasingly skeptical of President Barack Obama’s performance. His administration is pushing a proposal that would extend middle-income tax cuts while letting the top rates rise in order to mitigate the effect on the budget deficit.
Growth Forecast
Growth will average 2.1 percent from July through December, according to the median forecast of economists in a Bloomberg survey from Sept. 1 to Sept. 8, down from their projections a month earlier. Analysts also cut estimates for next year, predicting consumer spending will cool and unemployment will hold above 9 percent.
There’s a 20 percent chance the economy will slide into another recession, according to the median estimate the economists surveyed.
“We continue to see what we believe to be a slow-growth economy, but still a growth economy,” Charles “Wick” Moorman, chief executive of Norfolk Southern Corp., the second-largest U.S. railroad by market capitalization, said in a Bloomberg Television interview yesterday. “We saw a fairly sharp snap-back as 2009 went on and early in 2010. That seems now to have slowed.”
The S&P 500 fell 0.3 percent yesterday to close at 1,144.73, trimming the gauge’s biggest September rally since 1939. The two- year Treasury note reached a record-low yield of 0.41 percent on Sept. 22.
Jobs Lost
The loss of 8.4 million jobs caused by the recession, which ended in June 2009, has taken a toll on consumer confidence and spending. The housing market is yet to show sustained growth in the absence of a government tax credit for buyers.
At the same time, corporate profit gains indicate business investment, which has been the mainstay for manufacturing and the recovery, will keep growing, albeit at a slower pace.
Sluggish growth and low inflation are among the reasons economists in the Bloomberg monthly survey pushed back the timing of the Fed’s first rate increase to the fourth quarter of 2011 from the prior three months.
“The pace of recovery in output and employment has slowed in recent months,” Fed policy makers said in their statement on Sept. 21, when they kept the benchmark interest rate near zero. “Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.”
Consumer Spending
Today’s report showed consumer spending, which accounts for about 70 percent of the economy, rose at a 2.2 percent pace last quarter, the fastest since the first three months of 2007 and more than the 2 percent the government estimated last month. Spending added 1.54 percentage points to GDP in the second quarter.
Household spending figures for August, due tomorrow, may show a 0.3 percent gain following a 0.4 percent increase in July, according to the Bloomberg survey median
Today’s report showed the trade gap was revised to $449 billion from $445 billion, as imports climbed more than previously estimated. The deficit subtracted 3.5 percentage points from growth, the biggest reduction since record-keeping began in 1947.
A bigger gain in inventories contributed 0.82 percentage points to second-quarter growth, more than the government estimated last month.
The need to restock depleted inventories, a major driver of the economic recovery, will diminish in coming months as companies try to keep stockpiles more in line with demand.
Corporate Profits
Corporate profits increased 3 percent, the smallest gain since a decrease in the final three months of 2008, today’s report showed. They were up 10.5 percent in the first quarter. Earnings rose 37 percent from the second quarter of 2009, indicating companies have the means to lift spending on new equipment and payrolls.
Business spending on new equipment and software rose at a 24.8 percent pace last quarter, the most since 1983. Spending on structures including office buildings and factories declined 0.5 percent, previously reported as a 0.4 percent increase.
The Fed’s preferred price gauge, which is tied to consumer spending and strips out food and energy costs, climbed at a 1 percent annual pace. Policy makers, in their statement last week, also said that inflation is “somewhat below” levels consistent with the central bank’s congressional mandate for stable prices.
To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net
To contact the editor responsible for this story: Christopher Wellisz in Washington at cwellisz@bloomberg.net
By Shobhana Chandra
Sept. 30 (Bloomberg) -- The U.S. economy grew at a 1.7 percent annual rate in the second quarter, marking the start of a slowdown in growth that has concerned the Federal Reserve.
The revised increase in gross domestic product was more than the median forecast of economists surveyed by Bloomberg News and compares with a 1.6 percent estimate issued last month, figures from the Commerce Department showed today in Washington. The world’s largest economy grew 3.7 percent in the first three months of the year and 5 percent at the end of 2009.
Economists surveyed this month projected little pickup in growth for the rest of the year as a jobless rate hovering close to 10 percent hobbles consumer spending and housing languishes around record lows. Stocks and Treasury securities have rallied since Fed policy makers said Sept. 21 that they were prepared to do more to spur the economy and prevent prices from falling.
“The soft patch in the second quarter was pretty severe,” John Herrmann, senior fixed-income strategist at State Street Global Markets LLC in Boston, said before the report. “Unemployment will stay pretty close to where it is now as we’re moving at a slower pace of growth than we’d like to see. This is an economy that’s still healing and needs ongoing nurturing by the government and the Fed.”
Stock-index futures rose, erasing earlier losses, after a separate report showed first-time filings for jobless benefits declined. Futures on the Standard & Poor’s 500 Index expiring in December gained 0.3 percent to 1,143.90 at 8:36 a.m. in New York.
Jobless Claims
Initial jobless claims dropped by 16,000 to 453,000 last week, lower than the median forecast in a Bloomberg survey, Labor Department figures showed today.
GDP was forecast to grow at a 1.6 percent annual pace, according to the median estimate of 81 economists surveyed by Bloomberg. Projections ranged from gains of 1.3 percent to 2.2 percent. Today’s report is the third for the quarter.
The final revision to second-quarter growth reflected bigger gains in consumer spending and inventories.
The economy is among the top concerns for voters in the November congressional elections, and polls show the public is increasingly skeptical of President Barack Obama’s performance. His administration is pushing a proposal that would extend middle-income tax cuts while letting the top rates rise in order to mitigate the effect on the budget deficit.
Growth Forecast
Growth will average 2.1 percent from July through December, according to the median forecast of economists in a Bloomberg survey from Sept. 1 to Sept. 8, down from their projections a month earlier. Analysts also cut estimates for next year, predicting consumer spending will cool and unemployment will hold above 9 percent.
There’s a 20 percent chance the economy will slide into another recession, according to the median estimate the economists surveyed.
“We continue to see what we believe to be a slow-growth economy, but still a growth economy,” Charles “Wick” Moorman, chief executive of Norfolk Southern Corp., the second-largest U.S. railroad by market capitalization, said in a Bloomberg Television interview yesterday. “We saw a fairly sharp snap-back as 2009 went on and early in 2010. That seems now to have slowed.”
The S&P 500 fell 0.3 percent yesterday to close at 1,144.73, trimming the gauge’s biggest September rally since 1939. The two- year Treasury note reached a record-low yield of 0.41 percent on Sept. 22.
Jobs Lost
The loss of 8.4 million jobs caused by the recession, which ended in June 2009, has taken a toll on consumer confidence and spending. The housing market is yet to show sustained growth in the absence of a government tax credit for buyers.
At the same time, corporate profit gains indicate business investment, which has been the mainstay for manufacturing and the recovery, will keep growing, albeit at a slower pace.
Sluggish growth and low inflation are among the reasons economists in the Bloomberg monthly survey pushed back the timing of the Fed’s first rate increase to the fourth quarter of 2011 from the prior three months.
“The pace of recovery in output and employment has slowed in recent months,” Fed policy makers said in their statement on Sept. 21, when they kept the benchmark interest rate near zero. “Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.”
Consumer Spending
Today’s report showed consumer spending, which accounts for about 70 percent of the economy, rose at a 2.2 percent pace last quarter, the fastest since the first three months of 2007 and more than the 2 percent the government estimated last month. Spending added 1.54 percentage points to GDP in the second quarter.
Household spending figures for August, due tomorrow, may show a 0.3 percent gain following a 0.4 percent increase in July, according to the Bloomberg survey median
Today’s report showed the trade gap was revised to $449 billion from $445 billion, as imports climbed more than previously estimated. The deficit subtracted 3.5 percentage points from growth, the biggest reduction since record-keeping began in 1947.
A bigger gain in inventories contributed 0.82 percentage points to second-quarter growth, more than the government estimated last month.
The need to restock depleted inventories, a major driver of the economic recovery, will diminish in coming months as companies try to keep stockpiles more in line with demand.
Corporate Profits
Corporate profits increased 3 percent, the smallest gain since a decrease in the final three months of 2008, today’s report showed. They were up 10.5 percent in the first quarter. Earnings rose 37 percent from the second quarter of 2009, indicating companies have the means to lift spending on new equipment and payrolls.
Business spending on new equipment and software rose at a 24.8 percent pace last quarter, the most since 1983. Spending on structures including office buildings and factories declined 0.5 percent, previously reported as a 0.4 percent increase.
The Fed’s preferred price gauge, which is tied to consumer spending and strips out food and energy costs, climbed at a 1 percent annual pace. Policy makers, in their statement last week, also said that inflation is “somewhat below” levels consistent with the central bank’s congressional mandate for stable prices.
To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net
To contact the editor responsible for this story: Christopher Wellisz in Washington at cwellisz@bloomberg.net
私募债破局
私募债破局
私募债券发行规模有望捅破净资产40％的上限，并开创“先发行后审批”的债券发行模式
《财经》记者 王培成 张曼
银行间市场私募债券推出前夕，在发行规则上出现重大分歧。
9月17日，中国银行间市场交易商协会（下称交易商协会）召集20余家主承销商，就非金融企业债务融资工具私募发行规则进行讨论，争议多达十余处。
今年7月份，交易商协会负责人曾表示，私募债券的发行“万事具备，只欠东风”。8月底，上述交易规则获交易商协会理事会原则通过，只需向人民银行报备后，即可推出。
但是次讨论会上，却暴露出市场各方在私募债是否需要标准发行文本、信息披露等基本原则上，仍存在十余处分歧。
虽然发行规则还存争议，或将面临修改，但是私募债券已列为交易商协会年内推出的重点产品之一。其发行规模有望捅破净资产40％的上限，并开创“先发行后审批”的债券发行模式。
业内人士普遍认为，跟公募发行相比，私募发行不仅是发行方式的转变，更重要的意义在于丰富企业直接融资手段，缓解中小企业融资现状，甚至改变债券市场的“生态环境”，促进中国多层次债券市场的建设。
规则争议突起
发行规则的制定思路是，私募债发行不规定标准参考文本，也不对协议条款做出具体规定，而是由发行人、投资人和承销商等根据市场化原则，自行商定个性化的私募发行协议，形成债券募集说明书。这也是国际资本市场私募发行的惯例。
但承销商提出，现在银行间市场发债企业多为央企等大客户，发行人议价能力较强，在公开发行市场上都常常压价强势发行；若私募发行，承销商地位可能更被动。因此，承销商希望发行规则能规定协议标准的可参照文本，降低与发行人、投资人谈判协商的成本。
承销商还希望，制定严格的信息披露条款，主动要求交易商协会制定成体系的上报材料说明，以方便承销商查阅，同时也可以保证投资人利益，为债券发行定价、二级市场流通转让提供参考。
但“行政部门参与得越多，最后往政府身上赖道德风险的可能性越大”。交易商协会负责人今年7月表示，协会只负责简单登记注册，证明不是非法集资。具体到私募协议条款，应该由发行人、投资人和承销商协商制定。
从国际上私募发行方式看，私募发行一般采取注册制或登记制，不要求向证券交易委员会注册和公开财务报表等信息。这适合于一些希望信息保密的私营公司和中小企业。
17日的会议虽然名义上是讨论会，但更像是发行规则解释会议，主承销商对一些不清楚的地方提出了异议，规则制定者一一做了解答。参与该内部讨论会的人士说，交易商协会对私募债发行规则的设计和思路比较清晰，执行态度比较坚定。
私募债券的一大缺点是流动性较低，投资风险较高，针对这一问题，发行规则将允许债券在限定范围内的合格机构投资者之间流通、转让，转让采取一对一的询价交易，合格定向投资人需将投资书面承诺函报交易商协会备案。
此外，由于私募发行在中国法律中没有明确的含义和界定，与会人士建议，可将敏感度较高的“私募”一词改为“非公开定向发行”。
发行规模破界
据了解，首批试点中，铁道部、中国联通（600050.SH）等央企对私募债兴趣“浓厚”。今年年初，上述企业便开始筹备在银行间市场私募发债，但迟迟未能推出，融资计划一度搁置。
为保证发行顺利并合理控制风险，首批私募债试点企业限定为信用评级达到AAA、债务偿还能力较强的大型国有企业。此后再逐步推开，引入更多市场主体。
但现行《证券法》规定，企业债券累计发行额不得超过企业净资产的40％，而部分AAA级机构目前的发债规模已经接近甚至超过这一红线。
中国国际金融公司统计显示，截至2010年8月20日，中国国电集团发债规模已达到合并净资产的65.5％。中国长江电力股份公司和中国华能集团该比例已达62.4％和55.1％。
目前，交易商协会制定的私募债券所有制度中，没有对净资产40％的规模限制做出明确界定和解释。业界将此理解为，交易商协会希望借债券私募发行，来绕过上述政策限制。
私募发行方式和私募形式证券在中国尚未得到立法确认。2004年，中国证监会修改后的《证券公司债券管理暂行办法》规定，证券公司债券可以向社会公开发行，也可以向合格投资者定向发行。关于私募发行，只有定向、非公开发行等模糊表达，没有对含义和发行制度进行明确定义。
上述参与该规则制定的人士坦言，对于40％的政策红线，每个机构有各自的理解。在他看来，40％的限制是针对公开发行，但未明确也适用于非公开发行，所以从法理上讲，“问题”不会太大。但也有市场参与者质疑，“法律条文不能随便绕开”。
对此，中国人民银行等部门未明确表态。业内人士认为，如果依靠部门制定规章制度，通过行政的手段绕开这样的限制，缺乏法律支撑和保证，有些“欠妥”，可能会遭受指责，并引发不满。
同样，如果寄希望于通过立法程序解决这一争议，往往需要统一多方意见，耗时颇长。一位知情人士表示，虽然相关各方未能明确表态，但是就私募发行各方已经形成“默契”，40％的限制已经不是最大障碍。
40％的监管限制一旦突破，更多的企业将选择私募发行债券方式进行融资。传统的企业融资结构将被改变，银行信贷业务将直接受到冲击。就投资人来讲，40％的限制可被看做是否配置这类产品的参考标准，以此来衡量企业负债率，测量债券风险。
债市新格局
“现在各家承销商的积极性都不一样，因为发债渠道拓宽后，对银行传统的信贷业务会造成侵蚀。”多名银行间债券市场人士表示类似观点。
在9月17日的主承销商讨论会议上，四大行和股份制商业银行意见也出现分歧。个别大行甚至一言不发，没有表达任何意见。
银行间债券市场的承销团队以银行为主。对于银行系承销商来说，发债业务更多是依托银行存贷款客户，但由于发债融资成本比贷款低，不少客户将发债融得的资金用于偿还银行贷款，导致银行息差收入减少。因此，在不少银行内部，产生了公司部门与债券承销部门的博弈。
但对于大客户较少的股份制银行来说，债券承销业务是一个业务发展重点。如果私募发行方式日臻成熟，发行手续不断简化，发行周期不断缩短，又能规避净资产40％的规模限制，那么更多的企业将乐于选择这种方式融资。这对股份制银行来说将是一大利好。
业界人士预计，试点推开后，一些小企业和不符合公募条件的企业也将发行私募债券，这意味着高收益、高风险债券将逐步登陆市场。
交易商协会负责人表示，“私募债的推出，对整个经济的影响不亚于当年推行中期票据。”信息披露领域受限的企业和中小企业将是最大受惠者。
私募发行跟公募最大的不同在于，发行前已经确定了投资人，承销商、发行人和投资人在商定好发行协议后再向交易商协会进行报备，这种模式其实是“先发行后审批”的发行模式，对现有的债券发行体制构成“挑战”。
此外，私募发行要求承销商先行为发行人和投资者牵线搭桥，这将改变现行市场承销商仅对承揽项目进行销售的模式，很有可能引发以投资需求为导向的“逆向发行”。■
本刊记者曲艳丽、王晓璐对此文亦有贡献
私募债券发行规模有望捅破净资产40％的上限，并开创“先发行后审批”的债券发行模式
《财经》记者 王培成 张曼
银行间市场私募债券推出前夕，在发行规则上出现重大分歧。
9月17日，中国银行间市场交易商协会（下称交易商协会）召集20余家主承销商，就非金融企业债务融资工具私募发行规则进行讨论，争议多达十余处。
今年7月份，交易商协会负责人曾表示，私募债券的发行“万事具备，只欠东风”。8月底，上述交易规则获交易商协会理事会原则通过，只需向人民银行报备后，即可推出。
但是次讨论会上，却暴露出市场各方在私募债是否需要标准发行文本、信息披露等基本原则上，仍存在十余处分歧。
虽然发行规则还存争议，或将面临修改，但是私募债券已列为交易商协会年内推出的重点产品之一。其发行规模有望捅破净资产40％的上限，并开创“先发行后审批”的债券发行模式。
业内人士普遍认为，跟公募发行相比，私募发行不仅是发行方式的转变，更重要的意义在于丰富企业直接融资手段，缓解中小企业融资现状，甚至改变债券市场的“生态环境”，促进中国多层次债券市场的建设。
规则争议突起
发行规则的制定思路是，私募债发行不规定标准参考文本，也不对协议条款做出具体规定，而是由发行人、投资人和承销商等根据市场化原则，自行商定个性化的私募发行协议，形成债券募集说明书。这也是国际资本市场私募发行的惯例。
但承销商提出，现在银行间市场发债企业多为央企等大客户，发行人议价能力较强，在公开发行市场上都常常压价强势发行；若私募发行，承销商地位可能更被动。因此，承销商希望发行规则能规定协议标准的可参照文本，降低与发行人、投资人谈判协商的成本。
承销商还希望，制定严格的信息披露条款，主动要求交易商协会制定成体系的上报材料说明，以方便承销商查阅，同时也可以保证投资人利益，为债券发行定价、二级市场流通转让提供参考。
但“行政部门参与得越多，最后往政府身上赖道德风险的可能性越大”。交易商协会负责人今年7月表示，协会只负责简单登记注册，证明不是非法集资。具体到私募协议条款，应该由发行人、投资人和承销商协商制定。
从国际上私募发行方式看，私募发行一般采取注册制或登记制，不要求向证券交易委员会注册和公开财务报表等信息。这适合于一些希望信息保密的私营公司和中小企业。
17日的会议虽然名义上是讨论会，但更像是发行规则解释会议，主承销商对一些不清楚的地方提出了异议，规则制定者一一做了解答。参与该内部讨论会的人士说，交易商协会对私募债发行规则的设计和思路比较清晰，执行态度比较坚定。
私募债券的一大缺点是流动性较低，投资风险较高，针对这一问题，发行规则将允许债券在限定范围内的合格机构投资者之间流通、转让，转让采取一对一的询价交易，合格定向投资人需将投资书面承诺函报交易商协会备案。
此外，由于私募发行在中国法律中没有明确的含义和界定，与会人士建议，可将敏感度较高的“私募”一词改为“非公开定向发行”。
发行规模破界
据了解，首批试点中，铁道部、中国联通（600050.SH）等央企对私募债兴趣“浓厚”。今年年初，上述企业便开始筹备在银行间市场私募发债，但迟迟未能推出，融资计划一度搁置。
为保证发行顺利并合理控制风险，首批私募债试点企业限定为信用评级达到AAA、债务偿还能力较强的大型国有企业。此后再逐步推开，引入更多市场主体。
但现行《证券法》规定，企业债券累计发行额不得超过企业净资产的40％，而部分AAA级机构目前的发债规模已经接近甚至超过这一红线。
中国国际金融公司统计显示，截至2010年8月20日，中国国电集团发债规模已达到合并净资产的65.5％。中国长江电力股份公司和中国华能集团该比例已达62.4％和55.1％。
目前，交易商协会制定的私募债券所有制度中，没有对净资产40％的规模限制做出明确界定和解释。业界将此理解为，交易商协会希望借债券私募发行，来绕过上述政策限制。
私募发行方式和私募形式证券在中国尚未得到立法确认。2004年，中国证监会修改后的《证券公司债券管理暂行办法》规定，证券公司债券可以向社会公开发行，也可以向合格投资者定向发行。关于私募发行，只有定向、非公开发行等模糊表达，没有对含义和发行制度进行明确定义。
上述参与该规则制定的人士坦言，对于40％的政策红线，每个机构有各自的理解。在他看来，40％的限制是针对公开发行，但未明确也适用于非公开发行，所以从法理上讲，“问题”不会太大。但也有市场参与者质疑，“法律条文不能随便绕开”。
对此，中国人民银行等部门未明确表态。业内人士认为，如果依靠部门制定规章制度，通过行政的手段绕开这样的限制，缺乏法律支撑和保证，有些“欠妥”，可能会遭受指责，并引发不满。
同样，如果寄希望于通过立法程序解决这一争议，往往需要统一多方意见，耗时颇长。一位知情人士表示，虽然相关各方未能明确表态，但是就私募发行各方已经形成“默契”，40％的限制已经不是最大障碍。
40％的监管限制一旦突破，更多的企业将选择私募发行债券方式进行融资。传统的企业融资结构将被改变，银行信贷业务将直接受到冲击。就投资人来讲，40％的限制可被看做是否配置这类产品的参考标准，以此来衡量企业负债率，测量债券风险。
