Sunday, January 13, 2019

The Biggest Warning Yet! Clue: Not the Hanjin Default


Economic theory has demonstrated in an irrefutable way that a prosperity created by an expansionist monetary and credit policy is illusory and must end in a slump, an economic crisis. It has happened again and again in the past, and it will happen in the future, too—Ludwig von Mises

In this issue

The Biggest Warning Yet! Clue: Not the Hanjin Default
-2019 Opens With A $412 Million Hanjin Default: The Biggest Corporate Debt Default in Philippine History!
-Hanjin Takeover: Will China’s State-Owned Company Bailout Domestic Banks?
-The Hanjin Episode: The National Government Sensed It, There is Never One Cockroach!
-Hanjin Episode Exposes the Rapidly Deteriorating Health Conditions of the Banking System
-The Biggest Warning Yet: Philippine Treasury Yield Curve Inverts!

The Biggest Warning Yet! Clue: Not the Hanjin Default

Expect the Unexpected in 2019.

2019 Opens With A $412 Million Hanjin Default: The Biggest Corporate Debt Default in Philippine History!

2019 opened with an unexpected development: the biggest corporate debt default in Philippine history!

From the Inquirer: (January 11, 2019) [bold added]

Five of the country’s largest banks are rushing to cover a combined loan exposure of $412 million, most of it lent without the benefit of collateral protection, after the local shipbuilding unit of Korean conglomerate Hanjin declared bankruptcy earlier this week—the biggest corporate default in Philippine history.

More importantly, however, the involved financial institutions—Rizal Commercial Banking Corp.; Land Bank of the Philippines; Metropolitan Bank and Trust Co.;  Bank of the Philippine Islands, and Banco de Oro Universal Bank—have decided to move as one to take control of Hanjin Heavy Industries and Construction Philippines’ $1.6-billion shipyard in Subic Bay, Zambales, which employs about 23,000 workers…

Speaking on condition of anonymity, the bank president said his peers from other creditor banks had agreed that “no one will jump the gun” to seize collateral ahead of other creditors, an act that would trigger a free-for-all on Hanjin’s Philippine assets and jeopardize the rehabilitation plan that had been filed in the local courts.

Eventually, the provisional agreement among members of the loose consortium of Philippine banks may call for the forced sale of the Hanjin shipyard to a strategic investor as a way for the creditors to recoup their loans.

The Inquirer learned that RCBC has a loan exposure of $140 million to Hanjin. It was followed by Land Bank with an estimated $80 million; Metrobank, $72 million; BPI, about $60 million and BDO, $60 million.

Now you and I have been talking about and expecting this for a lengthy period of time, yes?

So while this comes as a surprise to them, it isn’t for us.

Hanjin’s default didn’t happen overnight. It declared bankruptcy first before defaulting. In other words, the consortium of creditors already knew of Hanjin’s difficulties for them to create a “provisional agreement” over the control of collateral and the likelihood of a “forced sale the Hanjin shipyard to a strategic investor”.

Interesting to note that the article opened with Hanjin’s default “without the benefit of collateral protection”.

Here’s the Php 20.3 trillion (Financial Resources of the Philippines as of October) question: if marginal collateral backed Hanjin’s debt, to what extent of loans, issued to the public by the banking system, has been structured under the same conditions?

Did the Hanjin default just opened the Pandora’s Box of fragility, sham, and delusions of the meme of “sound macroeconomic foundations”?

Hanjin Takeover: Will China’s State-Owned Company Bailout Domestic Banks?

The Bangko Sentral ng Pilipinas (BSP) moved to assure the public that the banking industry has “enough capital buffer” for it to “weather the sudden collapse of Hanjin Heavy Industries and Construction Philippines”.

Of course, they have to. The fractional-reserve banking standard rests primarily on a confidence trick. An admission of the system’s frailties would spark a bank run. As Austrian economist Murray Rothbard wrote, “that is, it can only work so long as the bulk of depositors do not catch on to the scare and try to get their money out..”  

The Hanjin default likewise unmasks the statistics of the banking system’s bad loans provided by the BSP.

The Duterte regime says that Hanjin may have found a white knight!

