BY JEFFREY GOLDFARB

There is relative optimism about Hong Kong reflected in its stock market. That’s hard to reconcile with past and present realities. It also doesn’t bode well for the future.

The city’s benchmark indicator of equities has lagged the S&P 500 Index since violent anti-government protests started in June. Nevertheless, the slide has been less severe than during the Asian financial crisis some two decades ago or the deadly SARS breakout that followed. As of mid-December, the Hang Seng Index was down less than 7% from its July apex. That’s modest when compared with peak-to-trough falls of more than 50% during each of the previous two calamities.

The main Hong Kong index includes more mainland companies than it used to, with such notable additions as Chinese tech titan Tencent. However, more locally skewed indices and stocks – including subway operator MTR, cosmetics retailer Sa Sa International and conglomerate Jardine Matheson – have held up comparatively well through more than six months of turbulence that drove the city into recession.

Clashes are likely to persist. Even under an optimistic scenario laid out by political risk consultancy Control Risks, any de-escalation would be temporary and underlying tensions “would not fully revert to pre-crisis levels.” That’s a bad omen for tourism, shopping and property prices.

The former British colony’s fortunes are also tied to China’s economy, which has been roiled by the volatile trade war being waged between Washington and Beijing. Progress in the negotiations has been slow, and any significant breakthrough looks distant. Under a newly passed law, the United States will now decide each year whether Hong Kong is “sufficiently autonomous” to qualify for special treatment on trade matters.

Any downward turn for buoyant U.S. stocks also would weigh on Hong Kong equities. The cyclically adjusted price-to-earnings ratio developed by economist Robert Shiller, which smooths out the profit for S&P 500 constituents over a decade, has been running at over 30 times. The level was breached only twice before, ahead of the 1929 crash and the dot-com bubble bursting. Likewise, the MSCI Hong Kong Index in late November was trading at a higher multiple of expected earnings than its long-term trend line, according to UBS. Investors will come to rue their risk appetite.

First published Dec. 19, 2019

IMAGE: REUTERS/Jorge Silva

BY NEIL UNMACK AND ANNA SZYMANSKI

Private equity looks set for a tricky ride in 2020. And it will be thanks to ructions in the $1 trillion market for bonds backed by the leveraged loans that finance many deals struck by Henry Kravis’s KKR and David Rubenstein’s Carlyle, for example. A weaker economy will make investors wary of buying these so-called CLOs and force vehicles to curb lending. That means higher borrowing costs, and probably fewer takeovers – though some industries and regions, such as Asia, will buck the trend.

Collateralised loan obligations, to give them their full name, hoover up over 70% of the loans buyout shops often use to finance their deals. They slice and dice these loans into tranches offering higher returns for riskier cuts. The U.S. CLO market has more than doubled since 2012 to over $650 billion. JPMorgan reckons the amount of outstanding CLOs should top $1 trillion next year. But this securitisation bonanza is starting to sputter.

It’s all about the arbitrage – or lack thereof. CLOs work when cash flows from the underlying loans exceed payments to the CLO noteholders, leaving annual returns of 15% or more for the lowest-ranking tranches, and fees for managers. But fears of a U.S. recession and general economic skittishness have made investors demand higher returns for some CLO debt. If yields rise much higher, the CLO new-issue machine is likely to grind to a halt.

Downgrades could also be a problem. The rating models that govern CLOs allow them to account for loans at face value. But the moment a CLO holds more than a certain percentage of assets rated CCC, typically 7.5%, managers have to value them with current market prices, which are usually far below par. If enough companies are downgraded, and the CLOs’ assets sufficiently devalued, income from loans is diverted to repay senior bondholders, cutting off lower-ranking investors.

The situation already looks quite fragile. A combination of high company debt and a stagnating global economy mean the share of loans in U.S. CLOs rated B-minus, one level above CCC, is nearly 20%, twice the level before the 2008 crisis, according to Standard & Poor’s. UBS analysts expect the average U.S. CLO CCC exposure to reach 11% in 2020.

The effect could be doubly bad. Investors in lower-ranking CLO tranches will take steep losses, sapping appetite for new deals. Meanwhile, existing CLOs will be less able to lend to lower-rated companies, driving up borrowing costs. That raises the risk of the dealmaking debt machine blowing a gasket.

First published Dec. 19, 2019

IMAGE: REUTERS/Mike Segar

BY LISA JUCCA

The world’s biggest banks are stirring up a new lending frenzy. More than a decade has passed since loans to subprime homebuyers went bad. Now UBS and other private banks are cranking up credit to uber-rich clients. This superprime bubble will bring higher returns and risks, too.

A global transparency push forced the wealth management industry to kick the lucrative habit of hiding clients’ assets from tax authorities. Now rock-bottom interest rates are making it harder to deliver positive returns. That’s putting pressure on fees and squeezing profit margins.

In an attempt to boost revenue, wealth managers are extending more loans to successful entrepreneurs and their offspring. Total lending revenue at top private banks grew 8% annually in the two years to mid-2019, according to Tricumen, a consultancy.

UBS’s private bank had extended $176 billion to wealthy clients at the end of September. That’s equal to 7% of the $2.5 trillion in assets it looks after. New global wealth management co-head Iqbal Khan, who previously cranked up lending at rival Credit Suisse, looks set to go further. Some executives reckon private banks could comfortably extend credit worth up to 15% of the assets they manage.