债市新格局
“现在各家承销商的积极性都不一样，因为发债渠道拓宽后，对银行传统的信贷业务会造成侵蚀。”多名银行间债券市场人士表示类似观点。
在9月17日的主承销商讨论会议上，四大行和股份制商业银行意见也出现分歧。个别大行甚至一言不发，没有表达任何意见。
银行间债券市场的承销团队以银行为主。对于银行系承销商来说，发债业务更多是依托银行存贷款客户，但由于发债融资成本比贷款低，不少客户将发债融得的资金用于偿还银行贷款，导致银行息差收入减少。因此，在不少银行内部，产生了公司部门与债券承销部门的博弈。
但对于大客户较少的股份制银行来说，债券承销业务是一个业务发展重点。如果私募发行方式日臻成熟，发行手续不断简化，发行周期不断缩短，又能规避净资产40％的规模限制，那么更多的企业将乐于选择这种方式融资。这对股份制银行来说将是一大利好。
业界人士预计，试点推开后，一些小企业和不符合公募条件的企业也将发行私募债券，这意味着高收益、高风险债券将逐步登陆市场。
交易商协会负责人表示，“私募债的推出，对整个经济的影响不亚于当年推行中期票据。”信息披露领域受限的企业和中小企业将是最大受惠者。
私募发行跟公募最大的不同在于，发行前已经确定了投资人，承销商、发行人和投资人在商定好发行协议后再向交易商协会进行报备，这种模式其实是“先发行后审批”的发行模式，对现有的债券发行体制构成“挑战”。
此外，私募发行要求承销商先行为发行人和投资者牵线搭桥，这将改变现行市场承销商仅对承揽项目进行销售的模式，很有可能引发以投资需求为导向的“逆向发行”。■
本刊记者曲艳丽、王晓璐对此文亦有贡献
Wednesday, September 29, 2010
Currency Wars: A Fight to Be Weaker
Currency Wars: A Fight to Be Weaker
Tensions Grow in Foreign-Exchange Market as Countries Scramble to Tamp Down Their Money
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By TOM LAURICELLA And JOHN LYONS
Tensions are growing in the global currency markets as political rhetoric heats up and countries battle to protect their exporters, raising concerns about potentially damaging trade wars.
At least half a dozen countries are actively trying to push down the value of their currencies, the most high-profile of which is Japan, which is attempting to halt the rise of the yen after a 14% rise since May. In the U.S., Congress is considering a law that targets China for keeping its currency artificially low, and in Brazil, the head of the central bank said the country may impose a tax on some short-term fixed income investments, which have contributed to a rise in the real.
View Full Image
monetjp
Agence France-Presse/Getty Images
Workers wave their union flags at a demonstration at the financial center in São Paulo, Brazil, in April.
monetjp
monetjp
Businesses always want to be more competitive and politicians often talk a big game. But in the current environment, as many economies are still struggling to recover from the global financial crisis, worries are growing that policy makers could be more aggressive in protecting their nation's business interests.
Rising protectionism is "a very big risk," says Erin Browne, a macro stock market strategist at Citigroup. "And it's something that could move more into the spotlight after the [U.S.] election.
Currency-market strains could also be a topic of discussion at next week's IMF/World Bank meeting in Washington where central bank and government finance officials will be gathering.
video
News Hub: Before the Opening Bell
1:56
Mike Reid joins Bob O'Brien and Kelly Evans to preview Wednesday's markets.
The Japanese government earlier this month stepped into the currency markets for the first time in years. To counter the yen's rise, Japan sold some $20 billion worth of its currency, which traders said was its biggest-ever effort in a single day.
Japan joined many other Asian emerging-market countries that have fighting rising currencies on a near daily basis, such as Taiwan, South Korea and Thailand. In Latin America, Brazil, Colombia and Peru have also intervened to tamp down their currencies.
In the U.S., protectionist efforts have been on the rise, especially when it comes to China, which is widely seen as keeping its currency, the yuan, at artificially low levels in order to boost its exports and make it more expensive for the Chinese to purchase goods produced abroad.
The House of Representatives is expected to pass legislation on Thursday that would let U.S. companies argue that Chinese currency policy represents an unfair subsidy. Democratic Senator Charles Schumer plans to push similar legislation to punish China for currency manipulation in the lame-duck session following the election. But it is considered unlikely the bill will pass.
Even so, the administration could use the threat of congressional action to press Beijing to make further adjustments in its currency, particularly as a summit of the Group-of-20 leaders in mid November draws closer.
IMF Managing Director Dominique Strauss-Kahn said he wouldn't rule out a currency war and that officials at both the fund and the Group of 20 nations were actively working to prevent such a battle of competitive depreciations.
However, in a press briefing in Washington, Mr. Strauss-Kahn said he didn't believe there was a big risk of such a war.
View Full Image
monet0924
Chris Ratcliffe/Bloomberg News
monet0924
monet0924
"There is no good to expect from intervention," he said. "History has shown that the effect of this kind of intervention doesn't last for very long."
Part of the challenge is that the moves in the currency markets that are raising the ire of central banks and politicians are being driven by longer-term investors.
Stronger economies in the emerging markets are attracting capital from the developed world, pumping up demand for local currencies. Talk of additional quantitative easing in the U.S. signals to investors that interest rates there will remain close to zero for a long time.
Meanwhile, inflation is building in Asia, forcing interest rates higher. Investors see that mismatch and are shuttling money from west to east, attracted to the higher yields.
"The flows that we're seeing are soundly based," says Richard Yetsenga, global head of emerging-market currency strategy at HSBC.
Some countries intervene more forcefully than others. Technology exporter Taiwan sees little fluctuation in its currency, thanks partly to heavy government intervention. Its currency is up less than 2% against the dollar this year. Malaysia, on the other hand, has allowed a stronger ringgit for the independence a free-floating currency gives its monetary policy makers, and the spur it gives to its exporters to become more efficient.
Government officials outside China for the most part step gingerly when it comes to the region's largest economy and its approach to currency reform, if they say anything at all. Singapore Prime Minister Lee Hsien Loong said last week in an interview with The Wall Street Journal regarding China's appreciation: "I can understand their caution, but on balance they need not go so slow."
The rhetoric was much hotter this week out of Brazil, where its currency has risen more than 30% against the dollar since last year partly because investors flock to its relatively high interest rates.
On Monday, Brazil's Finance Minister Guido Mantega lashed out at the U.S., Japan and other rich nations he says are letting their currencies weaken to spur growth—growth that comes at the expense of other exporters like Brazil.
"We're in the midst of an international currency war," Mr. Mantega said during an event in São Paulo. "This threatens us because it takes away our competitiveness."
The head of Brazil's central bank, which has been intervening in the currency markets to slow the real's rise, was more circumspect on Tuesday.
"There is a very serious currency problem which should be addressed," Henrique de Campos Meirelles said. Mr. Meirelles said that raising taxes on flows into Brazil was a possibility.
Officials say Brazil's 10.75% benchmark interest rate is necessary to squelch inflation and keep the Latin America's biggest economy from overheating. But it attracts a flood of investment from speculators who borrow in the U.S. or Japan where money is cheap, and deposit it in Brazil. The inflows of cash propel the real even higher.
With Brazil's presidential elections scheduled for Sunday, dealing with a strong currency is shaping up as the first major economic issue to face Brazil's next president. Dilma Rousseff, the former Energy Minister and handpicked successor to President Luiz Inácio Lula da Silva leading the polls, is an advocate of Brazil's 11-year-old floating exchange rate. But she is likely to face pressure from economists within her left-wing party, including Mr. Mantega, to intervene more heavily.
—Ian Talley, Bob Davis and Alex Frangos contributed to this article.
Write to Tom Lauricella at tom.lauricella@wsj.com and John Lyons at john.lyons@wsj.com
Tensions Grow in Foreign-Exchange Market as Countries Scramble to Tamp Down Their Money
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* larger Text smaller
By TOM LAURICELLA And JOHN LYONS
Tensions are growing in the global currency markets as political rhetoric heats up and countries battle to protect their exporters, raising concerns about potentially damaging trade wars.
At least half a dozen countries are actively trying to push down the value of their currencies, the most high-profile of which is Japan, which is attempting to halt the rise of the yen after a 14% rise since May. In the U.S., Congress is considering a law that targets China for keeping its currency artificially low, and in Brazil, the head of the central bank said the country may impose a tax on some short-term fixed income investments, which have contributed to a rise in the real.
View Full Image
monetjp
Agence France-Presse/Getty Images
Workers wave their union flags at a demonstration at the financial center in São Paulo, Brazil, in April.
monetjp
monetjp
Businesses always want to be more competitive and politicians often talk a big game. But in the current environment, as many economies are still struggling to recover from the global financial crisis, worries are growing that policy makers could be more aggressive in protecting their nation's business interests.
Rising protectionism is "a very big risk," says Erin Browne, a macro stock market strategist at Citigroup. "And it's something that could move more into the spotlight after the [U.S.] election.
Currency-market strains could also be a topic of discussion at next week's IMF/World Bank meeting in Washington where central bank and government finance officials will be gathering.
video
News Hub: Before the Opening Bell
1:56
Mike Reid joins Bob O'Brien and Kelly Evans to preview Wednesday's markets.
The Japanese government earlier this month stepped into the currency markets for the first time in years. To counter the yen's rise, Japan sold some $20 billion worth of its currency, which traders said was its biggest-ever effort in a single day.
Japan joined many other Asian emerging-market countries that have fighting rising currencies on a near daily basis, such as Taiwan, South Korea and Thailand. In Latin America, Brazil, Colombia and Peru have also intervened to tamp down their currencies.
In the U.S., protectionist efforts have been on the rise, especially when it comes to China, which is widely seen as keeping its currency, the yuan, at artificially low levels in order to boost its exports and make it more expensive for the Chinese to purchase goods produced abroad.
The House of Representatives is expected to pass legislation on Thursday that would let U.S. companies argue that Chinese currency policy represents an unfair subsidy. Democratic Senator Charles Schumer plans to push similar legislation to punish China for currency manipulation in the lame-duck session following the election. But it is considered unlikely the bill will pass.
Even so, the administration could use the threat of congressional action to press Beijing to make further adjustments in its currency, particularly as a summit of the Group-of-20 leaders in mid November draws closer.
IMF Managing Director Dominique Strauss-Kahn said he wouldn't rule out a currency war and that officials at both the fund and the Group of 20 nations were actively working to prevent such a battle of competitive depreciations.
However, in a press briefing in Washington, Mr. Strauss-Kahn said he didn't believe there was a big risk of such a war.
View Full Image
monet0924
Chris Ratcliffe/Bloomberg News
monet0924
monet0924
"There is no good to expect from intervention," he said. "History has shown that the effect of this kind of intervention doesn't last for very long."
Part of the challenge is that the moves in the currency markets that are raising the ire of central banks and politicians are being driven by longer-term investors.
Stronger economies in the emerging markets are attracting capital from the developed world, pumping up demand for local currencies. Talk of additional quantitative easing in the U.S. signals to investors that interest rates there will remain close to zero for a long time.
Meanwhile, inflation is building in Asia, forcing interest rates higher. Investors see that mismatch and are shuttling money from west to east, attracted to the higher yields.
"The flows that we're seeing are soundly based," says Richard Yetsenga, global head of emerging-market currency strategy at HSBC.
Some countries intervene more forcefully than others. Technology exporter Taiwan sees little fluctuation in its currency, thanks partly to heavy government intervention. Its currency is up less than 2% against the dollar this year. Malaysia, on the other hand, has allowed a stronger ringgit for the independence a free-floating currency gives its monetary policy makers, and the spur it gives to its exporters to become more efficient.
Government officials outside China for the most part step gingerly when it comes to the region's largest economy and its approach to currency reform, if they say anything at all. Singapore Prime Minister Lee Hsien Loong said last week in an interview with The Wall Street Journal regarding China's appreciation: "I can understand their caution, but on balance they need not go so slow."
The rhetoric was much hotter this week out of Brazil, where its currency has risen more than 30% against the dollar since last year partly because investors flock to its relatively high interest rates.
On Monday, Brazil's Finance Minister Guido Mantega lashed out at the U.S., Japan and other rich nations he says are letting their currencies weaken to spur growth—growth that comes at the expense of other exporters like Brazil.
"We're in the midst of an international currency war," Mr. Mantega said during an event in São Paulo. "This threatens us because it takes away our competitiveness."
The head of Brazil's central bank, which has been intervening in the currency markets to slow the real's rise, was more circumspect on Tuesday.
"There is a very serious currency problem which should be addressed," Henrique de Campos Meirelles said. Mr. Meirelles said that raising taxes on flows into Brazil was a possibility.
Officials say Brazil's 10.75% benchmark interest rate is necessary to squelch inflation and keep the Latin America's biggest economy from overheating. But it attracts a flood of investment from speculators who borrow in the U.S. or Japan where money is cheap, and deposit it in Brazil. The inflows of cash propel the real even higher.
With Brazil's presidential elections scheduled for Sunday, dealing with a strong currency is shaping up as the first major economic issue to face Brazil's next president. Dilma Rousseff, the former Energy Minister and handpicked successor to President Luiz Inácio Lula da Silva leading the polls, is an advocate of Brazil's 11-year-old floating exchange rate. But she is likely to face pressure from economists within her left-wing party, including Mr. Mantega, to intervene more heavily.
—Ian Talley, Bob Davis and Alex Frangos contributed to this article.
Write to Tom Lauricella at tom.lauricella@wsj.com and John Lyons at john.lyons@wsj.com
M&A Snaps Back as BHP, Intel Drive Busiest Quarter in 2 Years
M&A Snaps Back as BHP, Intel Drive Busiest Quarter in 2 Years
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By Brett Foley and Jeffrey McCracken
Sept. 29 (Bloomberg) -- Dealmaking staged a comeback in the third quarter, with a jump in multibillion-dollar takeovers putting this year on pace to surpass 2009.
