So, the mainstream appears to be catching up to what I’ve been saying all along.
Bloomberg’s Andy Mukherjee* noted that Philippine creditors have become more anxious as to demand more bond covenants to buttress or backup Philippine debts.
*Bloomberg Philippine Bond Jitters Bode Ill December 6, 2016
A bond covenant, notes the Investopedia, represents an agreement between creditor and borrower which either defines limits or proscriptions of the issuer from undertaking specific activities (restrictive) or for issuer to meet specific requirements (affirmative) covenants
This entails requirements for possible additional collateral (higher rates?), or again, restrictions on certain activities (too much expansion??).
In short, this means credit tightening. Yes, it’s US dollar short in motion!
The article attributes this to “deteriorating credit profiles of Philippine companies” which tightening could be “self-fulfilling” and consequently “could drag on earnings next year”
“And leverage is already an issue”, says Mr. Mukherjee, noting that “San Miguel Corp.'s obligations” which are as “high as 77 percent of its market capitalization, compared with the average for the MSCI Asia index ex-Japan of 27 percent”. He added that “Ayala Corp.'s net debt is approaching five times Ebitda, the most in more than a decade”.
These have all been too obvious.
I pointed out in November 2015 [see above chart from Gavekal as I showed in the Phisix 7,100: Surprise! ICTSI Chief Enrique Razon Warns: Another Financial Crisis is COMING!!!! SM Plays with Fire!; available online via Before Its News Link) that cash flows have become a problem primarily because of the increased reliance on real estate-retail industry as the main engine of economic activities, or the principal source of the BSP’s Keynesian aggregate demand.
The real estate, retail and construction industry according to the Philippine 3Q (year to date) GDP accounted for 39% share. Manufacturing came in second at 18%.
Don’t forget the frenzied race to build shopping malls comprise a significant role in the real estate industry.
More than this, the same industries accounted for 38% share of the banking loans to the industry (as of October)! There is yet the non-banking loans (as above)!
The article further noted that even the most creditworthy Philippine issuers, e.g. AC and ALI, has “seen default risk risen by one notch over the past month, according to a Bloomberg metric”.
While this might not be much, as an old saw goes, “a journey of a thousand miles begins with a single step”. It’s evidence of progressing entropy that has now spread from the periphery to the core.
Remember the tightening yield curve in 2015????
Importantly, the costs of debt-financed expansions or borrowing from the future for previous and current spending binge has ARRIVED:
“Loading up on debt was a good idea when it helped carve out a return on equity of 15 to 16 percent for the Philippine Stock Exchange PSEi composite index, from a return on assets of 3.5 to 4 percent.But those days are over. Profit margins have shrunk from four years ago for the 19 nonfinancial companies in the benchmark gauge, even as their assets are still producing roughly the same revenue. Leverage can mask the problem for a while. But with debt investors becoming cautious, the moment of reckoning for equities might arrive sooner rather than later.”
What is seen as analysis, from the above, has really functioned as a narrative description of current events more than they function as an economic explanation.
The article glossed over an increase in credit risks by noting that big problems from “some terrible mismatch between dollar liabilities and assets will “unlikely” produce problems because they are “hedged”, AGI and SM, are just two of “the four Philippine conglomerates…among the 10 Southeast Asian companies with the most dollar bonds due in the next 12 months”
The “moment of reckoning for equities” and “terrible mismatch” in maturity transformation have been entwined. So to disregard its relationship will serve as a significant sin of omission.
And currency hedging won’t be a free lunch. Once these hedges expire they have to be rolled over, at evidently, a higher cost. And the higher cost will pressure profits, and thus, amplify credit risks.
And again, the superficial observation of sterilized risks, because SM and AGI have been “switching to local-currency debt” since “local banking system is flush with funds”.
Yet the same article alluded to political obstacles particularly from Mr. Duterte’s “deadly anti-drug campaign, liberal spending policies, foreign policy flip-flops and bungling of domestic politics end up curtailing lenders' access to dollars.”
I have no quibble on the political issue which I think would function as aggravating, but not a primary factor.
The falling peso already equates to an implicit tightening.
That’s not only from increasing demand for more covenants and potential higher hedging costs, but on the impact of weak peso on USD liabilities, and from the alternate, debt shuffling.
Weaker peso means MORE peso required to pay existing USD debt. So if NGDP weakens this would amplify USD liabilities. And decaying NGDP translates to enhanced credit risks and a downturn in credit activities. It’s self fulfilling.
Furthermore, the switch to local-currency debt will not have a prophylactic effect IF debt continues to balloon. And aggressive credit expansion will lead to a bigger the fall of the peso as explained last weekend.
In short, credit expansion NEEDS to dramatically slow. But such would take the steam out of the statistical GDP (thereby raising the cost of credit) and curtail (tax and debt) subsidies to political ambitions and agenda of the leadership.
And since that’s not politically palatable, this is why the peso will serve as the unfortunate sacrificial lamb to the altar of false political glory.
More interesting has been the observation that “stocks look dangerously out of breath: Only 20 percent of the shares in the benchmark index are above their 200-day moving average, which makes the Philippines the second-weakest Asian market after Mongolia.”
See now why the Philippine stock market has transmogrified into a price fixing platform? The idea that is if sinking stocks has contributed to credit tightening, then stocks MUST be pumped at all cost to revive the “animal spirits”!
Unfortunately, doing so misses the point. Why? Because it will only exacerbate the “deteriorating credit profiles of Philippine companies”
The chicken has come home to roost!
We are witnessing an epic historical turning point.
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