Jun 27, 2012 06:29 EDT

China’s U.S. home loan risks being a subprime idea

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By Robert Cyran

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

China Development Bank appears to be toying with a subprime idea. The Asian firm is considering lending U.S. homebuilder Lennar $1.7 billion to construct two housing projects, according to the Wall Street Journal – one of them on a polluted man-made island in an earthquake zone. It has all the hallmarks of globally distorted economic incentives forcing yield-starved investors to take risky bets they don’t understand.   Real estate investing can be tricky for any bank. And converting Treasure Island, a former naval base near San Francisco, into housing isn’t straightforward, due to the competing governmental, environmental and seismic issues. But a good rule of thumb holds that the further afield a project, the greater the danger that the lender is getting out of its depth.   Of course, the projects have potential. The timing looks promising, as they could be investing at, or near, the bottom for housing. Average home prices actually rose 1.3 percent in April, according to the S&P/Case Shiller index. These projects won’t be finished for a decade or more, by which point markets could once again be sizzling. San Francisco has few spaces as well placed geographically as these two for big developments. And China Development Bank isn’t completely naïve – it has increasing amounts of experience investing in countries ranging from Australia to Pakistan.

Yet it’s worthwhile pondering why exactly a financial arm of the Chinese state is thinking of investing in building U.S. homes. After all, this foray hardly fits in with the bank’s original goals of building infrastructure in the Middle Kingdom and promoting strategic industries.

Perhaps the most salient reason stems from China’s policy of favoring exports. At about 3 percent of GDP, the current account surplus is a fraction of what it once was. But the country still has massive amounts of cash to invest overseas. Meanwhile, U.S. monetary policy has resulted in ultra-low interest rates. With U.S. 10-year Treasuries at 1.6 percent and set to remain around that level for some time, bankrolling complex construction projects starts to look unhealthily tempting by comparison.

Jun 26, 2012 21:58 EDT

Split wouldn’t fix all News Corp’s shortcomings

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By Quentin Webb

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Spinning off News Corp’s scandal-hit publishing arm won’t solve all Rupert Murdoch’s problems. The media mogul is preparing to drop his long-held resistance to a break-up, according to a report in his own Wall Street Journal. Outside investors will approve on strategic and financial grounds. But with the Murdoch family retaining a firm grip on both parts, governance remains troublesome. That will make it hard to insulate News Corp’s broadcasting and movie operations from Britain’s phone-hacking furore.

Spinning off the publishing unit, which houses HarperCollins books as well as newspapers such as the Times of London and the Australian, makes strategic sense. The division requires too much management attention while accounting for a small proportion of its parent’s $49 billion market cap. Its operating margins are less than half the wider group’s 16.6 percent; operating income of $458 million in the nine months to March was little more than 10 percent of the group total.

There’s financial merit too. These are fissiparous times: Kraft, Sara Lee, ConocoPhillips and others have already carved themselves into businesses that focus on doing fewer things better, and which investors can assess more easily. In theory at least, better stock-market valuations follow.

But there are limits to what a separation would achieve. News Corp’s dual-share structure means the Murdoch family’s 12 percent economic interest comes with effective control, thanks to 40 percent voting rights. That arrangement would apparently continue in both arms post-split.

Moreover, Murdoch will retain direct influence over both arms, probably as chairman. Politicians and regulators will question whether the separation is more than cosmetic. A separate listing might make it easier in time for the family to sell down its stake in publishing. Even so, the reputational damage in Britain could take years to repair. A split might help News Corp persuade regulators it should be allowed to keep its 39 percent stake in BSkyB. But resurrecting a full buyout of the UK satellite operator looks a long way off.

Jun 26, 2012 17:38 EDT

Murdoch all but erases discount he inflicted

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By Jeffrey Goldfarb The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Rupert Murdoch has all but erased the discount he inflicted on his media conglomerate. When scandal struck News Corp last year, a Breakingviews calculator found the company trading around 30 percent below the sum of its parts. The possibility of splitting the company in two, confirmed on Tuesday, may complete an improbable run to close the gap.