The quarter was the busiest in two years, with $562.6 billion of announced transactions, according to data compiled by Bloomberg. BHP Billiton Ltd. made an unsolicited $40 billion offer for Potash Corp. of Saskatchewan Inc., Sanofi-Aventis SA began its pursuit of Genzyme Corp. for at least $18.5 billion, and Intel Corp. announced its largest acquisition, the $7.7 billion takeover of security-software maker McAfee Inc.
“M&A activity in the third quarter was strong, even better than expected,” said Jeffrey Kaplan, global head of mergers and acquisitions at Bank of America Corp., which is advising Potash Corp. on its takeover defense. “I see real potential for a broad-based recovery with a lot of larger corporate deals.”
With almost $3 trillion of cash in their coffers, companies drove a 59 percent increase in takeovers from a year ago, Bloomberg data show. Record-low borrowing costs encouraged dealmaking as the Standard & Poor’s 500 Index headed for its best September since 1939. The number of transactions valued at more than $3 billion doubled in the quarter, the data show.
The jump in deals in the third quarter, typically the slowest three-month period of the year, brings total announced takeovers to $1.48 trillion in the first nine months of 2010, compared with $1.76 trillion in all of 2009. This quarter accounted for about 38 percent of the volume so far this year.
‘Flush With Cash’
“We are at the start of an up-cycle,” said Henrik Aslaksen, Deutsche Bank AG’s global head of M&A in London. “Companies are flush with cash and have decided that it might be a good time to pick up quality assets they may have been eyeing for a while.”
Oracle Corp. Chief Executive Officer Larry Ellison said on Sept. 23 the company is seeking to buy chipmakers and extend its push into computer hardware. Procter & Gamble Co. CEO Bob McDonald said earlier this month his company is on the lookout for brands with international appeal.
The 1,000 biggest companies by market value worldwide have amassed about $2.87 trillion in cash and equivalents based on their latest filings, according to data compiled by Bloomberg. The figure excludes financial-services firms. Nestle SA, Europe’s largest company by market value, got $28.1 billion from an asset sale last month, sparking investor speculation it may step up takeovers.
Record-Low Rates
“Major corporations have the ability to implement deals and long-term strategies now, given their large cash buildup and the availability of low-cost financing,” said Paul Parker, head of global M&A at Barclays Capital, the investment-banking unit of London-based Barclays Plc.
U.S. companies taking advantage of cheaper financing include Microsoft Corp., PepsiCo Inc. and Hewlett-Packard Co., which won a $2.35 billion takeover battle for 3Par Inc. in the third quarter and also agreed to buy ArcSight Inc., a maker of network-security software, for $1.5 billion.
Microsoft last week sold $1 billion of three-year notes at 0.875 percent, the lowest interest rate on record for that maturity, according to Barclays Capital data.
Buyouts also recovered in the quarter, with takeovers involving private-equity firms more than tripling from a year earlier to $58.3 billion. Burger King Holdings Inc. agreed to be acquired by 3G Capital for $3.3 billion in the biggest restaurant deal in at least a decade, while CVC Capital Partners Ltd. agreed to buy TDC A/S’s Swiss unit for 3.3 billion Swiss francs ($3.4 billion).
Tax Driver
Private-equity firms may do more deals in the remainder of the year as they race to sell assets ahead of possible tax changes in the U.S., according to Jeffrey Raich, managing director and co-founder of Moelis & Co. The rate on carried interest, or the share of profits that fund executives earn as part of their compensation, is slated to rise to 20 percent in 2011 from 15 percent currently.
“You are seeing a lot of seller deals based on concerns about increases in capital-gains tax rates and potential legislation around carried interest have driven private-equity firms to sell portfolio companies this year,” Raich said. New York-based Moelis advised Connecticut-based buyout firm Littlejohn & Co. on the $890 million sale of Van Houtte Inc. coffee to Green Mountain Coffee Roasters Inc. this month.
Blackstone Group LP, the world’s biggest private-equity firm, said Sept. 23 that a $10 billion buyout is possible as banks are more willing to lend.
Failed Deals
To be sure, volatile markets and the outlook for earnings in certain industries are making some deals hard to get done. At least one buyout failed to materialize when talks ended between disk-drive maker Seagate Technology Plc and private-equity firms TPG Capital and Silver Lake for a $7 billion deal, people with knowledge of the discussions said last week.
P&G dropped a plan to merge its Pringles unit with Diamond Foods Inc. in August, people with knowledge of the talks said this month. Confidence among U.S. consumers in September fell to the lowest level in seven months as Americans became more pessimistic about the labor market, according to Sept. 28 figures from the Conference Board.
“I’m the most positive I’ve been since the beginning of the year, but I don’t think we are about to experience a new M&A boom,” said Giuseppe Monarchi, head of Europe, Middle East and Africa M&A for Credit Suisse Group AG.
‘Significant Confidence’
Mergers and acquisitions will be the most robust in the financial-services, technology and natural resources industries, said Peter Weinberg, partner and co-founder of Perella Weinberg Partners in New York. He said improved confidence at the start of the year has been the impetus for activity now because of the typical six- to nine-month lag time to arrange a deal.
“People had significant confidence in the equity markets, the financing markets or their own strategic aspirations,” said Weinberg.
The S&P 500 Index rallied 80 percent from its bear market low in March 2009 through April 23 of this year, data compiled by Bloomberg show. The benchmark gauge for U.S. equities then retreated 16 percent through July 2 and has since rebounded 12 percent.
Goldman Sachs Group Inc. is the top takeover adviser this year with $325.9 billion of deals and was followed by Morgan Stanley, which has $301.6 billion, according to Bloomberg data. New York-based JPMorgan Chase & Co., which is advising BHP on its Potash Corp. bid, ranked third with $263.1 billion in deals. Credit Suisse and Bank of America ranked fourth and fifth, the data show.
“We are cautiously optimistic about next year,” said Hernan Cristerna, JPMorgan’s head of European M&A in London. “Conditions are in place for 2011 to be better than 2010 in terms of volumes.”
To contact the reporters on this story: Brett Foley in London at bfoley8@bloomberg.net; Jeffrey McCracken in New York at jmccracken3@bloomberg.net.
To contact the editors responsible for this story: Jeff St.Onge at jstonge@bloomberg.net; Jennifer Sondag at jsondag@bloomberg.net.
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By Brett Foley and Jeffrey McCracken
Sept. 29 (Bloomberg) -- Dealmaking staged a comeback in the third quarter, with a jump in multibillion-dollar takeovers putting this year on pace to surpass 2009.
The quarter was the busiest in two years, with $562.6 billion of announced transactions, according to data compiled by Bloomberg. BHP Billiton Ltd. made an unsolicited $40 billion offer for Potash Corp. of Saskatchewan Inc., Sanofi-Aventis SA began its pursuit of Genzyme Corp. for at least $18.5 billion, and Intel Corp. announced its largest acquisition, the $7.7 billion takeover of security-software maker McAfee Inc.
“M&A activity in the third quarter was strong, even better than expected,” said Jeffrey Kaplan, global head of mergers and acquisitions at Bank of America Corp., which is advising Potash Corp. on its takeover defense. “I see real potential for a broad-based recovery with a lot of larger corporate deals.”
With almost $3 trillion of cash in their coffers, companies drove a 59 percent increase in takeovers from a year ago, Bloomberg data show. Record-low borrowing costs encouraged dealmaking as the Standard & Poor’s 500 Index headed for its best September since 1939. The number of transactions valued at more than $3 billion doubled in the quarter, the data show.
The jump in deals in the third quarter, typically the slowest three-month period of the year, brings total announced takeovers to $1.48 trillion in the first nine months of 2010, compared with $1.76 trillion in all of 2009. This quarter accounted for about 38 percent of the volume so far this year.
‘Flush With Cash’
“We are at the start of an up-cycle,” said Henrik Aslaksen, Deutsche Bank AG’s global head of M&A in London. “Companies are flush with cash and have decided that it might be a good time to pick up quality assets they may have been eyeing for a while.”
Oracle Corp. Chief Executive Officer Larry Ellison said on Sept. 23 the company is seeking to buy chipmakers and extend its push into computer hardware. Procter & Gamble Co. CEO Bob McDonald said earlier this month his company is on the lookout for brands with international appeal.
The 1,000 biggest companies by market value worldwide have amassed about $2.87 trillion in cash and equivalents based on their latest filings, according to data compiled by Bloomberg. The figure excludes financial-services firms. Nestle SA, Europe’s largest company by market value, got $28.1 billion from an asset sale last month, sparking investor speculation it may step up takeovers.
Record-Low Rates
“Major corporations have the ability to implement deals and long-term strategies now, given their large cash buildup and the availability of low-cost financing,” said Paul Parker, head of global M&A at Barclays Capital, the investment-banking unit of London-based Barclays Plc.
U.S. companies taking advantage of cheaper financing include Microsoft Corp., PepsiCo Inc. and Hewlett-Packard Co., which won a $2.35 billion takeover battle for 3Par Inc. in the third quarter and also agreed to buy ArcSight Inc., a maker of network-security software, for $1.5 billion.
Microsoft last week sold $1 billion of three-year notes at 0.875 percent, the lowest interest rate on record for that maturity, according to Barclays Capital data.
Buyouts also recovered in the quarter, with takeovers involving private-equity firms more than tripling from a year earlier to $58.3 billion. Burger King Holdings Inc. agreed to be acquired by 3G Capital for $3.3 billion in the biggest restaurant deal in at least a decade, while CVC Capital Partners Ltd. agreed to buy TDC A/S’s Swiss unit for 3.3 billion Swiss francs ($3.4 billion).
Tax Driver
Private-equity firms may do more deals in the remainder of the year as they race to sell assets ahead of possible tax changes in the U.S., according to Jeffrey Raich, managing director and co-founder of Moelis & Co. The rate on carried interest, or the share of profits that fund executives earn as part of their compensation, is slated to rise to 20 percent in 2011 from 15 percent currently.
“You are seeing a lot of seller deals based on concerns about increases in capital-gains tax rates and potential legislation around carried interest have driven private-equity firms to sell portfolio companies this year,” Raich said. New York-based Moelis advised Connecticut-based buyout firm Littlejohn & Co. on the $890 million sale of Van Houtte Inc. coffee to Green Mountain Coffee Roasters Inc. this month.
Blackstone Group LP, the world’s biggest private-equity firm, said Sept. 23 that a $10 billion buyout is possible as banks are more willing to lend.
Failed Deals
To be sure, volatile markets and the outlook for earnings in certain industries are making some deals hard to get done. At least one buyout failed to materialize when talks ended between disk-drive maker Seagate Technology Plc and private-equity firms TPG Capital and Silver Lake for a $7 billion deal, people with knowledge of the discussions said last week.
P&G dropped a plan to merge its Pringles unit with Diamond Foods Inc. in August, people with knowledge of the talks said this month. Confidence among U.S. consumers in September fell to the lowest level in seven months as Americans became more pessimistic about the labor market, according to Sept. 28 figures from the Conference Board.
“I’m the most positive I’ve been since the beginning of the year, but I don’t think we are about to experience a new M&A boom,” said Giuseppe Monarchi, head of Europe, Middle East and Africa M&A for Credit Suisse Group AG.
‘Significant Confidence’
Mergers and acquisitions will be the most robust in the financial-services, technology and natural resources industries, said Peter Weinberg, partner and co-founder of Perella Weinberg Partners in New York. He said improved confidence at the start of the year has been the impetus for activity now because of the typical six- to nine-month lag time to arrange a deal.
“People had significant confidence in the equity markets, the financing markets or their own strategic aspirations,” said Weinberg.
The S&P 500 Index rallied 80 percent from its bear market low in March 2009 through April 23 of this year, data compiled by Bloomberg show. The benchmark gauge for U.S. equities then retreated 16 percent through July 2 and has since rebounded 12 percent.
Goldman Sachs Group Inc. is the top takeover adviser this year with $325.9 billion of deals and was followed by Morgan Stanley, which has $301.6 billion, according to Bloomberg data. New York-based JPMorgan Chase & Co., which is advising BHP on its Potash Corp. bid, ranked third with $263.1 billion in deals. Credit Suisse and Bank of America ranked fourth and fifth, the data show.
“We are cautiously optimistic about next year,” said Hernan Cristerna, JPMorgan’s head of European M&A in London. “Conditions are in place for 2011 to be better than 2010 in terms of volumes.”
To contact the reporters on this story: Brett Foley in London at bfoley8@bloomberg.net; Jeffrey McCracken in New York at jmccracken3@bloomberg.net.
To contact the editors responsible for this story: Jeff St.Onge at jstonge@bloomberg.net; Jennifer Sondag at jsondag@bloomberg.net.
Tuesday, September 28, 2010
Banks Face the Killing Yields
Banks Face the Killing Yields
By DAVID REILLY
The financial-services industry is built for speed. But while superlow interest rates are meant to be high-octane fuel for the economy, they are gumming up financial engines.
The problem for many banks, insurers and fund managers is that their cost of funding can't fall below zero. Yet returns from a number of businesses or products continue to decline with already near-record low bond yields. That compresses margins and threatens to make some business lines uneconomic.
While firms have dealt with falling yields for 30 years, this is the first time they have faced a zero floor on funding costs. Adding to the painful mix, the pressure on margins comes at a time of tighter regulation and a moribund U.S. economy.
Signs of angst are emerging. One senior investment banker recently talked in private of rock-bottom rates "decimating" the business if they continue for a number of years. No wonder there is talk of layoffs on Wall Street.
During Northern Trust's second-quarter earnings call, Chief Financial Officer Bill Morrison said that "the extremely low interest-rate environment reduced second-quarter revenues by about $70 million when compared with historical averages." He went on to add that low rates "mean that our money-market mutual funds cannot generate sufficient yield to cover the management fees."
Insurers have similar concerns. "A prolonged period of historically low rates is not healthy for our business fundamentals," Lincoln National Chief Financial Officer Fred Crawford said on his firm's second-quarter call.
That is another reason why the Federal Reserve is so keen to avoid deflation setting in and is considering a return to large-scale money printing to stoke inflation.
Persistently low rates could force firms to rethink or even exit from businesses. Consider fixed-rate annuities and life-insurance products that offer a guaranteed minimum payout. If insurers, when selling products, didn't match that liability with assets generating similar income, losses could ensue.
Firms usually hedge much of that risk. But they also face the prospect of declining business for some new products offering lower guaranteed payouts. Sales of fixed-rated, deferred annuities, for example, fell 45% in the second quarter of 2010 from the same period a year earlier, according to insurance-industry group Limra.
Insurers also can expect to generate lower income from their huge investment portfolios. Analysts at Keefe, Bruyette & Woods estimated that U.S. life insurers could see a 2% reduction in 2011 earnings and 4% in 2012 if yields stay at currently low levels.
Banks, too, are feeling the pinch. Many have already taken deposit rates close to zero and have converted high-yielding certificates of deposit to lower rates. That gives them less room to cut funding costs. The amount they can earn from lending or investing, though, is under continued pressure, shrinking banks' net interest margins.
If rates stay at current levels, U.S. regional banks could see net interest margins decline from an average of about 3.54 percentage points in the third quarter to some 3.44 percentage points this time next year, according to Credit Suisse analyst Craig Siegenthaler. That compares with margins well above four percentage points before the crisis.
Brokers such as Charles Schwab and TD Ameritrade Holding; banks with big brokerage or asset-management operations, such as Bank of America and Morgan Stanley; and trust banks, such as Northern Trust and State Street, face threats, Sanford C. Bernstein analyst Brad Hintz notes. One is the greatly reduced returns firms can generate from cash in so-called sweep accounts that hold customer funds between trades, as well as money-market accounts. Another is the falloff in securities lending margins and activity.
So while low rates may be seen as a panacea for the economy, they could prove to be a form of Chinese water torture for plenty of financial firms.
Write to David Reilly at david.reilly@wsj.com
By DAVID REILLY
The financial-services industry is built for speed. But while superlow interest rates are meant to be high-octane fuel for the economy, they are gumming up financial engines.
The problem for many banks, insurers and fund managers is that their cost of funding can't fall below zero. Yet returns from a number of businesses or products continue to decline with already near-record low bond yields. That compresses margins and threatens to make some business lines uneconomic.
While firms have dealt with falling yields for 30 years, this is the first time they have faced a zero floor on funding costs. Adding to the painful mix, the pressure on margins comes at a time of tighter regulation and a moribund U.S. economy.
Signs of angst are emerging. One senior investment banker recently talked in private of rock-bottom rates "decimating" the business if they continue for a number of years. No wonder there is talk of layoffs on Wall Street.
During Northern Trust's second-quarter earnings call, Chief Financial Officer Bill Morrison said that "the extremely low interest-rate environment reduced second-quarter revenues by about $70 million when compared with historical averages." He went on to add that low rates "mean that our money-market mutual funds cannot generate sufficient yield to cover the management fees."
Insurers have similar concerns. "A prolonged period of historically low rates is not healthy for our business fundamentals," Lincoln National Chief Financial Officer Fred Crawford said on his firm's second-quarter call.
That is another reason why the Federal Reserve is so keen to avoid deflation setting in and is considering a return to large-scale money printing to stoke inflation.
Persistently low rates could force firms to rethink or even exit from businesses. Consider fixed-rate annuities and life-insurance products that offer a guaranteed minimum payout. If insurers, when selling products, didn't match that liability with assets generating similar income, losses could ensue.