From the Inquirer: (January 12) “Two Chinese shipbuilding firms are interested to take over the Philippine business of the Hanjin Group of South Korea, a government official said, as the Duterte administration steps in to help save the troubled investor in Subic…Over the past few days, he said he had received queries on the state of Hanjin Philippines after the company declared bankruptcy earlier this week— triggering the biggest corporate default in local history. He said two Chinese shipbuilding firms—one of which is state-owned were interested to take over Hanjin’s operations in the Philippines…To take over, he said a company only had to pay off the company’s local debts, which amounted to $400 million. However, there were reports that Hanjin-Philippines also owed about $900 million to creditors back in South Korea…The financial state of the company has sunk so low that the takeover price as of Thursday was now six times smaller than what it was a year ago, back when another investor was still interested, Rodolfo said.”

Unless the investor would have new markets or new methods to decrease costs that would render operations profitable, would absorbing so much debt justify the viability of a takeover of a money-burning company?

As an aside, the Global Ship Building industry performed better in 2017 compared to 2016. However, according to Sea Europe Shipbuilding Market Monitoring (March 2018 report), ordering remains “at historically depressed levels as the increase occurred from a very low base and is still below the 2015 level. Weak newbuilding activity continues to severely impact a number of yards around the globe as well as the supply chain players serving global markets.”

The industry has been plagued by overcapacity since 2010. Should the synchronized slowdown in the global economy persist, such would only magnify the industry’s supply glut! And China is next to South Korea as the biggest shipbuilders in the world (as of 2018).

The local’s parent, Hanjin Shipping was declared by the Seoul Bankruptcy Court on February 2, 2017, for liquidation, according to the Hellenic Shipping News, as restructuring its debts would be “prohibitively expensive.” So the domestic banking industry should have already known of the industry’s conditions and should have extended loans with reservations and institute the necessary safeguards in its covenants.  The aromatic scent of profits has apparently, overwhelmed any sense of risk management such that these banks lent recklessly to the Korean shipbuilder backed by little collateral. Such are signs of times.

That is, of course, if there is other agenda than pursuing profits.

A possible takeover of Hanjin by a Chinese state-owned company would amount to a Chinese government bailout of domestic banks. 

Since governments are not subject to the discipline of profits and losses, taxpayers may subsidize an agency’s operations regardless of its financial conditions. In exchange for the bailout, what will the Chinese government get in return?

The Hanjin Episode: The National Government Sensed It, There is Never One Cockroach!

Back to the banking system.

Despite its roseate pronouncements to the domestic audience, the National Government (NG) has some inkling on the time bomb it keeps within the banking system.

The Bangko Sentral ng Pilipinas became a reporting member of the Bank for International Settlement (BIS) in January 2018. Perhaps part of the membership requirement is to publish an annual Financial Stability Report (FSR). In its inaugural, the BSP-led Financial Stability Coordinating Council (FSCC) reported to its BIS audience in its 2017 Financial Stability Report (FSR) that was published in the 3Q of 2018 the following conclusion from its Chapter 3 or Current Risks in the Financial System (p. 27)

While there is no definitive evidence of a looming crisis, it is also clear that shocks that have caused dislocations of crisis proportions have come as a surprise. What is not debatable is that repricing, refinancing and repayment risks (3Rs) are escalated versus last year and this could result in systemic risk if not properly addressed in a timely manner.

When this was published in September I wrote

And yes while outstanding debt represents a financial stability issue, the paramount concern should be the direction of the use of such a massive pileup of debt or its allocation or Malinvestments.Debt used for unproductive activities will be exposed by rising rates and defaulted upon..

Even if interest rates remain at a record low, the pulsating growth of debt, which has grown faster than the economy, renders a system vulnerable from overleveraging

The system’s debt did not just pop up. These were products of actions in response to policies which shaped the economic environment. Today’s outstanding debt represents an aggregation of such a process.
And if “shocks that have caused dislocations of crisis proportions have come as a surprise”, why should we rely on their assessment of “no definitive evidence of a looming crisis”?

Differently put, they implicitly say that they should be trusted upon to protect us from a crisis, even if they didn’t see the shocks coming!


The BSP also confessed of mounting signs of deterioration in the corporate debt spectrum. I wrote this in May 2017: (bold italics original)

The BSP on the Philippine corporate debt conditions (bold added)

Data compiled for the BSP Financial Stability Committee suggest that NFC leverage has increased in recent years. We also know from BIS reporting countries that cross-border debt incurred by non-bank corporates in the Philippines increased from USD 7,781 million as of end 2008 to USD 13,046 million as of March 2016.
 In the sample data we monitor, we also find that the corporations that have increased their debts have also experienced a decline in their ROE. On paper, this indicates some impairment in their capacity to pay, but more granular information tells us that the bulk of the outstanding loans will mature in three to five years. Thus,unless there are specific cross-default cross-acceleration provisions in the debt contracts, this“impairment” may not be as imminent as it may seem.