The phone-hacking affair at the company’s British tabloids exacerbated the “Murdoch discount.” This special breed of conglomerate markdown took hold because of the octogenarian mogul’s affinity for newspapers despite their low margins and lack of growth and his undisciplined approach to acquisitions.

But the misdeeds have sharpened News Corp’s focus. In the past year, the company has increased its dividend and announced $10 billion of stock buybacks. After Murdoch’s son, James, was sidelined, Chase Carey, Murdoch’s right-hand man, took a more prominent role and considered shareholders who don’t bear the family name.

News Corp still trades at a discount to peers like Time Warner and Walt Disney. But the market’s valuation now more closely adheres to the sum of its disparate parts, according to an updated Breakingviews analysis using divisional profit forecasts by Barclays and comparable valuation data from Thomson Reuters.

Put the company’s cable operations, including Fox News, on a multiple of nine and they’re worth nearly $30 billion. Earnings from its studio, producer of films like “Prometheus,” and its U.S. Fox broadcast network, home to hit shows like “Glee,” are more unpredictable, but should be valued at over $13 billion together. Sky Italia and various private holdings add about another $4.5 billion. Stakes in publicly traded companies including BSkyB contribute almost $9.5 billion more.

The publishing unit, which includes HarperCollins and the Wall Street Journal, is worth a mere $2.5 billion. But the idea it might be spun off added 8 percent to News Corp’s market value on Tuesday, bringing it to nearly $53 billion. Ignoring the unprofitable digital unit and stripping out net debt of almost $5 billion, the company’s pieces should add up to more than $54 billion, or just about 4 percent more than where they trade. In a way, the scandal may have been the best thing to happen to News Corp.

Jun 26, 2012 11:21 EDT

Sandberg does neither herself nor women any favors

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By Jeffrey Goldfarb The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

It was an important milestone for Facebook’s timeline on Monday. The newly public $69 billion company made Chief Operating Officer Sheryl Sandberg the first female director. But joining a rubber-stamp board that Facebook’s chief executive treats haughtily won’t much enhance Sandberg’s already sterling reputation. Leading women executives like Sandberg would be better off pushing for representation where they can make a real difference.

Females are in short supply in the American boardroom. Only about one in six Fortune 500 directors are women, according to Catalyst. The problem is even more pronounced in Silicon Valley, where the ratio is less than one in 10, Spencer Stuart found. Facebook’s much-hyped initial public offering last month made its board’s homogeneity all the more glaring.

Until Monday, it was a group of seven white men, including tech grandees like Marc Andreessen and Washington Post Chief Executive Donald Graham. Shareholders and activists railed against the composition. The $150 billion California teachers’ pension fund sent a critical letter to Facebook in February, pushing it to diversify the board ahead of the IPO.

Adding Sandberg, who also owns nearly $1 billion of Facebook restricted stock, seemed like a no-brainer. The former Google executive and Treasury official helped founder Mark Zuckerberg accelerate the social network’s transformation from a plaything into a very profitable business. She also has championed gender diversity in corporate America. While it can’t hurt for Sandberg to become a director at Facebook, it’s questionable whether her elevation helps women more broadly achieve the goal of exerting greater influence in male-dominated companies.

Zuckerberg controls Facebook, so directors serve at his whim. The group’s shareholder structure, which gives him more than half of the votes, means the board needn’t have a majority of independent members, unlike at, say, Walt Disney, where Sandberg also is a director. And Zuckerberg made clear just before the IPO what he thinks of the board by dropping $1 billion on Instagram without consulting them. Sandberg’s presence lends unnecessary credence to the puppet show.

The 28-year-old Facebook mastermind already holds Sandberg in high regard, so maybe she can be as influential as a director as she has as Zuckerberg’s right-hand woman. But the timing of her appointment also makes the matter look like an afterthought. It seems more likely that Sandberg will enhance the diversity statistics without truly advancing the cause of diversity.

COMMENT

To become a fortune 500 director you need to be focused on greed, domination, and self. It would be naive to think that a director would succeed in a capitalist competition if they behaved differently. Maybe there are so few female directors because they are better than this? What proportion of environmental or societal charities are run by women?