Firms usually hedge much of that risk. But they also face the prospect of declining business for some new products offering lower guaranteed payouts. Sales of fixed-rated, deferred annuities, for example, fell 45% in the second quarter of 2010 from the same period a year earlier, according to insurance-industry group Limra.
Insurers also can expect to generate lower income from their huge investment portfolios. Analysts at Keefe, Bruyette & Woods estimated that U.S. life insurers could see a 2% reduction in 2011 earnings and 4% in 2012 if yields stay at currently low levels.
Banks, too, are feeling the pinch. Many have already taken deposit rates close to zero and have converted high-yielding certificates of deposit to lower rates. That gives them less room to cut funding costs. The amount they can earn from lending or investing, though, is under continued pressure, shrinking banks' net interest margins.
If rates stay at current levels, U.S. regional banks could see net interest margins decline from an average of about 3.54 percentage points in the third quarter to some 3.44 percentage points this time next year, according to Credit Suisse analyst Craig Siegenthaler. That compares with margins well above four percentage points before the crisis.
Brokers such as Charles Schwab and TD Ameritrade Holding; banks with big brokerage or asset-management operations, such as Bank of America and Morgan Stanley; and trust banks, such as Northern Trust and State Street, face threats, Sanford C. Bernstein analyst Brad Hintz notes. One is the greatly reduced returns firms can generate from cash in so-called sweep accounts that hold customer funds between trades, as well as money-market accounts. Another is the falloff in securities lending margins and activity.
So while low rates may be seen as a panacea for the economy, they could prove to be a form of Chinese water torture for plenty of financial firms.
Write to David Reilly at david.reilly@wsj.com
Stan Druckenmiller is Leaving
Stan Druckenmiller is Leaving
- The New Normal has a new set of rules. What once pumped asset prices and favored the production of paper, as opposed to things, is now in retrograde.
- The hard cold reality from Stan Druckenmiller’s “old normal” is that prosperity and overconsumption was driven by asset inflation that in turn was leverage and interest rate correlated.
- Investors are faced with 2.5% yielding bonds and stocks staring straight into new normal real growth rates of 2% or less. There is no 8% there for pension funds. There are no stocks for the long run at 12% returns.
So the hedgies are in retreat and, in some cases, on the run. Ken Griffin at Citadel is considering cutting fees, and Stan Druckenmiller at Duquesne/ex-Soros is packing his bags for the golf course. Frustrated at his inability to replicate the accustomed 30% annualized returns that his business model and expertise produced over the past several decades, Stan is throwing in the towel. Who’s to blame him? I don’t. I respect him, not only for his financial wizardry, but his philanthropy which includes not only writing big checks, but spending lots of time with personal causes such as the Harlem Children’s Zone. And at 57, he’s certainly learned how to smell more roses, pick more daisies, and replace more divots than yours truly has at the advancing age of 66. So way to go Stan. Enjoy.
But his departure and Mr. Griffin’s price-cutting are more than personal anecdotes. They are reflective of a broader trend in the capital markets, one which saw the availability of cheap financing drive asset prices to unsustainable heights during the dotcom and housing bubble of the past decade, and then suffered the slings and arrows of a liquidity crisis in 2008 to date. Similarly, liquidity at a discount drove lots of other successful business models over the past 25 years: housing, commercial real estate, investment banking, goodness – dare I say, investment management – but for them, its destination is more likely to be a semi-permanent rest stop than a freeway. The New Normal has a new set of rules. What once pumped asset prices and favored the production of paper, as opposed to things, is now in retrograde. Leverage and deregulation are fading from the horizon and their polar opposites are in the ascendant. Some characterize it in biblical terms – seven fat years to be followed by seven years of lean. Others like Michael Moore and Oliver Stone describe it in terms of social justice – greed no longer is good. And the hedgies – well, they just take their ball and go home. What, after all, is the use of competing if you can’t play by the old rules?
Whoever’s slant or side you choose to take in this transition from the old to the “new” normal, the unmistakable fact is that future investment returns will be far lower than historical averages. If a levered Druckenmiller, Soros, or Griffin could deliver double-digit returns in the past, then a less levered hedge fund community with a lower yielding menu will likely resign themselves to a high single-digit future. If a “stocks for the long run” Jeremy Siegel grew used to historically “validated” 9 to 10% returns from stocks prior to writing his bestseller in the late 1990s, then the experience of the last decade should at least temper his confidence that the “market” will deliver any sort of magical high single-digit return over the long-term future. And, if bond investors believe that the resplendent and abundant capital gains of the past 25 years will be duplicated from yield levels of 2 to 3% – well, they just haven’t been to Japan, have they?
There are all sizes and shapes of “investors” out there who have not correctly visualized the lower return world of the New Normal. The New York Times just last week described the previous balancing act that pension funds – both corporate and state-oriented – are now attempting to perform. Their article describes their predicament as the “illusion of savings,” a condition which features the assumption that asset returns on their investment portfolios will average 8% over the long-term future. No matter that returns for the past 10 years have averaged 3%. They remain stuck on the notion that the 25-year history shown in Chart 1 is the appropriate measure. Sort of a stocks for the long run parody in pension space one would assume. Yet commonsense would only conclude that a 60/40 allocation of stocks and bonds would require nearly a 12% return from stocks in order to get there. The last time I checked, the investment grade bond market yielded only 2.5% and a combination of the two classic asset classes would require 12% from stocks to hit the magical 8% pool ball. That requires a really long cue stick dear reader, or what they call a “bridge” in pool hall parlance. Best of luck.
The predicament, of course, is mimicked by all institutions with underfunded liability structures – insurance companies, Social Security, and perhaps least acknowledged or respected, households. If a family is expecting to earn a high single-digit return on their 401(k) to fund retirement, or a similar result from their personal account to pay for college, there will likely not be enough in the piggy bank at time’s end to pay the bills. If stocks are required to do the heavy lifting because of rather anemic bond yields, it should be acknowledged that bond yields are rather anemic because of extremely low new normal expectations for growth and inflation in developed economies. Even the wildest bulls on Wall Street and worldwide bourses would be hard-pressed to manufacture 12% equity returns from nominal GDP growth of 2 to 3%. The hard cold reality from Stan Druckenmiller’s “old normal” is that prosperity and overconsumption was driven by asset inflation that in turn was leverage and interest rate correlated. With deleveraging the fashion du jour, and yields about as low as they are going to go, prosperity requires another foundation.
What might that be? Well, let me be the first to acknowledge that the best route to prosperity is the good old-fashioned route (no, not the dated Paine Webber road map utilizing hoped for paper gains of 12%+) but good old-fashioned investment in production. If we are to EARN IT – the best way is to utilize technology and elbow grease to make products that the rest of the world wants to buy. Perhaps we can, but it would take a long time and an increase in political courage not seen since Ronald Reagan or FDR.
What is more likely is a policy resort to reflation on a multitude of policy fronts: low interest rates and quantitative easing from the Federal Reserve, near double-digit deficits as a percentage of GDP from Washington. What the U.S. economy needs to do in order to return to the “old” normal is to recreate nominal GDP growth of 5%, the majority of which likely comes from inflation. Inflation is the classic “coin shaving” technique of government since the Roman Empire. In modern parlance, you print money faster than required, pray that the private sector will spend it to generate investment and consumption, and then worry about the consequences in a later decade. Ditto for deficits and fiscal policy. It’s that prayer, however, which the financial markets are now doubting, resembling circumstances which in part are reminiscent of the lost decades in Japan since the early 1990s. If the private sector – through undue caution and braking demographic influences –refuses to take the bait, the reflationary trap will never snap shut.
Investors will likely not know whether the mouse has grabbed for the cheese for several years forward. In the meantime, they are faced with 2.5% yielding bonds and stocks staring straight into new normal real growth rates of 2% or less. There is no 8% there for pension funds. There are no stocks for the long run at 12% returns. And the most likely consequence of stimulative government policies that strain to get us there will be a declining dollar and a lower standard of living. Stan Druckenmiller is leaving, and with good reason. A future of low investment returns, and a heap of trouble for those expecting more, is what lies ahead.
William H. Gross
Managing Director
Whoever’s slant or side you choose to take in this transition from the old to the “new” normal, the unmistakable fact is that future investment returns will be far lower than historical averages. If a levered Druckenmiller, Soros, or Griffin could deliver double-digit returns in the past, then a less levered hedge fund community with a lower yielding menu will likely resign themselves to a high single-digit future. If a “stocks for the long run” Jeremy Siegel grew used to historically “validated” 9 to 10% returns from stocks prior to writing his bestseller in the late 1990s, then the experience of the last decade should at least temper his confidence that the “market” will deliver any sort of magical high single-digit return over the long-term future. And, if bond investors believe that the resplendent and abundant capital gains of the past 25 years will be duplicated from yield levels of 2 to 3% – well, they just haven’t been to Japan, have they?
There are all sizes and shapes of “investors” out there who have not correctly visualized the lower return world of the New Normal. The New York Times just last week described the previous balancing act that pension funds – both corporate and state-oriented – are now attempting to perform. Their article describes their predicament as the “illusion of savings,” a condition which features the assumption that asset returns on their investment portfolios will average 8% over the long-term future. No matter that returns for the past 10 years have averaged 3%. They remain stuck on the notion that the 25-year history shown in Chart 1 is the appropriate measure. Sort of a stocks for the long run parody in pension space one would assume. Yet commonsense would only conclude that a 60/40 allocation of stocks and bonds would require nearly a 12% return from stocks in order to get there. The last time I checked, the investment grade bond market yielded only 2.5% and a combination of the two classic asset classes would require 12% from stocks to hit the magical 8% pool ball. That requires a really long cue stick dear reader, or what they call a “bridge” in pool hall parlance. Best of luck.
What is more likely is a policy resort to reflation on a multitude of policy fronts: low interest rates and quantitative easing from the Federal Reserve, near double-digit deficits as a percentage of GDP from Washington. What the U.S. economy needs to do in order to return to the “old” normal is to recreate nominal GDP growth of 5%, the majority of which likely comes from inflation. Inflation is the classic “coin shaving” technique of government since the Roman Empire. In modern parlance, you print money faster than required, pray that the private sector will spend it to generate investment and consumption, and then worry about the consequences in a later decade. Ditto for deficits and fiscal policy. It’s that prayer, however, which the financial markets are now doubting, resembling circumstances which in part are reminiscent of the lost decades in Japan since the early 1990s. If the private sector – through undue caution and braking demographic influences –refuses to take the bait, the reflationary trap will never snap shut.
Investors will likely not know whether the mouse has grabbed for the cheese for several years forward. In the meantime, they are faced with 2.5% yielding bonds and stocks staring straight into new normal real growth rates of 2% or less. There is no 8% there for pension funds. There are no stocks for the long run at 12% returns. And the most likely consequence of stimulative government policies that strain to get us there will be a declining dollar and a lower standard of living. Stan Druckenmiller is leaving, and with good reason. A future of low investment returns, and a heap of trouble for those expecting more, is what lies ahead.
William H. Gross
Managing Director
Tuesday, September 21, 2010
The Myth of Diversification: Risk Factors vs. Asset Classes
The Myth of Diversification: Risk Factors vs. Asset Classes
- In our New Normal world, regime shifts in economic conditions will continue to cause significant challenges for risk management and portfolio construction.
- On average, correlations across risk factors are lower than correlations across asset classes, and risk factor correlations tend to be more robust to regime shifts.
- Risk factors provide a flexible language with which investors may express their forward-looking economic views, adapt to regime shifts and diversify their portfolios accordingly.
The word “risk” derives from the early Italian risicare, which means “to dare.” In this sense, risk is a choice rather than a fate.
– Peter L. Bernstein
Diversification often disappears when you need it most.
Consider this: From January 1970 to February 2008, when both the U.S. and World ex-U.S. stock markets – as represented by monthly returns for the Russell 3000 and MSCI World Ex-U.S. indexes, respectively – were up more than one standard deviation above their respective full-sample mean, the correlation between them was −17%. In contrast, when both markets were down more than one standard deviation, the correlation between them was +76%. (Standard deviation measures the dispersion of a set of data from its mean.) Should we expect similar asymmetry going forward? As our colleague Richard Clarida noted in a recent essay, we live in a New Normal world in which markets oscillate between two regimes: “risk on” and “risk off.” In such a world diversification across asset classes might work on average, but it might feel like having your head in the oven and your feet in a tub of ice: Even though your average body temperature is OK, your chances of survival are low.
Investors have long recognized that economic conditions frequently undergo regime shifts. The economy typically oscillates between:
- A steady, low volatility state characterized by economic growth; and
- A panic-driven, high volatility state characterized by economic contraction.
Evidence of such regimes has been well documented in market turbulence, inflation and GDP growth. In our New Normal world, regime shifts will continue to cause significant challenges for risk management and portfolio construction.
PIMCO believes asset class returns are driven by common risk factors, and risk factor returns are highly regime-specific. Hence, we believe risk factors – as opposed to asset classes – should be the building blocks for portfolio construction. Risk factors provide a flexible language with which investors may express their forward-looking economic views and diversify their portfolios accordingly.
Asset Class vs. Risk Factor Diversification
In a recent analysis, we used monthly data from 1994 to 2009 to compare the effectiveness of risk factor diversification vs. asset class diversification. We recognized that in many periods in our sample, there were no significant events that caused prices to change; hence, returns merely reflected the fact that prices were “noisy.” But in other periods, prices shifted in response to significant events. Therefore, we partitioned returns from this analysis into two sub-samples: one associated with our full sample (1994–2009) and the other associated with specific “regimes” of market turbulence during that same period. (“Regime” is risk-management vernacular that connotes periods sharing specific qualities of risk.) To do so, we used a robust mathematical technique called the Mahalanobis distance, which defines market turbulence based on both volatility and co-movements. Then we computed standard deviations and correlations for each of the samples based on a threshold calibrated to capture the most turbulent periods: The Asian financial crisis, Russian debt default and Long Term Capital Management flameout of the late 1990s; the dot.com bust, 9/11 and credit crisis early this decade; and the most recent global financial crisis sparked by the subprime mortgage fallout.
As we expected, correlations across risk factors were lower than across asset classes – hence to diversify across risk factors should be more efficient than to diversify across asset classes. Most importantly, our results revealed the average correlation across risk factors did not increase during market turbulence. Figure 1 shows average asset class and risk factor correlations for the full-sample, calm, and turbulent periods. In quiet times, the average asset class correlation was 30%, compared with 51% in turbulent times. In contrast, the average risk factor correlation remained in the 2% range in both our quiet and turbulent times.
Extreme Correlations and Tail Risk Hedging
Asset class correlations are typically higher than risk factor correlations because most asset classes contain indirect exposure to equity risk. To complicate things, indirect equity risk is like a virus that remains dormant until the body weakens: It tends to manifest itself during extreme market moves. The equity factor exposure is always there, but in normal times investors attribute the returns to real estate or hedge funds or private equity as being the result of good alpha decisions, where in reality they are the result of factor betas like equity; in bad times, they realize they owned equity factor exposure. Investors are often surprised by how seemingly unrelated risky assets and strategies suddenly become highly correlated with equities during a crisis.
Consider the example of the currency carry trade. According to this strategy, the investor sells low-yielding currencies to invest in higher yielding currencies. In normal markets (and on average), this strategy has the potential to be profitable because the high interest rate currencies have not depreciated enough over a given period to offset the gain from the interest rate differential embedded in the currency forwards. But during “risk off” panics, which are generally associated with significant equity downturns, the carry trade can produce devastating losses. Figure 2 shows how the AUD/Equities and JPY/Equities correlations change as a function of equity market returns. It shows that during market downturns, the AUD becomes highly correlated with equities while the JPY becomes more and more negatively correlated. Because a typical carry trade strategy position would be long AUD and short JPY, this pattern is bad news for an investor with capital invested in both equities and in the carry trade.
Overall, our findings reveal that during crises, investors that have not directly diversified their risk factor exposures will find themselves holding two crude asset classes: 1) risk assets and 2) nominally “safe” assets (although all investments carry risk). For tail hedging purposes, these findings can be used to the investor’s advantage. Indeed, proxy hedges such as credit default swap (CDS) tranches and short carry trade positions may be cheaper than equity puts and yet still hedge most of the portfolio’s equity factor risk exposure.
Putting it All Together
When they seek to diversify their portfolios, a majority of investors don’t think twice before they average their risk exposures across quiet and turbulent regimes. Consequently, much of the time, investors’ portfolios are suboptimal. For example, during the recent financial crisis, correlations and volatilities across asset classes changed drastically and seemingly diversified portfolios performed poorly.
Here we’ve introduced a regime-specific approach to portfolio construction and risk management. Our results showed that on average, correlations across risk factors are lower than correlations across asset classes, and risk factor correlations tend to be more robust to regime shifts than asset class correlations. Therefore, a risk factor approach to portfolio construction provides a robust platform for investors to express cyclical and secular macroeconomic views and adapt to regime shifts. Moreover, to view the world in risk factor space may also help investors better understand tail risk and find opportunities for cheap proxy hedging.
References
Bender, Jennifer, Remy Briand, Frank Nielsen, and Dan Stefek. 2010. “Portfolio of Risk Premia: A New Approach to Diversification.” The Journal of Portfolio Management. Winter 2010, Vol. 36, No. 2: pp 17-25
Bhansali, Vineer. March 2009. “The Equity Risk in a Bond Manager’s World.” PIMCO Viewpoints.