Lending to people who are already rich appears relatively low-risk. So-called Lombard loans, which are secured against a portfolio of securities lodged with the private bank, are typically the safest. Gross margins on such loans tend to be less than 100 basis points, says consultancy Capco. Banks can charge twice as much for fancier collateral such as real estate or shares in unlisted companies, and even more for credit backed by art, yachts or wine. However, private bankers will sometimes reduce rates to win a bigger mandate – or lock in an investment-banking client.

Even though wealthy borrowers can generally repay the loan, accidents do happen. When Steinhoff International revealed a massive accounting fraud in 2017, the likes of Bank of America and Citigroup suffered losses on 1.6 billion euros of loans secured against shares owned by Christo Wiese, the South African retailer’s former chairman.

Such lending is safer than risking big fines by helping money launderers or tax dodgers. And by rights it ought not to have the potential to blow up the entire financial system like the subprime crisis did. Such comparisons, though, can breed a false sense of security, and complacency. That means this bubble has further to inflate – and will leave a mess when it pops.

First published Dec. 30, 2019

IMAGE: REUTERS/Arnd Wiegmann

BY CHRISTOPHER THOMPSON

There are some benefits to having a former investment banker as president. Shares in La Française des Jeux rose by up to 18% on their debut after the government-controlled national lottery made its stock market debut in a listing championed by Emmanuel Macron, the ex-Rothschild banker who now occupies the Elysee Palace. But resurgent protests and a national strike will make it harder for him to flog other state assets in the coming year.

The biggest French retail stock offering since the global financial crisis was a success for around 500,000 domestic punters who saw their cut-price shares jump by almost a fifth. The state and its advisers, however, will face charges of underpricing the country’s showpiece privatisation by leaving around 600 million euros of value on the table.

In truth, the FDJ soufflé may yet deflate. A market capitalisation of around 4.3 billion euros means the company trades at a heady 22 times expected earnings for next year. That’s a hefty premium to Greek peer Greek Organisation of Football Prognostics, which is valued on a multiple of 15 despite higher expected sales growth, according to Refinitiv data.

The successful initial public offering should whet investors’ appetite for the sale of other French assets, much as the British government offloaded telecom and gas holdings in the 1980s. Top of the list is the government’s 51% stake in Aeroports de Paris, which Macron wants to use to start an innovation fund. Shares in the 18 billion euro manager of the Charles de Gaulle and Orly airports have crept back up after suffering a selloff in May, when France’s constitutional court approved plans for opposition politicians to ballot for a referendum on the idea.

Yet hostility to privatisations has hardly gone away. Parisian bankers speak of the “social issues” overshadowing a sale of ADP, including a national strike planned for December. One of the likely beneficiaries of a selloff is Vinci, the French infrastructure company which already owns 8% of ADP and would probably buy more. The operator of French highway toll booths is a frequent target of “gilets jaunes” protestors.

The ADP ballot is well short of the threshold needed to force a national vote on the issue. And Macron can point to a fruitful lottery IPO. But French bankers hoping their former colleague will push more lucrative business their way may be disappointed.

First published Nov. 21, 2019

IMAGE: Daniel Leal-Olivas/Pool via REUTERS

BY JENNIFER SABA

Walt Disney Chief Executive Bob Iger rarely puts a foot wrong. In his 14 years in charge he has bought properties like Star Wars and the Avengers, and while he paid a high price in the auction of assets from Twenty-First Century Fox, at least he won. Expectations are therefore high for his next magic trick: creating a video-streaming product to rival Netflix. This feat may be beyond him.

An eye-popping 10 million people signed up for Disney+ on its first day out of the gate in November, a number that added $18 billion to Disney’s market capitalization within hours of disclosing it. Disney’s stock was in mid-December trading at 26 times 2020 forecast earnings, according to Refinitiv, having overtaken Apple and Google owner Alphabet’s multiple during 2019. Iger wants up to 90 million subscribers by September 2024 – by which time he says he will no longer be chief executive.

Is that growth feasible? It’s pretty much what Netflix did, times two. Reed Hastings’ streaming pioneer went from just under 10 million subscribers in 2008, which included by-mail DVD rental, to 44.3 million five years later. Apply that same rate of growth to Disney and it would be just halfway towards Iger’s upper target. And that’s already faster than Facebook’s growth in monthly active users between 2009 and 2014 for a product which, unlike Disney+ and Netflix, is free to use.

Granted, Disney has advantages its rivals didn’t, like name recognition and splashy content including Yoda and animated works from Pixar. And it’s cheap at $6.99 a month, about half the price of Netflix. That too, though, is a problem. Disney effectively hopes to grow at twice the speed of Netflix in its early days, but at half the revenue per user that Hastings’ service gets today. A slew of rival offerings from companies like Comcast’s NBC Universal and AT&T-owned HBO will make it tough to raise prices.

That suggests Disney investors are already living in “Fantasia.” Netflix, with an enterprise value of $136 billion in mid-December, is valued at around $860 per user. Take half that rate and apply it to 90 million subscribers, and Disney’s digital service ought to be worth around $40 billion five years from now. Yet the company’s market capitalization has increased roughly $50 billion since details of Disney+ started to emerge in April. The return to earth promises to be anything but magical.

First published Dec. 19, 2019

IMAGE: REUTERS/Mario Anzuoni