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Jun 26, 2012 06:36 EDT

Evergrande red flags are real, even if fraud isn’t

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By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Short sellers launched a rocket at Evergrande, China’s second-largest property developer, last week. It hasn’t quite hit the mark. Citron Research, the maverick investment house that launched the allegations of bribery and dodgy accounting, may have shot itself in the foot by fudging some numbers, and leaping to unlikely conclusions. Yet the Hong Kong-listed Evergrande’s red flags are real, even if the supposed fraud isn’t.

Evergrande, now worth just under $8 billion, has lost $1 billion in market value since Citron called it “insolvent” and “fraudulent”. Yet on some counts, Citron just got it wrong. A calculation of how Evergrande cooked the books on its average price of land acquisitions looks impressive – except that to get there, it seems Citron used a pure “land bank” figure when it should have used a different number that includes unfinished buildings.

In other cases, Citron may have just laid it on too thick. Its suggestion that an unexplained growth in “other accounts receivable” represents fraud sounds thin. That line of the books can increase faster than seemingly related accounting entries for non-fraudulent reasons too, such as paying deposits for land or lending to buyers of assets. Large increases wouldn’t thrill shareholders, but they aren’t fraud.

In some ways, however, Citron’s objections to Evergrande’s business model are valid. The company has relied too heavily for profit on revaluations of its investment property. The creep into other businesses – like running a football team – is concerning. Meanwhile the company’s use of trust structures to provide financing is risky, although common practice for Chinese developers.

Evergrande might have avoided some of the brickbats by being clearer. The company itself mixes and matches different land bank numbers to flatter its own acquisition costs. And required disclosure on trust structures is sketchy at best. Wall Street analysts, who overwhelmingly rated Evergrande a “buy”, have rushed to its defence. But even without fraud, investors should retain a healthy scepticism.

Jun 25, 2012 17:28 EDT

Man U’s New York listing crowns race to the bottom

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By Rob Cox The author is a Reuters Breakingviews columnist. The opinions expressed are his own. If Manchester United kicks off its public stock offering in New York this year, it will probably be touted as a triumph for U.S. capital markets. This is, after all, England’s top soccer team, and of all the listing venues the club could have chosen, not least London’s, it looks like Man U is coming to America.

But this apparent financial score isn’t worth cheering like an extra-time win. While U.S. exchanges dwarf the competition in raising capital this year, there’s a dark side to this distinction that investors should heed. Man U won’t be choosing New York because Americans are gaga for the sport. Just 1 percent of respondents in a recent Harris Interactive poll called soccer their favorite sport. Rather, the Glazer family, which also owns the NFL’s Tampa Bay Buccaneers, will be taking advantage of the leeway America’s listing standards offer companies to practice poor corporate governance.

New York’s stock markets permit companies to categorize their shareholders into different classes, allowing founders and owners to sell shares while maintaining control. In London, such a setup gets you excluded from key indexes. It’s an aberration of democratic capitalism, which in its purest form gives one vote per share.

The mechanism lets Mark Zuckerberg hold shares in Facebook with 10 times the voting power of those available to the investing masses. Similar structures enable Rupert Murdoch, the Sulzbergers at the New York Times, the Ford family, and dozens of others to keep a grip on their companies that is far greater than the capital they have at stake.

While this practice has been tolerated for years, it has lately gained considerable ground. This year there have been 21 IPOs on the NYSE and Nasdaq that have sold more than $200 million in shares. All told, they have reaped $24.2 billion, according to Thomson Reuters data. Nearly 80 percent of the money, through nine of the deals, came from the sale of securities with subpar ownership rights.

Facebook, which raised $16 billion and promptly saw its shares tumble, was the biggest of the bunch, but it wasn’t alone. Carlyle Group, the private equity firm that owns Dunkin’ Donuts and 200 other companies, harvested $671 million by selling securities that give investors almost no say whatsoever in the way the company is run. Oaktree Capital, an investment firm, did the same in April.