Bhansali, Vineer. 2010. “Bond Portfolio Investing and Risk Management”. McGraw-Hill.
Bhansali, Vineer. 2008. “Tail Risk Management.” The Journal of Portfolio Management, Vol. 34, No. 4: pp68-75.
Bhansali, Vineer. 2010. “Offensive Risk Management II: The Case for Active Tail Risk Hedging.” The Journal of Portfolio Management, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1601573.
Bhansali, Vineer and Josh Davis. 2010. “Offensive Risk Management: Can Tail Risk Hedging Be Profitable?” The Journal of Portfolio Management, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1573760.
Brittain, Bruce, Jim Moore, and Mark Taborsky. March 2010. “Evolving Investment Solutions Confront the Challenges of the New Normal“. PIMCO Featured Solutions, www.pimco.com
Chua, David, Mark Kritzman, and Sebastien Page. 2009. “The Myth of Diversification.” The Journal of Portfolio Management, vol. 36, no. 1 (Fall 2009).
Clarida, Rich. July 2010. “The Mean of the New Normal Is an Observation Rarely Realized.” PIMCO Global Perspectives.
De Leon, Bill, Niels Pedersen, Joe Simonian, and Sebastien Page. 2010. “How Much Equity Exposure Does Your Bond Portfolio Have?” PIMCO Internal Working Paper.
Kritzman, Mark, Sebastien Page, and David Turkington. 2010. “In Defense of Optimization: The Fallacy of 1/N.” The Financial Analyst Journal, vol. 66, no. 2,
Kritzman, Mark, and Yuanzhen Li. 2010. “Skulls, Financial Turbulence, and Risk Management.” The Financial Analyst Journal, September/October 2010, Vol. 66, No. 5.
Merton, Robert. 1974. “On the Pricing of Corporate Debt: The Risk Structure of Interest Rates.” Journal of Finance, 29, 449-470.
August Housing Starts
August Housing Starts
Highlights
- Housing starts rose 10.5% in August from 541,000 to 598,000. This was the highest level of new housing starts since the end of the homebuyer tax credit.
- The Briefing.com consensus expected housing starts to increase a much more modest 1.7% to 550,000.
Key Factors
- Even as homebuilder sentiment holds near its all-time lowest levels, builders remain bullish on housing demand.
- Unfortunately, 600,000 new housing starts does not look like a new equilibrium level. Multifamily housing starts, which are extremely volatile, rose 32.2% in August after rising 36.0% in July. Typically, a rise above 20% in one month would bring a decline the next. Since the opposite occurred in August, we expect a substantial reversion in September.
- Single-family construction increased 4.3% during the month -- the first monthly increase since April. We expect single-family construction to remain near its current level through the end of the year.
Big Picture
- Housing starts are at extremely low levels and the outlook is not likely to improve any time soon due to high levels of inventories of unsold new homes. An uptrend in construction will require an improvement in employment and income, and then take some time as inventories need to be reduced.
| Category | AUG | JUL | JUN | MAY | APR |
|---|---|---|---|---|---|
| Starts | 598K | 541K | 539K | 588K | 679K |
| 1 Unit | 438K | 420K | 450K | 459K | 563K |
| Multi Units | 160K | 121K | 89K | 129K | 116K |
| Permits | 569K | 559K | 583K | 574K | 610K |
Monday, September 20, 2010
Bond Markets Get Riskier
Bond Markets Get Riskier
Demand for High-Yield Junk Bonds Boosts Prices; Investor Protections Decline.
By CARRICK MOLLENKAMP and MARK GONGLOFF
Bond markets are growing riskier as investors seeking steady returns bid up prices and ignore some early warning signs similar to those that flashed during the credit bubble.
Last week, prices on high-yield, or junk, bonds hit their highest level since 2007, nearly double their lows of the credit crisis. Nine months into the year, companies have sold $172 billion in junk bonds, already an annual record, according to data provider Dealogic.
To some extent, the bull case for junk bonds is based on a declining rate of corporate defaults lately and a belief that, as long as the economy doesn't relapse into recession, default rates will continue to decline. The financial crisis purged many weak borrowers from the system, and corporate balance sheets are generally stronger today than before the crisis. However, a double-dip recession could hurt another, albeit smaller, wave of borrowers.
The U.S. high-yield default rate fell to 5.1% in August from 13.2% a year ago, Moody's Investors Service reported recently, adding it expected the rate to fall to less than 3% by the end of the year.
Interest rates paid by companies with strong credit ratings have tumbled this year, falling to 1.8 percentage points above the yields on comparable U.S. Treasury bonds, which themselves are among the lowest yields in decades. Companies with weak credit ratings are paying 6.2 percentage points above Treasurys, down from nearly 20 percentage points in 2008, according to Barclays Capital indexes.
Treasurys have already seen their weaknesses exposed after a recent sell-off. Since the start of September, 10-year Treasurys have lost 2.2% and 30-year government bonds are down 6.9%, compared with a 5.6% gain for the Dow Jones Industrial Average.
The demand for bonds has allowed some of the riskiest borrowers to sell bonds with fewer protections for investors. These provisions, or covenants, prevent companies from taking actions that would hurt bondholders and would protect investors if companies are sold.
The bond boom has so far been a positive for the economy, allowing the U.S. government and major corporations to borrow at cheap rates and giving weaker companies financial breathing room until business picks up.
But continued strong demand by investors can have unintended consequences. Cheap, plentiful debt fueled the housing and leveraged-buyout booms, both of which collapsed after buyers who borrowed too much couldn't repay loans.
"Bondholders got burned" buying deals in 2005 through 2007 because indentures, or the contracts that govern the bonds, didn't protect them, said Adam Cohen, founder of Covenant Review LLC, a New York credit research firm. "They said 'never again,' but now in a hot bond market, people are buying into those covenant loopholes all over again, and they're going to get burned again."
One reason why bond yields keep falling is lack of supply. Despite nearly two years of heavy borrowing by the federal government and nonfinancial corporations, the total amount of debt outstanding in the U.S. is still nearly $700 billion lower than it was at its peak in the first quarter of 2009, according to Federal Reserve data released on Friday.
Still, few analysts say the bond market is anywhere near as risky as it was several years ago.
"It's more accurate to say that we're still disgorging the last credit bubble than that we're starting a new one," says Harvard economics professor Kenneth Rogoff, who has studied financial crises with Carmen Reinhart of the University of Maryland and notes that new credit bubbles don't typically form immediately in the aftermath of old ones.
While most analysts don't think the bond market is in a bubble, they are seeing a repeat of some behavior from the last run-up. "In 2001-2003, clients were desperate for yield and were willing to invest in stuff you could tell was risky because it promised a higher return," says George Feiger, CEO of Contango Capital Advisors. "You see the same pressure today."
Some have watered down covenants, which are supposed to protect investors if a company is sold and prevent companies from loading on too much other debt or paying out their cash, which would cause a drop in value of the bonds or make it less likely the bonds they hold would get paid off.
Fifty-seven percent of junk-bond issuers had less-stringent covenants than their previous junk deals, according to an analysis for The Wall Street Journal by Covenant Review which analyzed 58 junk bonds issued in 2010 by companies that previously had issued debt. Just one deal had stronger covenants for investors. Some 41% of the deals had the same covenants.
A decline in investor rights was a marker of a rising bubble in the years leading up to the market collapse of 2008. Just like then, investors are scrambling to invest in deals, some of which are completed in a day in what are called on Wall Street "drive-by" offerings.
"It reflects a weakening in covenant protections even below those existing at the peak of the market, in 2006 and 2007," Alexander Dill said in a May report from Moody's.
When Tenet Healthcare Corp. sold $600 million in junk bonds in August, investors had fewer protections than they had in previous Tenet bonds. The bond deal from the Dallas hospital operator and health-care company lacked an asset-sale covenant, which would have forced the company to use proceeds from the sale of a material asset to buy another asset, make capital expenditures or repay bond investors.
Those covenants also prevent companies from using cash from asset sales to pay salaries. The recent Tenet deal also lacks a restricted payment covenant, which blocks dividend payouts.
In an email statement, Tenet spokesman Rick Black says the recent debt sale was a private placement to sophisticated investors who understand credit markets and are "extremely well-informed about prevailing market terms" including covenants.
He added: "'The market' dictates the terms, condition and pricing of debt offerings."
Two junk bonds issued by Chesapeake Energy Corp., an Oklahoma City company that is the second-largest U.S. natural-gas producer, illustrate how new bonds are being sold. In an August sale, Chesapeake sold $2 billion worth of junk bonds maturing in eight and 10 years. Chesapeake is using the bond sales to pay down existing debt and for general corporate use, the company said in an August news release.
According to Covenant Review, neither bond offers a "change-of-control" covenant. When that protection is included and a company is sold, bondholders can sell back their bonds at 101% of par value. In an Aug. 9 report to clients, Covenant Review said Chesapeake "is yet another issuer trying to take advantage of a hot market by quickly passing off a materially worse covenant package." Mr. Cohen says that analysis reflects both the lack of a change of control provision and weak covenants that protect how assets can be pledged.
In an interview, Chesapeake Treasurer Jennifer Grigsby says investors didn't want the covenant in the recent sale. "We were advised by our underwriters that we did not need to add a change of control" covenant in the deals "in order to achieve a successful sale of the bonds," says Ms. Grigsby.
Ms. Grigsby acknowledges the sale took place quickly, but notes the offering was three-times oversubscribed and if investors had concerns after having more time to review the bond documents, they would have been selling the bonds. Instead, the bonds now are trading at 104 cents on the dollar. She also says the covenants limit Chesapeake's ability to use its oil and gas properties to secure financing.
A spokesman for lead underwriter Credit Suisse Group said in a statement, "Chesapeake is viewed by investors as a high-quality issuer and has not included a Change of Control put provision in any of the bonds they have offered to U.S. high-yield investors for several years."
Write to Carrick Mollenkamp at carrick.mollenkamp@wsj.com and Mark Gongloff at mark.gongloff@wsj.com
Demand for High-Yield Junk Bonds Boosts Prices; Investor Protections Decline.
By CARRICK MOLLENKAMP and MARK GONGLOFF
Bond markets are growing riskier as investors seeking steady returns bid up prices and ignore some early warning signs similar to those that flashed during the credit bubble.
Last week, prices on high-yield, or junk, bonds hit their highest level since 2007, nearly double their lows of the credit crisis. Nine months into the year, companies have sold $172 billion in junk bonds, already an annual record, according to data provider Dealogic.
To some extent, the bull case for junk bonds is based on a declining rate of corporate defaults lately and a belief that, as long as the economy doesn't relapse into recession, default rates will continue to decline. The financial crisis purged many weak borrowers from the system, and corporate balance sheets are generally stronger today than before the crisis. However, a double-dip recession could hurt another, albeit smaller, wave of borrowers.
The U.S. high-yield default rate fell to 5.1% in August from 13.2% a year ago, Moody's Investors Service reported recently, adding it expected the rate to fall to less than 3% by the end of the year.
Interest rates paid by companies with strong credit ratings have tumbled this year, falling to 1.8 percentage points above the yields on comparable U.S. Treasury bonds, which themselves are among the lowest yields in decades. Companies with weak credit ratings are paying 6.2 percentage points above Treasurys, down from nearly 20 percentage points in 2008, according to Barclays Capital indexes.
Treasurys have already seen their weaknesses exposed after a recent sell-off. Since the start of September, 10-year Treasurys have lost 2.2% and 30-year government bonds are down 6.9%, compared with a 5.6% gain for the Dow Jones Industrial Average.
The demand for bonds has allowed some of the riskiest borrowers to sell bonds with fewer protections for investors. These provisions, or covenants, prevent companies from taking actions that would hurt bondholders and would protect investors if companies are sold.
The bond boom has so far been a positive for the economy, allowing the U.S. government and major corporations to borrow at cheap rates and giving weaker companies financial breathing room until business picks up.
But continued strong demand by investors can have unintended consequences. Cheap, plentiful debt fueled the housing and leveraged-buyout booms, both of which collapsed after buyers who borrowed too much couldn't repay loans.
"Bondholders got burned" buying deals in 2005 through 2007 because indentures, or the contracts that govern the bonds, didn't protect them, said Adam Cohen, founder of Covenant Review LLC, a New York credit research firm. "They said 'never again,' but now in a hot bond market, people are buying into those covenant loopholes all over again, and they're going to get burned again."
One reason why bond yields keep falling is lack of supply. Despite nearly two years of heavy borrowing by the federal government and nonfinancial corporations, the total amount of debt outstanding in the U.S. is still nearly $700 billion lower than it was at its peak in the first quarter of 2009, according to Federal Reserve data released on Friday.
Still, few analysts say the bond market is anywhere near as risky as it was several years ago.
"It's more accurate to say that we're still disgorging the last credit bubble than that we're starting a new one," says Harvard economics professor Kenneth Rogoff, who has studied financial crises with Carmen Reinhart of the University of Maryland and notes that new credit bubbles don't typically form immediately in the aftermath of old ones.
While most analysts don't think the bond market is in a bubble, they are seeing a repeat of some behavior from the last run-up. "In 2001-2003, clients were desperate for yield and were willing to invest in stuff you could tell was risky because it promised a higher return," says George Feiger, CEO of Contango Capital Advisors. "You see the same pressure today."
One of the worrisome developments is occurring in the junk-bond market, where companies are taking advantage of strong demand to sell bonds that have fewer protections for investors than similar bonds sold by the companies in years past.
Some have watered down covenants, which are supposed to protect investors if a company is sold and prevent companies from loading on too much other debt or paying out their cash, which would cause a drop in value of the bonds or make it less likely the bonds they hold would get paid off.
Fifty-seven percent of junk-bond issuers had less-stringent covenants than their previous junk deals, according to an analysis for The Wall Street Journal by Covenant Review which analyzed 58 junk bonds issued in 2010 by companies that previously had issued debt. Just one deal had stronger covenants for investors. Some 41% of the deals had the same covenants.
A decline in investor rights was a marker of a rising bubble in the years leading up to the market collapse of 2008. Just like then, investors are scrambling to invest in deals, some of which are completed in a day in what are called on Wall Street "drive-by" offerings.
"It reflects a weakening in covenant protections even below those existing at the peak of the market, in 2006 and 2007," Alexander Dill said in a May report from Moody's.
When Tenet Healthcare Corp. sold $600 million in junk bonds in August, investors had fewer protections than they had in previous Tenet bonds. The bond deal from the Dallas hospital operator and health-care company lacked an asset-sale covenant, which would have forced the company to use proceeds from the sale of a material asset to buy another asset, make capital expenditures or repay bond investors.
Those covenants also prevent companies from using cash from asset sales to pay salaries. The recent Tenet deal also lacks a restricted payment covenant, which blocks dividend payouts.
In an email statement, Tenet spokesman Rick Black says the recent debt sale was a private placement to sophisticated investors who understand credit markets and are "extremely well-informed about prevailing market terms" including covenants.
He added: "'The market' dictates the terms, condition and pricing of debt offerings."
Two junk bonds issued by Chesapeake Energy Corp., an Oklahoma City company that is the second-largest U.S. natural-gas producer, illustrate how new bonds are being sold. In an August sale, Chesapeake sold $2 billion worth of junk bonds maturing in eight and 10 years. Chesapeake is using the bond sales to pay down existing debt and for general corporate use, the company said in an August news release.
According to Covenant Review, neither bond offers a "change-of-control" covenant. When that protection is included and a company is sold, bondholders can sell back their bonds at 101% of par value. In an Aug. 9 report to clients, Covenant Review said Chesapeake "is yet another issuer trying to take advantage of a hot market by quickly passing off a materially worse covenant package." Mr. Cohen says that analysis reflects both the lack of a change of control provision and weak covenants that protect how assets can be pledged.
In an interview, Chesapeake Treasurer Jennifer Grigsby says investors didn't want the covenant in the recent sale. "We were advised by our underwriters that we did not need to add a change of control" covenant in the deals "in order to achieve a successful sale of the bonds," says Ms. Grigsby.
Ms. Grigsby acknowledges the sale took place quickly, but notes the offering was three-times oversubscribed and if investors had concerns after having more time to review the bond documents, they would have been selling the bonds. Instead, the bonds now are trading at 104 cents on the dollar. She also says the covenants limit Chesapeake's ability to use its oil and gas properties to secure financing.
A spokesman for lead underwriter Credit Suisse Group said in a statement, "Chesapeake is viewed by investors as a high-quality issuer and has not included a Change of Control put provision in any of the bonds they have offered to U.S. high-yield investors for several years."
Write to Carrick Mollenkamp at carrick.mollenkamp@wsj.com and Mark Gongloff at mark.gongloff@wsj.com
Saturday, September 18, 2010
A Risky-Loan Market Is Back in Gear
A Risky-Loan Market Is Back in Gear
Leveraged Debt, Part of the Credit Bubble, Attracts Yield-Hunting Investors; Not as Frothy as '07.
By MARK GONGLOFF
One of the markets at the heart of the credit bubble has surged back with surprising speed as investors chasing yield are increasingly willing to finance riskier companies.
.Poster children of the mid-2000s credit bubble, leveraged loans are set to have their busiest year since 2008, thanks to a rush of money into the market from investors looking for high-yielding alternatives to stocks and junk bonds. It is a boon for speculative-grade companies looking to refinance and for private-equity firms hoping to start a buyout wave.
But just as the market has sprung back from its depths, so too has the relative riskiness of many loans. Investors are letting companies take on more debt relative to their cash flows and use the proceeds for creditor-unfriendly activities like paying dividends to stockholders.