The point is that we see the debt build-up in publicly available corporate balance sheets but we do not yet fully appreciate what lies behind these figures. The financial stability concern cannot be defined exclusively by the increase in leverage. Rather, it is the fact that the results of network analysis and contingent claimsanalysis tell us that debt defaults strongly link the real economy and banks.

Read the statements again.

That’s actually a stunning confession!!!

First, this signifies an amazing acknowledgment that surging credit has begun to impact corporate balance sheets!

Such is something one would hardly ever hear from media.

More importantly, the BSP shockingly admits that it actually has NO IDEA “we do not yet fully appreciate what lies behind these figures” of the risks from the swift rate of growth of corporate leveraging and its transmission channels!

Network effects and contingency claims are extensions to the linkages from leverage exposures.

So the BSP HOPES that their measures would work in times of stress. Good luck to them!


In a month, two regulatory bailouts were launched by the NG. Citing high volatility, the Insurance Commission granted regulatory relief to the pre-need industry last November. The BSP implemented the Countercyclical Capital Buffer (CCyB), which allows them to lower bank capital requirements during times of stress.  These events are unlikely coincidences. And in response to the distressed industry’s clamor for relief, these measures came to the fore.



The proverbial chickens have come home to roost.

Also, to borrow Warren Buffett’s quote on Wells Fargo’s scandals, “there's never just one cockroach”. The Hanjin default should be the first among the many string of defaults.  San Miguel’s humongous 3Q Php 777 billion debt should be one among them.

Unless a bailout occurs, the Hanjin saga will blow a hole to the balance sheets, income statement, capital reserves and liquidity conditions of the banking industry. It will also impact jobs and the supply and demand chains attached to the Hanjin operations.

Hanjin Episode Exposes the Rapidly Deteriorating Health Conditions of the Banking System

The risks in the banking system have become so palpable for people who open their eyes. 
Figure 1
Banks have placed almost all their revenue eggs in the lending business. Unfortunately, the bigger their loan portfolio, the lesser profits the industry generates. As of the 3Q, bank loans account for 77% share of the industry’s operating income. Before 2013, it was less than 70%.

Profitability ratios continue to fall. It has been an entrenched trend since 2013. The explosion of bank margins since 2012 gave the opposite results to profitability. In 2018, margins have turned lower which has pressured earnings.

The larger the loan portfolio, the greater the risks of defaults once the economy slows.

Banks declare that they generate profits, but that’s only accounting profits.
Figure 2

The industry’s liquidity conditions continue to dwindle reinforcing its long-term trend. Cash and due banks to deposit ratio dropped to 19.45% in November from 19.66% a month ago. Liquid assets to deposit ratio improved slightly to 46.15% in November from 46.05% in October. (figure 2, upper window)

How can a profitable industry suffer from sustained draining of liquidity?  

Deposit liability growth continues to fortify its declining trend. Deposit liabiilty growth decreased to 8.87% in November from 9.04% a month ago. November Peso deposit growth remained the same with October at 9.53%. (figure 2, middle window) Savings deposit growth, its biggest component, plummeted to 8.76% from 10.92% over the same period.  Foreign currency deposit growth dived to 5.75% in November from  6.74%. Reduced access to deposits should hamper bank lending operations. 

Should bank profitability attract more and not fewer deposits?

Why has the banking industry been panic stuffing their investment assets to the Held-To-Maturity (HTM) category?The industry’s HTM asset growth continues to zoom with three successive months of a whopping over 50% growth: November +57.36%, October +53.59% and September +53.0%! (figure 3 lowest window)

The FSCC’s FSRs provides an answer (p.24): “Banks face marked-to-market (MtM) losses from rising interest rates. Higher market rates affect trading since existing holders of tradable securities are taking MtM losses as a result. While somebanks have resorted to reclassifying their available-for-sale (AFS) securities into held-to-maturity (HTM), some PHP845.8 billion in AFS (as of end-March 2018) are still subject to MtMlosses. Furthermore, the shift to HTM would take away market liquidity since these securities could no longer be traded prior to their maturity.”

The gist: To shield from losses banks use HTMs. Liquidity represents the opportunity cost of such actions.