All of this is amply disclosed ahead of time, so buyers can beware. And there are sometimes perfectly good reasons, such as tax advantages, for owning the equivalent of coach-class securities like the ones Man U will likely be peddling. But winning a race to the bottom by selling out the rights of shareholders is hardly worth celebrating.

Jun 25, 2012 17:09 EDT

Blaming London for bank botches is too convenient

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By Jeffrey Goldfarb The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Say what you will about JPMorgan’s stupid trades, the bank has at least owned up to its failings. That’s more than can be said for some U.S. authorities, who are exploiting the fiasco to point fingers at their UK counterparts. This convenient distraction is really an effort to grab international power. The best hope is it revives dragging global efforts to coordinate the rules.

Britain-bashing escalated on Capitol Hill last week. Gary Gensler, chairman of the U.S. Commodity Futures Trading Commission, spearheaded the rhetoric, rattling off anecdotal examples of risky dealings in London that came “crashing back to our shores.” They included AIG’s financial products unit, the London affiliate of Lehman Brothers and Citigroup’s off-balance-sheet vehicles.

Carolyn Maloney, a Democratic representative from New York, pinned the problem on Britain’s financial capital, too. “It seems to be that every big trading disaster happens in London,” she said. Maloney pressed JPMorgan’s primary regulator, Comptroller of the Currency Thomas Curry, about shifting more resources from the Potomac to the Thames.

It’s all a bit of sleight of hand. London is a big financial center bound to have its fair share of misdeeds. But for every AIG, Citi, or JPMorgan trader, there’s a Long Term Capital Management, MF Global and Bernie Madoff that operated unnoticed by U.S. watchdogs. In JPMorgan’s case, there’s no reason the Whale’s trading positions couldn’t have been more closely scrutinized in New York.

Broadly speaking, London may be known for a lighter touch and Washington for tougher enforcement on certain matters. But the American regime is also hamstrung by overlap and turf wars between rival agencies. Witness Gensler’s attempt to extend his reach by applying U.S. swaps rules internationally. That bold initiative also looks like a stab at enveloping other regimes in the U.S. web.

The opportunism fills a void. Following the crisis, the G20 agreed to take steps to bring financial regulation into better accord. There has been little visibility on such initiatives, if they have happened. The euro zone mess is a distraction. But if global authorities don’t get their acts together, U.S. regulators will continue to use every misstep as a reason to extend their reach.

Jun 24, 2012 23:46 EDT

Monte dei Paschi faces its moment of truth

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By George Hay

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The citizens of Siena are used to white knuckle rides. On July 2 each year, the medieval Tuscan town hosts the Palio, a world-renowned horse race in which 10 brightly coloured jockeys and their mounts thunder three times round the central Piazza del Campo. But this year, the really gripping action will take place a week earlier, up the road at the Palazzo Salimbeni. And it will involve the local bank.

Monte dei Paschi is unique in European finance. Established in 1472, it is the world’s oldest bank. And it does much more than take deposits and make loans. Its largest shareholder, the Fondazione Monte dei Paschi di Siena, supports local artistic, social and commercial interests. MPS dividends pay to train horses for the Palio and maintain a stunning collection of renaissance art. The bank even produces its own highly drinkable Chianti.

Yet in European finance MPS has become notorious for flunking pan-European bank stress tests. The most recent examination in December identified a 3.3 billion euro capital hole – more than the lender’s current market value – to be filled by 30 June. MPS has waited until the last minute to say exactly how it will do so.

The bank’s problems started with one outlandishly bad deal. In 2007 it bought rival Antonveneta from Santander for 9 billion euros – a third more than the Spanish lender had valued the business a few months earlier. This stretched MPS’s balance sheet just as the financial crisis was gathering speed. Sienese public prosecutors, who raided the bank’s head office and homes of former executives in May, are investigating the price paid for Antonveneta.