Though the market is nowhere near as frothy as in 2007, some of these loans could suggest investors will make riskier bets to attain higher-yielding assets, despite the economy's wobbles.
"I wouldn't be so surprised by some of these deals in a normal environment, where we were growing steadily or recovering in a fulsome way, but we're not," said Peter Cecchini, chief strategist and head of special situations at BGC Capital.
Through May, the bulk of loan issuance was refinancing old debt. But the balance is beginning to shift, with nearly a quarter of all deals since June being used for leveraged buyouts, such as those of Burger King and Interactive Data Corp., up from just 10% earlier in the year, according to data from Standard & Poor's Leveraged Commentary & Data Group. Merger, acquisition and leveraged-buyout activity makes up 47% of the market, up from 29% earlier this year.
That percentage will likely grow, given the number of deals bankers see in the pipeline. The surge in activity is striking considering the losses investors had in the sector in recent years.
Experience WSJ professional Editors' Deep Dive: Subtle Changes in the Leveraged Loan MarketHIGH YIELD REPORT
Leveraged Finance is Back to Basics
.Investment Dealers Digest
Call Protection for Leveraged Loans
.Bank Loan Report
Loans are Cheap to Default Risk. Access thousands of business sources not available on the free web. Learn More .Meanwhile, a number of companies, such as pharmaceutical maker Warner Chilcott, are tapping the loan market to pay dividends. Fixed-income investors often frown on such activity because the company ends up saddled with more debt, hurting lenders while rewarding stock investors. Warner Chilcott's leverage ratio is still relatively low, and Moody's recently upgraded its debt, citing strong cash flow.
In a sign the market hasn't returned to its old ways, investors recently thwarted CVC Capital Partners' attempt to borrow to pay a dividend, arguing it would have piled the company's debt burden too high.
Debt burdens are rising for many borrowers. One key measure of a company's debt burden is the ratio of debt to earnings before interest, depreciation and amortization, or Ebitda. Known as the "leverage ratio," this offers a rough measure of how easily a borrower can pay debts.
At the peak of the 2007 loan-market frenzy loan issuers carried leverage ratios above eight times Ebitda, said Andy O'Brien, co-head of syndicated and leveraged finance for J.P. Morgan.
.Leverage ratios of firms borrowing today aren't that high, but have risen. Recent deals have had leverage ratios of six times Ebitda or more, up from a low of four in 2009, noted Mr. O'Brien. "The difference in this recovery is the speed with which leverage has returned to the system," Mr. O'Brien said. "What took years to recover in prior cycles is only taking months this time."
For now, investors still have the balance of power. Trading at less than 93 cents on the dollar in the secondary market, up from a low of 63.5 cents in 2008, loans remain cheaper than junk bonds at 99 cents, said S&P. The typical loan can yield up to 5%, depending on its base floating rate—less than a high-yield "junk" bond, but with more protection for investors because loans get paid before bonds in a bankruptcy.
Demand for new loans has been steady, and recent deals have been so hungrily received that they have been able to cut their yields or bolster their size.
"In lots of markets, demand creates supply," says Steve Miller, head of the S&P leveraged-commentary group. "These issuers have all wanted to do loan transactions for a while. The demand is there now, so they're putting deals out there."
Some $319 billion in leveraged loans have been marketed in the U.S. this year, by companies from American International Group to United Health Services, said data firm Dealogic. It was $173 billion this time a year ago. The market is on track to be the busiest since at least 2008.
Loans have returned 6% this year and nearly 43% since the end of 2008, according to S&P.
The market has rebounded with a general resurgence in investor demand for high-yielding debt at time when cash is yielding virtually nothing. Because loans are floating-rate, they can also offer investors protection against rising interest rates.
One group of investors that haven't returned are collateralized loan obligations—debt instruments made up of pools of leveraged loans—that once put the market on steroids. CLO creation has remained all but dead since the onset of the crisis.
Mutual and pension funds have picked up some of the slack. Loan-focused mutual funds have enjoyed steady inflows since the end of 2008, including more than $8 billion this year, according to Lipper FMI, more than doubling their assets under management.
Yield-seeking investors are being compensated fairly well, with loans offering coupons of more than four percentage points over the London interbank offered rate. During the boom, that spread often fell well below three percentage points.
Write to Mark Gongloff at mark.gongloff@wsj.com
Leveraged Debt, Part of the Credit Bubble, Attracts Yield-Hunting Investors; Not as Frothy as '07.
By MARK GONGLOFF
One of the markets at the heart of the credit bubble has surged back with surprising speed as investors chasing yield are increasingly willing to finance riskier companies.
.Poster children of the mid-2000s credit bubble, leveraged loans are set to have their busiest year since 2008, thanks to a rush of money into the market from investors looking for high-yielding alternatives to stocks and junk bonds. It is a boon for speculative-grade companies looking to refinance and for private-equity firms hoping to start a buyout wave.
But just as the market has sprung back from its depths, so too has the relative riskiness of many loans. Investors are letting companies take on more debt relative to their cash flows and use the proceeds for creditor-unfriendly activities like paying dividends to stockholders.
Though the market is nowhere near as frothy as in 2007, some of these loans could suggest investors will make riskier bets to attain higher-yielding assets, despite the economy's wobbles.
"I wouldn't be so surprised by some of these deals in a normal environment, where we were growing steadily or recovering in a fulsome way, but we're not," said Peter Cecchini, chief strategist and head of special situations at BGC Capital.
Through May, the bulk of loan issuance was refinancing old debt. But the balance is beginning to shift, with nearly a quarter of all deals since June being used for leveraged buyouts, such as those of Burger King and Interactive Data Corp., up from just 10% earlier in the year, according to data from Standard & Poor's Leveraged Commentary & Data Group. Merger, acquisition and leveraged-buyout activity makes up 47% of the market, up from 29% earlier this year.
That percentage will likely grow, given the number of deals bankers see in the pipeline. The surge in activity is striking considering the losses investors had in the sector in recent years.
Experience WSJ professional Editors' Deep Dive: Subtle Changes in the Leveraged Loan MarketHIGH YIELD REPORT
Leveraged Finance is Back to Basics
.Investment Dealers Digest
Call Protection for Leveraged Loans
.Bank Loan Report
Loans are Cheap to Default Risk. Access thousands of business sources not available on the free web. Learn More .Meanwhile, a number of companies, such as pharmaceutical maker Warner Chilcott, are tapping the loan market to pay dividends. Fixed-income investors often frown on such activity because the company ends up saddled with more debt, hurting lenders while rewarding stock investors. Warner Chilcott's leverage ratio is still relatively low, and Moody's recently upgraded its debt, citing strong cash flow.
In a sign the market hasn't returned to its old ways, investors recently thwarted CVC Capital Partners' attempt to borrow to pay a dividend, arguing it would have piled the company's debt burden too high.
Debt burdens are rising for many borrowers. One key measure of a company's debt burden is the ratio of debt to earnings before interest, depreciation and amortization, or Ebitda. Known as the "leverage ratio," this offers a rough measure of how easily a borrower can pay debts.
At the peak of the 2007 loan-market frenzy loan issuers carried leverage ratios above eight times Ebitda, said Andy O'Brien, co-head of syndicated and leveraged finance for J.P. Morgan.
.Leverage ratios of firms borrowing today aren't that high, but have risen. Recent deals have had leverage ratios of six times Ebitda or more, up from a low of four in 2009, noted Mr. O'Brien. "The difference in this recovery is the speed with which leverage has returned to the system," Mr. O'Brien said. "What took years to recover in prior cycles is only taking months this time."
For now, investors still have the balance of power. Trading at less than 93 cents on the dollar in the secondary market, up from a low of 63.5 cents in 2008, loans remain cheaper than junk bonds at 99 cents, said S&P. The typical loan can yield up to 5%, depending on its base floating rate—less than a high-yield "junk" bond, but with more protection for investors because loans get paid before bonds in a bankruptcy.
Demand for new loans has been steady, and recent deals have been so hungrily received that they have been able to cut their yields or bolster their size.
"In lots of markets, demand creates supply," says Steve Miller, head of the S&P leveraged-commentary group. "These issuers have all wanted to do loan transactions for a while. The demand is there now, so they're putting deals out there."
Some $319 billion in leveraged loans have been marketed in the U.S. this year, by companies from American International Group to United Health Services, said data firm Dealogic. It was $173 billion this time a year ago. The market is on track to be the busiest since at least 2008.
Loans have returned 6% this year and nearly 43% since the end of 2008, according to S&P.
The market has rebounded with a general resurgence in investor demand for high-yielding debt at time when cash is yielding virtually nothing. Because loans are floating-rate, they can also offer investors protection against rising interest rates.
One group of investors that haven't returned are collateralized loan obligations—debt instruments made up of pools of leveraged loans—that once put the market on steroids. CLO creation has remained all but dead since the onset of the crisis.
Mutual and pension funds have picked up some of the slack. Loan-focused mutual funds have enjoyed steady inflows since the end of 2008, including more than $8 billion this year, according to Lipper FMI, more than doubling their assets under management.
Yield-seeking investors are being compensated fairly well, with loans offering coupons of more than four percentage points over the London interbank offered rate. During the boom, that spread often fell well below three percentage points.
Write to Mark Gongloff at mark.gongloff@wsj.com
United SEC Votes to Propose Pulling Back Drapes on Debt
United SEC Votes to Propose Pulling Back Drapes on Debt
By KARA SCANNELL And MICHAEL RAPOPORT
The Securities and Exchange Commission unanimously voted to propose rules to help investors spot companies that slash their debt before quarterly reports, a practice called "window dressing."
The new disclosure rules will help in more effectively evaluating companies' financial risks, said SEC Chairman Mary Schapiro. She called the information "critical to assessing a company's prospects for the future, and even the likelihood of its survival. This principle was borne out during the recent financial crisis."
The move follows heightened focus on financial window dressing. A report in March by a bankruptcy-court examiner said Lehman Brothers Holdings Inc. used an accounting strategy to remove debt from its balance sheet to make it look healthier than it was.
In a separate series of investigative articles, The Wall Street Journal has detailed how a group of 18 large banks as a group have consistently lowered a key type of debt at the end of each of the past six quarters, reducing it on average by 42% from quarterly peaks. The short-term borrowings—known as repurchase agreements or "repos"—are used to fuel bigger trades by banks. The banks have said they aren't doing anything improper.
All repos and other short-term borrowing would be covered by the new rule, which will almost certainly pass following a 60-day comment period.
Under the proposed rule, all companies would have to disclose not only how much debt they have at the end of the quarter but also average and maximum figures during the quarter. Banks and other financial institutions would have to disclose the maximum on any given day within the quarter and daily averages, while other companies would disclose the maximum month-end level within the quarter and monthly averages.
All repos and other short-term borrowing would be covered by the new rule, which is subject to a 60-day comment period and requires a second vote before becoming final.
Under the proposed rule, all companies would have to disclose not only how much debt they have at the end of the quarter but also average and maximum figures during the quarter. Banks and other financial institutions would have to disclose the maximum on any given day within the quarter, while other companies would disclose the maximum month-end level within the quarter.
Companies also would have to explain the business purpose behind the borrowing, the importance of the borrowing to the company's liquidity and capital, and any meaningful fluctuations between the average and maximum levels compared with the quarter-end level.
Small companies, generally those with market values of less than $75 million, would be exempt from some requirements.
As an example, Ms. Schapiro pointed that out retailers rely on short-term borrowing to finance inventory throughout the year. "If those borrowings are repaid by year-end, the year-end disclosure may not fully inform investors of the importance to the company of this type of borrowing," she said.
Commissioner Luis Aguilar, a Democrat, supported the proposal but said enforcing the rules is essential. "Rules have not been enough to end attempts to dress up the balance sheet. It is essential to accompany principles and rules with tough enforcement," he said.
Separately, the SEC said it also would consider whether to issue guidance about current disclosure requirements related to liquidity and funding levels.
Laura Corsell, a partner at Philadelphia law firm Montgomery McCracken and a former SEC staff attorney, said the need for new disclosure rules targeting window dressing is a reflection of how "things move very fast in the markets that we're in now."
Write to Kara Scannell at kara.scannell@wsj.com and Michael Rapoport at Michael.Rapoport@dowjones.com
By KARA SCANNELL And MICHAEL RAPOPORT
The Securities and Exchange Commission unanimously voted to propose rules to help investors spot companies that slash their debt before quarterly reports, a practice called "window dressing."
The new disclosure rules will help in more effectively evaluating companies' financial risks, said SEC Chairman Mary Schapiro. She called the information "critical to assessing a company's prospects for the future, and even the likelihood of its survival. This principle was borne out during the recent financial crisis."
The move follows heightened focus on financial window dressing. A report in March by a bankruptcy-court examiner said Lehman Brothers Holdings Inc. used an accounting strategy to remove debt from its balance sheet to make it look healthier than it was.
In a separate series of investigative articles, The Wall Street Journal has detailed how a group of 18 large banks as a group have consistently lowered a key type of debt at the end of each of the past six quarters, reducing it on average by 42% from quarterly peaks. The short-term borrowings—known as repurchase agreements or "repos"—are used to fuel bigger trades by banks. The banks have said they aren't doing anything improper.
All repos and other short-term borrowing would be covered by the new rule, which will almost certainly pass following a 60-day comment period.
Under the proposed rule, all companies would have to disclose not only how much debt they have at the end of the quarter but also average and maximum figures during the quarter. Banks and other financial institutions would have to disclose the maximum on any given day within the quarter and daily averages, while other companies would disclose the maximum month-end level within the quarter and monthly averages.
All repos and other short-term borrowing would be covered by the new rule, which is subject to a 60-day comment period and requires a second vote before becoming final.
Under the proposed rule, all companies would have to disclose not only how much debt they have at the end of the quarter but also average and maximum figures during the quarter. Banks and other financial institutions would have to disclose the maximum on any given day within the quarter, while other companies would disclose the maximum month-end level within the quarter.
Companies also would have to explain the business purpose behind the borrowing, the importance of the borrowing to the company's liquidity and capital, and any meaningful fluctuations between the average and maximum levels compared with the quarter-end level.
Small companies, generally those with market values of less than $75 million, would be exempt from some requirements.
As an example, Ms. Schapiro pointed that out retailers rely on short-term borrowing to finance inventory throughout the year. "If those borrowings are repaid by year-end, the year-end disclosure may not fully inform investors of the importance to the company of this type of borrowing," she said.
Commissioner Luis Aguilar, a Democrat, supported the proposal but said enforcing the rules is essential. "Rules have not been enough to end attempts to dress up the balance sheet. It is essential to accompany principles and rules with tough enforcement," he said.
Separately, the SEC said it also would consider whether to issue guidance about current disclosure requirements related to liquidity and funding levels.
Laura Corsell, a partner at Philadelphia law firm Montgomery McCracken and a former SEC staff attorney, said the need for new disclosure rules targeting window dressing is a reflection of how "things move very fast in the markets that we're in now."
Write to Kara Scannell at kara.scannell@wsj.com and Michael Rapoport at Michael.Rapoport@dowjones.com
Japan Weighs More Risk in Pension
By MARIKO SANCHANTA And MEGUMI FUJIKAWA
TOKYO—Japan's public pension fund, the largest in the world with assets totaling 123 trillion yen ($1.433 trillion), is weighing the idea of investing in emerging-market economies in order to gain higher returns as it faces a wave of payout obligations over the next four to five years, the fund president said in an interview.
The Government Pension Investment Fund, which has roughly 67.5% of its assets tied up in low-yielding domestic bonds, is selling a record four trillion yen of assets by the end of March 2011 to free up funds for payouts to Japan's aging population. By the year 2055, 40% of all Japanese are expected to be over 65.
Some U.S. public pension funds face similar issues. Burned by the financial crisis, some are rethinking their commitments to assets that tie up cash, such as real estate, while others are on the hunt for higher returns to make up lost ground and support swelling obligations to their pensioners.
Japan's situation has its own distinguishing factors. Japan now has a record proportion of older people, with 21% over 65 years old, according to the Ministry of Internal Affairs and Communications. Within Japan, debate has been brewing over how the pension fund, also known by the acronym GPIF, allocates its assets in the near term, given the shrinking number of workers who pay pension contributions.
In addition to the roughly 67.5% of the fund's assets in domestic bonds, including government and corporate bonds, 12% are in Japanese stocks, 10.8% in overseas shares, and 8.3% in foreign bonds.
Takahiro Mitani, president of the pension fund, said in an interview the fund could face a few years in which its payouts exceed its incoming contributions.
We "may face difficulty in the next four to five years…we currently have a hard time catching up with payouts since wages have been on a downtrend recently," he said.
Mr. Mitani said the fund won't sell just domestic bonds. "It could be [Japanese] stocks or foreign-currency-denominated securities or stocks," depending on market conditions, he said.
Some have been urging the pension fund to invest in higher-risk, higher-return assets, or prodding it to consider setting up a Singapore-style sovereign-wealth fund. The yield on the 10-year Japanese government bond is 1.075%.
"They need to take on more risk," said John Vail, chief global strategist at Nikko Asset Management. "Global equities are a wise investment for the GPIF, especially with equities being so inexpensive."
Mr. Mitani said his mandate is to invest in "safe" assets with a long-term view.
"In 2008 after the collapse of Lehman, while we posted a negative result we were relatively better than overseas pension funds thanks to our conservative, cautious stance. We posted only a single-digit loss, while others posted a double-digit loss," he said.