HTMs account for 14.36% of the industry’s assets. The extensive use of HTMs, by the banking industry, has commenced in 2013. HTM growth rate re-accelerated since Jan 2017.

So what happened to profitability, thereby liquidity? Why have banks been increasingly relying on the people’s savings to shore up their balance sheets? [See The Crowding-Out: Wave of Announcements for Another Round of Massive Bank Financing! The Minsky Cycle to the Minsky Moment September 23, 2018]

As one would note, the Hanjin event has been related to the banking system’s decadent conditions.

The systemic fragility from the banking system’s unhealthy conditions has been escalating.

The Biggest Warning Yet: Philippine Treasury Yield Curve Inverts!

Last week, I wrote that the BSP, DoF and the Stock market shouldn’t be celebrating the decline of CPI because of its unintended consequences.

Well, the Hanjin event signifies one of its consequences.

The Hanjin event is a symptom of a disease.

The FSR’s 3Rs (Repayment, Refinancing, and Refinancing risks), higher rates, street inflation, liquidity drain, bank health deterioration, and malinvestments have been products of principally of monetary inflation, and secondarily, the deficit spending running at a historic pace.

The bigger warning of them all, I wrote in the same article.

And despite the BSP managed treasury market, the domestic yield curve is at the risk of inversion!


That inversion has arrived.
Figure 3

The Bankers Association of the Philippines started to use Bloomberg’s BVAL (Bloomberg Valuation) rates on October 29 for pricing Philippine Treasuries. The PDS website publishes the daily BVAL rates

As of Friday, January 11, despite falling rates, the 1-year yield has now been higher than the 2-year to 10-year rates. A day before, the 1-year yield had only been higher than the 2- to 4-year counterparts.

The PDS benchmark still exists. However, the investing.com publishes the PDS rates. PDS rates also show higher 1-year yield compared to its 2-5 years counterparts

Back in 2014, I wrote this: (bold original)

An inversion will likely occur when a credit crunch has become evident….

Yet the feedback loop between accruing losses and increasing credit strains will extrapolate to higher demand for short term loans which should drive short term yields to even higher levels relative to the longer end.

If such dynamic is sustained then this will eventually lead to a yield curve inversion. The inversion will now signal a recession, if not a crisis!


The Hanjin default could be part of this process.
Figure 4
Back in 2014, the flattening dynamic of the Philippine treasury yield curve was arrested by the BSP. The BSP rescued or bailed out the banking system when it embarked on its QE.

Back then, “build, build and build” or record deficits were non-existent.

Fast forward today.

Today, not only have rates risen and the curve flattened in 2018, the curve inverted in 2019

The BSP kicked the can down the road, today we have reached the can.

From the New York Fed’s Arturo Estrella and Mary R. Trubin:

Monetary policy can influence the slope of the yield curve. A tightening of monetary policy usually means a rise in short-term interest rates, typically intended to lead to a reduction in inflationary pressures. When those pressures subside, it is expected that a policy easing—lower rates—will follow. Whereasshort-term interest rates are relatively high as a result of the tightening, longterm rates tend to reflect longer term expectations and rise by less than short-term rates. The monetary tightening both slows down the economy and flattens (or even inverts) the yield curve.

Changes in investor expectations can also change the slope of the yield curve. Consider that expectations of future short-term interest rates are related to future real demand for credit and to future inflation. A rise in short-term interest rates induced by monetary policy could be expected to lead to a future slowdown in real economic activity and demand for credit, putting downward pressure on future real interest rates. At the same time, slowing activity may result in lower expected inflation, increasing the likelihood of a future easing in monetary policy. The expected declines in short-term rates would tend to reduce current long-term rates and flatten the yield curve. Clearly, this scenario is consistent with the observed correlation between the yield curve and recessions.

Arturo Estrella and Mary R. Trubin, The Yield Curve as a Leading Indicator: Some Practical Issues July/August 2006, New York Fed

I would add a third factor, the tightening liquidity of banks in competition with the government’s aggressive deficit financing.

At the very least, the Philippine economy should sharply slow (in about a year) whether this leads to a recession or crisis will all depend on the magnitude of imbalances embedded into the system, as well as the policy response. Influences from the external environment may accelerate the process.

Will the BSP accelerate the use of its ‘printing press’?

Oh, the November tax revenue plunge and the crashing CPI could be telltale signs.

Expect the Unexpected in 2019
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