In Siena, the bank’s travails are causing havoc. To conserve capital, MPS has been forced to cut its dividend – the foundation’s main source of income. Worse, the foundation stretched itself to support the bank’s capital raisings in 2008 and 2011. In an effort to avoid dilution, the foundation borrowed 1 billion euros secured against its MPS shares. But as the shares tumbled – they’re down 75 percent over the last year – the foundation was forced to restructure its debt, reducing its shareholding from 50 percent to 36 percent.

Jun 22, 2012 07:19 EDT

Japan needs more than apologies on insider trades

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By Wayne Arnold

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Handing responsibility for the sale of a $6 billion stake in Japan Tobacco to Nomura Holdings’ rivals after the bank apologized for leaking earlier share sales seemed like a rebuke from Japan’s government. But Nomura probably lost fair and square. Either way, though, Tokyo needs to make such leaks illegal and attempts to profit on them much more painful.

Privatizing a third of the government’s 50 percent stake in the tobacco giant is the kind of deal bankers love. So losing the deal to smaller rivals reinforces the image of Nomura as a teetering colossus. Though it still dominates Japan’s investment banking scene, its leading market share in stock sales slipped last year to 30 percent from 37 percent. The company’s shares have lost a quarter of their value since March and some shareholders are restless as Wednesday’s annual meeting approaches – with one irate owner proposing votes on things as wide-ranging as executive pay and underarm odor.

The firm’s admission that its employees leaked information to clients ahead of three public share offerings in 2010 doesn’t help. But despite appearances, that’s unlikely to have contributed to the Japan Tobacco win by rivals Daiwa and Mizuho. The government’s beauty contest relied on a 160-point scoring system, with only 20 points for regulatory compliance.

Nomura’s transgressions should matter much more. Leaking inside information isn’t illegal in Japan. Only trading on it is. Overzealous underwriters can clue favored investors into upcoming secondary issues, which gives them a head start to profit from the typical discount for such sales, sometimes by selling the issuer’s stock short before the public announcement of the sale. That can help underwriters too. Because shorting tends to drive a stock price lower, it can make it easier for them to sell the stock they’re on the hook for.

Japan’s rules don’t provide much disincentive. Regulators imposed a mere 10 million yen ($125,000) fine on First New York Securities for trading on information about a share offering in 2010. And even that’s a fortune next to the 130,000 yen they fined Chuo Mitsui for profiting on leaks from Nomura.

Jun 22, 2012 07:01 EDT

Downgraded banks should rush to borrow

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By Antony Currie

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

What should the 15 global banks do now that Moody’s has cut their credit ratings? Go out and borrow money as quickly as possible is what. In times past, that might have seemed rash. After all, a debt downgrade is supposed to mean borrowing costs go up. And most of the banks affected probably don’t need the cash. But jumping back into the markets quickly is the best way to show up Moody’s.

For starters, the rating agency is pretty late to the party, despite the nail-biting attention given its decision. Rivals Fitch and Standard & Poor’s concluded their reviews last year. Bondholders, however, took action long before that: they’re demanding higher interest rates from virtually all large financial institutions before lending to them. Morgan Stanley, for example, is paying about 3.9 percentage points above U.S. Treasuries for five-year paper, far more than before the crisis.   And that’s after banks were forced to restructure their balance sheets to reduce risks. Leverage is down and common equity is up. Meanwhile, most have already addressed other weak points exposed by the crisis. There’s much less reliance on commercial paper, at least among U.S. banks. Morgan Stanley, Goldman Sachs and Bank of America have none, for example. And many have removed any linkage of repo funding to ratings.   Even where the actions by Moody’s might have an effect, only the woefully unprepared should feel much pain. Morgan Stanley, for example, will have to post as much as $6.7 billion in extra collateral after its two-notch downgrade left it at Baa1. With almost $180 billion in excess liquidity, that’s hardly a problem. Like its peers, it also means the bank isn’t desperate to raise more cash. What’s more, Morgan Stanley has spent the time since Moody’s announced its review in February restructuring or renegotiating most of the derivatives contracts that could be hit by the downgrade.

Even the surprises from Moody’s look manageable. Credit Suisse was whacked by three notches, though still remains a solid A-rated credit. So, what better way to shrug off the news than to head into the market and sell some bonds?