The California Public Employees' Retirement System, known as Calpers and the largest in the U.S. with assets of about $200 billion, reported a 23% slump in the year ended June 30, 2009. Some of the biggest hits were from alternative investments like real estate, an investment area Calpers has been retooling. In comparison, the GPIF reported a 7.6% slump in the fiscal year ended March 31 2009.
In terms of possibly investing in emerging markets, Mr. Mitani said it is unlikely the GPIF would focus on one country, such as China.
"One of our basic investment philosophies is to have diversity in our investment. So, it's hard to imagine for us to invest in a China-exclusive fund, for instance…we would diversify our investment to a certain degree when investing in emerging markets," he said.
In the U.S., New Jersey officials are contemplating upping the pension plan's "alternative investments," which include typically less-liquid investments such as real estate and hedge funds. The state's investment council this week recommended that the fund should be allowed to increase its alternative-investment allocations to as high as 38% from the maximum of 28% of its total investments.
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Bloomberg News
Takahiro Mitani said the fund could face a few years in which its payouts exceed its incoming contributions.
JPENSION_JUMP
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"In a world in which public-market equity returns have been relatively unexciting, but much more volatile, and in which bond yields are low single digits, it makes sense to at least consider assets which can improve returns on a risk-adjusted basis," said Robert Grady, the council's newly elected chairman and a managing director at Cheyenne Capital Fund, a private-equity firm.
A spokesman for the state Treasury Department said it would take several months before any changes can be enacted.
Mr. Mitani, of the Japan pension fund, expects the 10-year Japanese government-bond yield to stay mostly below 1.5% for the next two to three years, although it may break above that point temporarily. Others are less convinced. Some hedge-fund investors, such as Kyle Bass of Hayman Advisors LP, argue that the shift by the Japanese pension fund to sell Japanese government bonds, even as Japan competes with governments around the world to attract investors to its bonds, will push Japanese government-bond prices lower, sending yields much higher.
For his part, Mr. Mitani said he isn't too concerned about the risk that government-bond prices will plunge due to fears about increasing supply.
"If financial firms keep receiving ample funds from [the Bank of Japan], if companies remain reluctant to borrow, and if individuals keep savings at banks, there's no choice but to purchase government bonds," Mr. Mitani said.
—Michael Corkery and Gregory Zuckerman contributed to this article.
Write to Mariko Sanchanta at mariko.sanchanta@wsj.com and Megumi Fujikawa at megumi.fujikawa@dowjones.net
TOKYO—Japan's public pension fund, the largest in the world with assets totaling 123 trillion yen ($1.433 trillion), is weighing the idea of investing in emerging-market economies in order to gain higher returns as it faces a wave of payout obligations over the next four to five years, the fund president said in an interview.
The Government Pension Investment Fund, which has roughly 67.5% of its assets tied up in low-yielding domestic bonds, is selling a record four trillion yen of assets by the end of March 2011 to free up funds for payouts to Japan's aging population. By the year 2055, 40% of all Japanese are expected to be over 65.
Some U.S. public pension funds face similar issues. Burned by the financial crisis, some are rethinking their commitments to assets that tie up cash, such as real estate, while others are on the hunt for higher returns to make up lost ground and support swelling obligations to their pensioners.
Japan's situation has its own distinguishing factors. Japan now has a record proportion of older people, with 21% over 65 years old, according to the Ministry of Internal Affairs and Communications. Within Japan, debate has been brewing over how the pension fund, also known by the acronym GPIF, allocates its assets in the near term, given the shrinking number of workers who pay pension contributions.
In addition to the roughly 67.5% of the fund's assets in domestic bonds, including government and corporate bonds, 12% are in Japanese stocks, 10.8% in overseas shares, and 8.3% in foreign bonds.
Takahiro Mitani, president of the pension fund, said in an interview the fund could face a few years in which its payouts exceed its incoming contributions.
We "may face difficulty in the next four to five years…we currently have a hard time catching up with payouts since wages have been on a downtrend recently," he said.
Mr. Mitani said the fund won't sell just domestic bonds. "It could be [Japanese] stocks or foreign-currency-denominated securities or stocks," depending on market conditions, he said.
Some have been urging the pension fund to invest in higher-risk, higher-return assets, or prodding it to consider setting up a Singapore-style sovereign-wealth fund. The yield on the 10-year Japanese government bond is 1.075%.
"They need to take on more risk," said John Vail, chief global strategist at Nikko Asset Management. "Global equities are a wise investment for the GPIF, especially with equities being so inexpensive."
Mr. Mitani said his mandate is to invest in "safe" assets with a long-term view.
"In 2008 after the collapse of Lehman, while we posted a negative result we were relatively better than overseas pension funds thanks to our conservative, cautious stance. We posted only a single-digit loss, while others posted a double-digit loss," he said.
The California Public Employees' Retirement System, known as Calpers and the largest in the U.S. with assets of about $200 billion, reported a 23% slump in the year ended June 30, 2009. Some of the biggest hits were from alternative investments like real estate, an investment area Calpers has been retooling. In comparison, the GPIF reported a 7.6% slump in the fiscal year ended March 31 2009.
In terms of possibly investing in emerging markets, Mr. Mitani said it is unlikely the GPIF would focus on one country, such as China.
"One of our basic investment philosophies is to have diversity in our investment. So, it's hard to imagine for us to invest in a China-exclusive fund, for instance…we would diversify our investment to a certain degree when investing in emerging markets," he said.
In the U.S., New Jersey officials are contemplating upping the pension plan's "alternative investments," which include typically less-liquid investments such as real estate and hedge funds. The state's investment council this week recommended that the fund should be allowed to increase its alternative-investment allocations to as high as 38% from the maximum of 28% of its total investments.
View Full Image
JPENSION_JUMP
Bloomberg News
Takahiro Mitani said the fund could face a few years in which its payouts exceed its incoming contributions.
JPENSION_JUMP
JPENSION_JUMP
"In a world in which public-market equity returns have been relatively unexciting, but much more volatile, and in which bond yields are low single digits, it makes sense to at least consider assets which can improve returns on a risk-adjusted basis," said Robert Grady, the council's newly elected chairman and a managing director at Cheyenne Capital Fund, a private-equity firm.
A spokesman for the state Treasury Department said it would take several months before any changes can be enacted.
Mr. Mitani, of the Japan pension fund, expects the 10-year Japanese government-bond yield to stay mostly below 1.5% for the next two to three years, although it may break above that point temporarily. Others are less convinced. Some hedge-fund investors, such as Kyle Bass of Hayman Advisors LP, argue that the shift by the Japanese pension fund to sell Japanese government bonds, even as Japan competes with governments around the world to attract investors to its bonds, will push Japanese government-bond prices lower, sending yields much higher.
For his part, Mr. Mitani said he isn't too concerned about the risk that government-bond prices will plunge due to fears about increasing supply.
"If financial firms keep receiving ample funds from [the Bank of Japan], if companies remain reluctant to borrow, and if individuals keep savings at banks, there's no choice but to purchase government bonds," Mr. Mitani said.
—Michael Corkery and Gregory Zuckerman contributed to this article.
Write to Mariko Sanchanta at mariko.sanchanta@wsj.com and Megumi Fujikawa at megumi.fujikawa@dowjones.net
Wednesday, September 15, 2010
Pimco Makes $8.1 Billion Bet Against ‘Lost Decade’ of Deflation
Pimco Makes $8.1 Billion Bet Against ‘Lost Decade’ of Deflation
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By Miles Weiss
Sept. 15 (Bloomberg) -- Bill Gross’s Pacific Investment Management Co. made an $8.1 billion wager that the U.S. won’t suffer a decade of deflation like the one that crippled Japan starting in the 1990s.
That’s the notional value of long-term derivative contracts tied to the U.S. consumer price index that Pimco’s mutual funds entered into during the first half of this year, according to a regulatory filing. The funds received $70.5 million in up-front premiums under these contracts, known as inflation floors, in return for agreeing to pay investors should prices decline in the 10 years ending in 2020.
“We think the possibility that the U.S. goes 10 years with stagnant or falling prices is remote,” Mihir Worah, the head of Pimco’s real return portfolio management team, said in an e- mailed response to questions. “The options were priced at rich levels to the underlying” risk, added Worah, whose funds invest in Treasury inflation protected securities.
The cost of protecting against deflation has doubled since January as signs of an economic slowdown in the U.S. prompted investors including Canadian insurer Fairfax Financial Holdings Ltd. to buy the derivatives. James Bullard, president of the Federal Reserve Bank of St. Louis, said the U.S. could suffer the same type of economic malaise as Japan. Pimco Chief Executive Officer Mohamed El-Erian said last month the chance of deflation in the U.S. is around 25 percent.
‘New Normal’
El-Erian has been among the most outspoken proponents of a theory forecasting years of below-average economic growth, elevated unemployment and a decreasing dominance of the U.S. in the global economy. While falling prices are not his main scenario in that outlook, named “new normal,” El-Erian has argued that increased fear of deflation may have been one reason for recent sell-offs in financial markets such as the 2.8 percent decline in the Standard & Poor’s 500 on Aug. 11.
Pimco disclosed in a June filing that its funds began writing 10-year inflation floors during March and reported last month that they issued additional contracts in April. According to the Aug. 27 filing with the U.S. Securities and Exchange Commission, 25 Pimco funds entered into these inflation floors during this year’s first half, with Gross’s $247.9 billion Pimco Total Return fund accounting for $6.57 billion of the $8.1 billion total.
Premiums from the contracts help boost fund income as yields on government bonds are near record lows. Potential losses are limited because the fixed-income securities that account for a majority of the $1.1 trillion the Newport Beach, California, firm oversees would probably gain in value if consumer prices had a protracted decline.
‘High-Severity Outcome’
“Falling or lower inflation than we have today on a steady basis is the bond market’s greatest friend,” said David Ader, the head of government bond strategy at CRT Capital Group LLC, a Stamford, Connecticut, broker-dealer. “First and foremost, it would make government debt very valuable, because you know they will pay you back.”
Inflation floors, structured as options on the consumer price index for all urban consumers, are similar to insurance. The buyer of the contract pays a premium at the outset in return for the right to receive a payment after 10 years should the CPI decline during this period, according to D’Arcy Miell, global head of inflation products at BGC Partners LP, a New York-based inter-dealer broker.
The size of the payment would be calculated by multiplying the cumulative percentage decline in the consumer price index with the face value or ‘notional’ amount of the contracts, said Mark Greenwood, head of inflation options in the London office of Royal Bank of Scotland Group Plc.
Pimco’s Wager
In Pimco’s case, a cumulative 10 percent decline in the price index over 10 years would require the funds to pay out a total of about $810 million, based on that formula. The funds would pay nothing to the counterparties and keep the premiums if prices in 2020 are equal to or higher than in December 2009 or January 2010, depending on the contracts.
“This is obviously a very low-frequency, high-severity event,” Greenwood said. “Investors fear deflation, but most ascribe a low probability to it.”
Worah said Pimco’s inflation floors are “analogous” to the $36 billion of equity index put options that Warren Buffett’s Berkshire Hathaway Inc. has on major stock market indexes, including the S&P 500. Berkshire received $4.9 billion in derivative premiums in return for agreeing to make payments to the counterparties, starting in 2018, if the stock indexes are lower than when the contracts were signed.
Deflation Fear
With U.S. unemployment stuck near 10 percent and consumer prices rising just 1.2 percent for the 12 months ended in July, investors have been seeking financial products that would protect their holdings from deflation. Canadian insurer Fairfax Financial Holdings said in July that it bought 10-year contracts tied to consumer price indexes with a face value of $21.5 billion in this year’s first half.
The price of 10-year inflation floors has risen to 146 basis points, or 1.46 percent of the face value of each contract, from an average of 78 basis points in March and as little as 42 basis points in October, according to data compiled by Bloomberg.
Pimco on average received about 87 basis points, according to the premiums reported in its filing. Premiums on 10-year inflation floors equaled about 108 basis points at June 30.
“We have seen tremendous growth since the end of last year, less so in inflation caps and more so in floors,” said Allan Levin, head of structured rates for North America at Deutsche Bank Securities Inc. in New York. “It reflects an increasing fear of deflation.”
‘Lost Decade’
As recently as April, Pimco’s Worah wrote that inflation, not deflation, was the primary long-term concern in the U.S., given that the federal government could choose to address widening budget deficits by devaluing the dollar. Scott Mather, Pimco’s head of global portfolio management, wrote in August that the odds had increased of the U.S. suffering a Japanese- style “lost decade.”
“If you have inflation going down toward zero, you enter a new regime where expectations can become a self-fulfilling prophecy,” Mather said in an interview. “That is what we saw in Japan as well,” he said, referring to an era of declining real estate and equity prices that began in the early 1990s.
While the derivative contracts suggest that deflation fears have increased, the risk of deflation in the U.S. is lower than it was in Japan because the two countries have different currency policies, said Donald Ratajczak, an economic consultant and former director of the Economic Forecasting Center at Georgia State University.
‘Bad Bet’
Japanese deflation stems from government policies to maintain the value of the yen that depleted the money supply there, said Ratajczak, who won acclaim from the Boston Federal Reserve Bank for his inflation forecast in the 1990s.
“We don’t care as much about our dollar,” said Ratajczak. “People who are betting on ten years of deflation are making a bad bet.”
Wall Street dealers write derivative contracts for clients that want to bet on or protect their holdings from changes in interest rates, commodities, stock prices and other financial markets. The dealers can then keep the contracts, sell some of them to other Wall Street firms through the inter-dealer market, or find counterparties such as Pimco that will take the other side of the trade.
The value of inflation floors traded between dealers doubled to $3 billion in the first half of this year, from $1.5 billion for all of 2009, according to Miell at BGC Partners. That’s a fraction of the $21.5 billion Fairfax Financial bought.
Buffett’s Model
Fairfax, based in Toronto, sells insurance and invests the premiums it receives in out-of-favor securities, similar to Buffett’s investment model. Equities are more at risk from deflation than fixed income securities such as the Treasury bonds Pimco holds in its funds, and which gain in value as interest rates decline.
Given the size of the inflation floors bought by Fairfax Financial, Pimco may have taken the other side on some of them, said Greenwood.
Paul Rivett, Fairfax Financial’s chief legal officer, declined to comment on the counterparties to the contracts.
“We are very concerned about deflation and have put this trade on to hedge some of what we see as a not insignificant risk,” Rivett said in an e-mail. “Unfortunately, we have not publicly disclosed the inner mechanics of the trade.”
To contact the reporter on this story: Miles Weiss in Washington at mweiss@bloomberg.net
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By Miles Weiss
Sept. 15 (Bloomberg) -- Bill Gross’s Pacific Investment Management Co. made an $8.1 billion wager that the U.S. won’t suffer a decade of deflation like the one that crippled Japan starting in the 1990s.
That’s the notional value of long-term derivative contracts tied to the U.S. consumer price index that Pimco’s mutual funds entered into during the first half of this year, according to a regulatory filing. The funds received $70.5 million in up-front premiums under these contracts, known as inflation floors, in return for agreeing to pay investors should prices decline in the 10 years ending in 2020.
“We think the possibility that the U.S. goes 10 years with stagnant or falling prices is remote,” Mihir Worah, the head of Pimco’s real return portfolio management team, said in an e- mailed response to questions. “The options were priced at rich levels to the underlying” risk, added Worah, whose funds invest in Treasury inflation protected securities.
The cost of protecting against deflation has doubled since January as signs of an economic slowdown in the U.S. prompted investors including Canadian insurer Fairfax Financial Holdings Ltd. to buy the derivatives. James Bullard, president of the Federal Reserve Bank of St. Louis, said the U.S. could suffer the same type of economic malaise as Japan. Pimco Chief Executive Officer Mohamed El-Erian said last month the chance of deflation in the U.S. is around 25 percent.
‘New Normal’
El-Erian has been among the most outspoken proponents of a theory forecasting years of below-average economic growth, elevated unemployment and a decreasing dominance of the U.S. in the global economy. While falling prices are not his main scenario in that outlook, named “new normal,” El-Erian has argued that increased fear of deflation may have been one reason for recent sell-offs in financial markets such as the 2.8 percent decline in the Standard & Poor’s 500 on Aug. 11.
Pimco disclosed in a June filing that its funds began writing 10-year inflation floors during March and reported last month that they issued additional contracts in April. According to the Aug. 27 filing with the U.S. Securities and Exchange Commission, 25 Pimco funds entered into these inflation floors during this year’s first half, with Gross’s $247.9 billion Pimco Total Return fund accounting for $6.57 billion of the $8.1 billion total.
Premiums from the contracts help boost fund income as yields on government bonds are near record lows. Potential losses are limited because the fixed-income securities that account for a majority of the $1.1 trillion the Newport Beach, California, firm oversees would probably gain in value if consumer prices had a protracted decline.
‘High-Severity Outcome’
“Falling or lower inflation than we have today on a steady basis is the bond market’s greatest friend,” said David Ader, the head of government bond strategy at CRT Capital Group LLC, a Stamford, Connecticut, broker-dealer. “First and foremost, it would make government debt very valuable, because you know they will pay you back.”
Inflation floors, structured as options on the consumer price index for all urban consumers, are similar to insurance. The buyer of the contract pays a premium at the outset in return for the right to receive a payment after 10 years should the CPI decline during this period, according to D’Arcy Miell, global head of inflation products at BGC Partners LP, a New York-based inter-dealer broker.
The size of the payment would be calculated by multiplying the cumulative percentage decline in the consumer price index with the face value or ‘notional’ amount of the contracts, said Mark Greenwood, head of inflation options in the London office of Royal Bank of Scotland Group Plc.
Pimco’s Wager
In Pimco’s case, a cumulative 10 percent decline in the price index over 10 years would require the funds to pay out a total of about $810 million, based on that formula. The funds would pay nothing to the counterparties and keep the premiums if prices in 2020 are equal to or higher than in December 2009 or January 2010, depending on the contracts.
“This is obviously a very low-frequency, high-severity event,” Greenwood said. “Investors fear deflation, but most ascribe a low probability to it.”
Worah said Pimco’s inflation floors are “analogous” to the $36 billion of equity index put options that Warren Buffett’s Berkshire Hathaway Inc. has on major stock market indexes, including the S&P 500. Berkshire received $4.9 billion in derivative premiums in return for agreeing to make payments to the counterparties, starting in 2018, if the stock indexes are lower than when the contracts were signed.
Deflation Fear
With U.S. unemployment stuck near 10 percent and consumer prices rising just 1.2 percent for the 12 months ended in July, investors have been seeking financial products that would protect their holdings from deflation. Canadian insurer Fairfax Financial Holdings said in July that it bought 10-year contracts tied to consumer price indexes with a face value of $21.5 billion in this year’s first half.
The price of 10-year inflation floors has risen to 146 basis points, or 1.46 percent of the face value of each contract, from an average of 78 basis points in March and as little as 42 basis points in October, according to data compiled by Bloomberg.
Pimco on average received about 87 basis points, according to the premiums reported in its filing. Premiums on 10-year inflation floors equaled about 108 basis points at June 30.
“We have seen tremendous growth since the end of last year, less so in inflation caps and more so in floors,” said Allan Levin, head of structured rates for North America at Deutsche Bank Securities Inc. in New York. “It reflects an increasing fear of deflation.”
‘Lost Decade’
As recently as April, Pimco’s Worah wrote that inflation, not deflation, was the primary long-term concern in the U.S., given that the federal government could choose to address widening budget deficits by devaluing the dollar. Scott Mather, Pimco’s head of global portfolio management, wrote in August that the odds had increased of the U.S. suffering a Japanese- style “lost decade.”
“If you have inflation going down toward zero, you enter a new regime where expectations can become a self-fulfilling prophecy,” Mather said in an interview. “That is what we saw in Japan as well,” he said, referring to an era of declining real estate and equity prices that began in the early 1990s.
While the derivative contracts suggest that deflation fears have increased, the risk of deflation in the U.S. is lower than it was in Japan because the two countries have different currency policies, said Donald Ratajczak, an economic consultant and former director of the Economic Forecasting Center at Georgia State University.
‘Bad Bet’
Japanese deflation stems from government policies to maintain the value of the yen that depleted the money supply there, said Ratajczak, who won acclaim from the Boston Federal Reserve Bank for his inflation forecast in the 1990s.
“We don’t care as much about our dollar,” said Ratajczak. “People who are betting on ten years of deflation are making a bad bet.”
Wall Street dealers write derivative contracts for clients that want to bet on or protect their holdings from changes in interest rates, commodities, stock prices and other financial markets. The dealers can then keep the contracts, sell some of them to other Wall Street firms through the inter-dealer market, or find counterparties such as Pimco that will take the other side of the trade.
The value of inflation floors traded between dealers doubled to $3 billion in the first half of this year, from $1.5 billion for all of 2009, according to Miell at BGC Partners. That’s a fraction of the $21.5 billion Fairfax Financial bought.
Buffett’s Model
Fairfax, based in Toronto, sells insurance and invests the premiums it receives in out-of-favor securities, similar to Buffett’s investment model. Equities are more at risk from deflation than fixed income securities such as the Treasury bonds Pimco holds in its funds, and which gain in value as interest rates decline.
Given the size of the inflation floors bought by Fairfax Financial, Pimco may have taken the other side on some of them, said Greenwood.
Paul Rivett, Fairfax Financial’s chief legal officer, declined to comment on the counterparties to the contracts.
“We are very concerned about deflation and have put this trade on to hedge some of what we see as a not insignificant risk,” Rivett said in an e-mail. “Unfortunately, we have not publicly disclosed the inner mechanics of the trade.”
To contact the reporter on this story: Miles Weiss in Washington at mweiss@bloomberg.net
Japan Sells Yen First Time Since 2004 to Aid Growth (Update2)
Japan Sells Yen First Time Since 2004 to Aid Growth (Update2)
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By Toru Fujioka and Aki Ito
Sept. 15 (Bloomberg) -- Japan intervened in the foreign- exchange market for the first time since 2004 after a surge in the yen to the strongest against the dollar in 15 years threatened to stunt the nation’s economic recovery.
Finance Minister Yoshihiko Noda told reporters in Tokyo the yen sales were unilateral. Chief Cabinet Secretary Yoshito Sengoku said the ministry “seems to think” 82 yen per dollar to be the line of defense, after it reached 82.88 earlier today. Government officials speaking on condition of anonymity have previously said volatility was a bigger concern than the level. One official said Japan is prepared to keep selling the yen in U.S. trading after earlier operations in Europe and Japan.
Prime Minister Naoto Kan was under pressure from business leaders to stop the yen’s gains from undermining the exports propelling Japan’s growth. It may do little for the economy because Japan alone won’t be able to keep the yen from rising, said analyst Tohru Sasaki.
“In the medium-term it can’t change the overall direction” of the currency, said Sasaki, head of Japan rates and foreign-exchange research in Tokyo at JPMorgan Chase & Co., who yesterday said he perceived a bigger chance for intervention after Kan’s reelection as head of Japan’s ruling party.
The yen tumbled past 85 per dollar for the first time in almost two weeks, trading at 85.24 at 12:37 p.m. in London. The currency had risen more than 11 percent from mid-May through yesterday. Against the euro, the yen fell 2.5 percent to 110.61. The benchmark Nikkei 225 Stock Average jumped 2.3 percent to 9,516.56.
Watching Closely
The yen reached a level against the dollar “we couldn’t ignore,” Kan told reporters in Tokyo, adding that he will continue to watch the currency closely.
Japan’s currency has rallied amid concern about the durability of the U.S. recovery and the effect of Europe’s debt woes. The yen typically gains when investors avoid risk because of the country’s current-account surplus and deflation.
Authorities decided to intervene today because the yen’s climb yesterday and overnight was due to traders’ views that Kan wouldn’t take such a step, said Junko Nishioka, chief economist at RBS Securities Japan Ltd. in Tokyo. Kan’s opponent to head the Democratic Party of Japan, former DPJ chief Ichiro Ozawa, had specifically called for yen sales.
‘Bold’ Pledge
It was incorrect for observers to judge that chances for intervention receded with Kan’s reelection, a government official told reporters on condition of anonymity. The official also said today’s yen sales were very large, without specifying a total, and traders were probably thinking intervention would come at 80 per dollar, so the step came as a surprise.
“Investors were starting to doubt the government’s commitment to its pledge that it would take bold action,” said Yoshimasa Maruyama, a senior economist at Itochu Corp. in Tokyo. Kan and Noda in recent weeks repeatedly said that Japan was ready to take “bold” measures to stem the currency.
The Japanese government official said European and U.S. officials were informed of the move in an effort to avoid a negative reaction. It took a while to convince Europe because authorities there didn’t like the idea, the person said.
U.S. Treasury spokeswoman Natalie Wyeth declined to comment on Japan’s announcement when reached by telephone. China’s central bank declined to comment, as did spokespeople for the Canadian finance ministry and central bank, U.K. Treasury and European Central Bank.
BOJ Liquidity
Japan’s central bank sought to strengthen the impact of the action by leaving the extra yen in the financial system. The BOJ historically would mop up the extra funds by selling domestic securities.
“The BOJ will provide abundant liquidity to the financial market by utilizing the funds injected by intervention,” Bank of Japan board member Tadao Noda said at a press conference in Shimonoseki, western Japan today. The finance ministry makes the decision on currency interventions, with the central bank carrying out the operation.
Until now, the government has pressed the Bank of Japan to step up liquidity injections to help address the gains in the yen. The central bank last month increased a credit program by 10 trillion yen ($119 billion) after an emergency meeting. The step had little impact on the currency.
Top business executives have been calling for government action to stem the yen’s rise.
Coordination Need
“We want verbal or actual intervention if the yen appreciates more than the current level,” Hiromasa Yonekura, head of Japan’s Keidanren business lobby, said at a Sept. 13 press conference. “Rapid change should be managed,” Hiroaki Nakanishi, president of Hitachi Ltd., said this week in Tokyo.
Some analysts have said that official action by Japan might not weaken the yen for long unless it’s conducted together with overseas authorities. Kan said last week in a debate with Ozawa that getting international cooperation to halt the yen’s rise is “difficult.”
It’s “pretty unlikely” officials will be able to return the yen to the level “that companies are basing their profit forecasts” on, Nishioka at RBS Securities said. Firms said they remain profitable as long as the yen trades at 92.90 per dollar or weaker, according to the Cabinet Office’s annual report released in February.
U.S. Hearing
For China, Japan’s decision is a “favorable development,” because it adds another country to the list of those intervening, said Tomo Kinoshita, co-head of Asia Economic Research at Nomura Holdings Inc. in Hong Kong. China has limited gains of its own currency to less than 2 percent since ending a two-year peg to the dollar in June.
U.S. lawmakers have criticized China’s currency policy for providing a subsidy to the nation’s exporters. The House Ways and Means Committee is scheduled to hold a hearing on the subject today in Washington.
Japan hadn’t intervened to sell yen in the foreign-exchange market since 2004, when the yen was around 109 per dollar. The Bank of Japan, acting on behest of the Ministry of Finance, sold 14.8 trillion yen in the first three months of 2004, after record sales of 20.4 trillion yen in 2003.
“We can’t overlook these movements that could have a negative effect on the stability of the economy,” Finance Minister Noda said today. “We conducted intervention to contain excessive movements in the currency market. We will continue to watch developments in the market carefully and we will take bold actions including further intervention if necessary.”
Geithner’s Advice
Bank of Japan Governor Masaaki Shirakawa said in a statement that the action should “contribute to a stable foreign exchange-rate formation.”
U.S. Treasury Secretary Timothy F. Geithner declined to comment about the prospects for currency intervention in an interview last week, instead saying that Japanese officials should do what they can to help their economy grow.
“They’re working through some difficult problems,” Geithner said on Bloomberg Television. “My view is they should be focusing like we are on how to make sure they’re reinforcing recovery in Japan and doing things that are going to help.”
Recent Japanese data have pointed to the expansion losing momentum. The government yesterday revised its July industrial output figures to show that production fell rather than increased from a month earlier. Japan’s economy expanded at a 1.5 percent annual rate in the second quarter, less than half the pace of the previous period, and consumer confidence slid to a four-month low in August.
To contact the reporter on this story: Toru Fujioka in Tokyo at tfujioka1@bloomberg.net;
Share Business ExchangeTwitterFacebook| Email | Print | A A A
By Toru Fujioka and Aki Ito
Sept. 15 (Bloomberg) -- Japan intervened in the foreign- exchange market for the first time since 2004 after a surge in the yen to the strongest against the dollar in 15 years threatened to stunt the nation’s economic recovery.
Finance Minister Yoshihiko Noda told reporters in Tokyo the yen sales were unilateral. Chief Cabinet Secretary Yoshito Sengoku said the ministry “seems to think” 82 yen per dollar to be the line of defense, after it reached 82.88 earlier today. Government officials speaking on condition of anonymity have previously said volatility was a bigger concern than the level. One official said Japan is prepared to keep selling the yen in U.S. trading after earlier operations in Europe and Japan.
Prime Minister Naoto Kan was under pressure from business leaders to stop the yen’s gains from undermining the exports propelling Japan’s growth. It may do little for the economy because Japan alone won’t be able to keep the yen from rising, said analyst Tohru Sasaki.
“In the medium-term it can’t change the overall direction” of the currency, said Sasaki, head of Japan rates and foreign-exchange research in Tokyo at JPMorgan Chase & Co., who yesterday said he perceived a bigger chance for intervention after Kan’s reelection as head of Japan’s ruling party.
The yen tumbled past 85 per dollar for the first time in almost two weeks, trading at 85.24 at 12:37 p.m. in London. The currency had risen more than 11 percent from mid-May through yesterday. Against the euro, the yen fell 2.5 percent to 110.61. The benchmark Nikkei 225 Stock Average jumped 2.3 percent to 9,516.56.
Watching Closely
The yen reached a level against the dollar “we couldn’t ignore,” Kan told reporters in Tokyo, adding that he will continue to watch the currency closely.
Japan’s currency has rallied amid concern about the durability of the U.S. recovery and the effect of Europe’s debt woes. The yen typically gains when investors avoid risk because of the country’s current-account surplus and deflation.
Authorities decided to intervene today because the yen’s climb yesterday and overnight was due to traders’ views that Kan wouldn’t take such a step, said Junko Nishioka, chief economist at RBS Securities Japan Ltd. in Tokyo. Kan’s opponent to head the Democratic Party of Japan, former DPJ chief Ichiro Ozawa, had specifically called for yen sales.
‘Bold’ Pledge
It was incorrect for observers to judge that chances for intervention receded with Kan’s reelection, a government official told reporters on condition of anonymity. The official also said today’s yen sales were very large, without specifying a total, and traders were probably thinking intervention would come at 80 per dollar, so the step came as a surprise.
“Investors were starting to doubt the government’s commitment to its pledge that it would take bold action,” said Yoshimasa Maruyama, a senior economist at Itochu Corp. in Tokyo. Kan and Noda in recent weeks repeatedly said that Japan was ready to take “bold” measures to stem the currency.
The Japanese government official said European and U.S. officials were informed of the move in an effort to avoid a negative reaction. It took a while to convince Europe because authorities there didn’t like the idea, the person said.
U.S. Treasury spokeswoman Natalie Wyeth declined to comment on Japan’s announcement when reached by telephone. China’s central bank declined to comment, as did spokespeople for the Canadian finance ministry and central bank, U.K. Treasury and European Central Bank.
BOJ Liquidity
Japan’s central bank sought to strengthen the impact of the action by leaving the extra yen in the financial system. The BOJ historically would mop up the extra funds by selling domestic securities.
“The BOJ will provide abundant liquidity to the financial market by utilizing the funds injected by intervention,” Bank of Japan board member Tadao Noda said at a press conference in Shimonoseki, western Japan today. The finance ministry makes the decision on currency interventions, with the central bank carrying out the operation.
Until now, the government has pressed the Bank of Japan to step up liquidity injections to help address the gains in the yen. The central bank last month increased a credit program by 10 trillion yen ($119 billion) after an emergency meeting. The step had little impact on the currency.
Top business executives have been calling for government action to stem the yen’s rise.
Coordination Need
“We want verbal or actual intervention if the yen appreciates more than the current level,” Hiromasa Yonekura, head of Japan’s Keidanren business lobby, said at a Sept. 13 press conference. “Rapid change should be managed,” Hiroaki Nakanishi, president of Hitachi Ltd., said this week in Tokyo.
Some analysts have said that official action by Japan might not weaken the yen for long unless it’s conducted together with overseas authorities. Kan said last week in a debate with Ozawa that getting international cooperation to halt the yen’s rise is “difficult.”
It’s “pretty unlikely” officials will be able to return the yen to the level “that companies are basing their profit forecasts” on, Nishioka at RBS Securities said. Firms said they remain profitable as long as the yen trades at 92.90 per dollar or weaker, according to the Cabinet Office’s annual report released in February.
U.S. Hearing
For China, Japan’s decision is a “favorable development,” because it adds another country to the list of those intervening, said Tomo Kinoshita, co-head of Asia Economic Research at Nomura Holdings Inc. in Hong Kong. China has limited gains of its own currency to less than 2 percent since ending a two-year peg to the dollar in June.
U.S. lawmakers have criticized China’s currency policy for providing a subsidy to the nation’s exporters. The House Ways and Means Committee is scheduled to hold a hearing on the subject today in Washington.
Japan hadn’t intervened to sell yen in the foreign-exchange market since 2004, when the yen was around 109 per dollar. The Bank of Japan, acting on behest of the Ministry of Finance, sold 14.8 trillion yen in the first three months of 2004, after record sales of 20.4 trillion yen in 2003.
“We can’t overlook these movements that could have a negative effect on the stability of the economy,” Finance Minister Noda said today. “We conducted intervention to contain excessive movements in the currency market. We will continue to watch developments in the market carefully and we will take bold actions including further intervention if necessary.”
Geithner’s Advice
Bank of Japan Governor Masaaki Shirakawa said in a statement that the action should “contribute to a stable foreign exchange-rate formation.”
U.S. Treasury Secretary Timothy F. Geithner declined to comment about the prospects for currency intervention in an interview last week, instead saying that Japanese officials should do what they can to help their economy grow.
“They’re working through some difficult problems,” Geithner said on Bloomberg Television. “My view is they should be focusing like we are on how to make sure they’re reinforcing recovery in Japan and doing things that are going to help.”
Recent Japanese data have pointed to the expansion losing momentum. The government yesterday revised its July industrial output figures to show that production fell rather than increased from a month earlier. Japan’s economy expanded at a 1.5 percent annual rate in the second quarter, less than half the pace of the previous period, and consumer confidence slid to a four-month low in August.
To contact the reporter on this story: Toru Fujioka in Tokyo at tfujioka1@bloomberg.net;
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