Tensions Soar As Trump Admin Could Scrap Audit Deal For US-Listed Chinese Firms Tyler DurdenTue, 07/14/2020 — 08:26
Global stocks slumped on Tuesday as a safety bid appears in the dollar as Sino-US tensions continue to worsen.
There were a couple of significant developments in the overnight session involving China and the US. First, Chinese Foreign Ministry spokesman Zhao Lijian said Beijing would sanction US defense contractor Lockheed Martin for its latest arms deal with Chinese-claimed Taiwan.
The second development is from Reuters, detailing how the Trump administration plans to abandon a 2013 agreement between the US and Chinese auditing authorities, a move that suggests a widespread crackdown on US-Listed Chinese firms sidestepping US disclosure rules is ahead.
The deal allowed the Public Company Accounting Oversight Board (PCAOB) to seek auditing documents in enforcement cases of Chinese companies listed on US exchanges - was considered a breakthrough at the time.
But PCAOB has complained over the years that many of the requests into Chinese firms were ignored.
Keith Krach, the undersecretary for economic growth, energy, and the environment, said, “lack of transparency has prompted administration officials to lay the groundwork to exit the deal soon.”
“The action is imminent,” Krach told Reuters, in an emailed response on Monday. “This is a National Security issue because we cannot continue to afford to put American shareholders at risk, to put American companies at a disadvantage and allow our preeminence of being the gold standard for financial markets to erode.”
Reuters notes an official within the Trump administration and three former White House officials said the termination of the 2013 auditing deal was under careful consideration.
There’s been very little information about withdrawing from the agreement — the discussions so far point to increasing frustrations by the Trump administration over Chinese companies failing to disclose critical financial data.
And maybe the Trump administration has a point, due mostly because in April, Chinese company Luckin Coffee, trading on the Nasdaq, crashed 85% in one day over allegations it fabricated $300 million sales.
The Trump administration has recently pressured pension funds for federal employees to stop investing in Chinese companies for risks that could result in malinvestment — such as what happened to Luckin Coffee.
In June, President Trump demanded the Securities and Exchange Commission (SEC) and PCAOB to recommend new measures within 60 days to protect investors “from the failure of the Chinese government to allow PCAOB-registered audit firms to comply with United States securities laws.”
The Republican-led Senate has passed a bill if approved by the Democratic-led House of Representatives and signed into law would prevent any foreign entity from listing stock on US exchanges unless they had three years of consecutive audits that meet PCAOB standards.
Republican Senator Marco Rubio, a China hardliner and sanctioned by the Chinese government on Monday for his involvement over sanctioning Chinese officials last week for their human rights abuses against minority Uighur Muslims, described the move as “long overdue” and said more measures are needed.
“In addition to terminating this MOU [Memorandum of understanding], which allows Chinese companies to openly defy USS laws and regulations for financial transparency and accountability, we must address the Chinese Communist Party’s exploitation of USS capital markets, which is a clear and ongoing risk to USS economic and national security,” Rubio said in a statement to Reuters.
Hayman Capital’s Kyle Bass said, “The MOU represents a gaping hole in US investor protections while providing the framework for systemic Chinese fraud,” adding that, “It’s unconscionable that the United States continues to allow Chinese companies raising trillions of dollars from US investors to avoid complying with basic USS securities and audit standards.”
Simmering Sino-US tensions could derail the rally in global stocks as the US appears to kick financial decoupling with China into overdrive ahead of elections.
Wells CEO Is “Extremely Disappointed” With First Quarterly Loss Since 2008; Massive Dividend CutTyler DurdenTue, 07/14/2020 — 08:18
While JPMorgan at least had a stellar trading quarter to offset another surge in loan loss reserves (i.e. balance sheet deterioration vs income statement improvement), Wells Fargo just had the ugly balance sheet to flaunt and boy was it ugly.
For the second quarter, Warren Buffett’s favorite bank reported a Q2 loss per share of 66 cents, down sharply from the $1.30 profit a year ago, and far worse than the 13 cent loss consensus estimate. More importantly, this was the first time Wells posted a quarterly loss since 2008,confirming that this is indeed the biggest crisis since Lehman.
And while it was widely expected that the bank would cut its dividend of 55 cents, with the bank saying last month that it would cut the dividend to comply with the new restrictions the Federal Reserve brought on payouts, consensus expected the cut to be to 20 cents per share. Which is why when Wells unveiled that its new dividend would be just 10 cents (from 55 cents previously), it led to even more disgust with — and selling of — one of the worst performing stocks of 2020.
A few other Bloomberg headlines from what was a catastrophic quarter for Wells:
2Q Rev. $17.84B, –17% Y/Y
2Q Net Interest Margin 2.25%, Est. 2.33%
2Q Loans $935.2B, Est. $1T
2Q Net Interest Income $9.9B, Est. $10.32B
2Q Total Average Loans $971.3B, +0.7% Q/Q
2Q Incl $8.4B Boost in Credit Loss Reserve
2Q Efficiency Ratio 81.6%, Est. 70.4%
View of Length, Severity of Downturn Deteriorated
There was more. Consensus also got a kick in the groin after Wells reported that its Q2 provision for credit losses would be a whopping $9.5BN, double the $4.86BN expected, and consisting of $8.4 billion increase in the allowance for credit lossesas well as $1.1 billion of net charge-offs for loans. The provisions were 17 times the amount taken a year agoand double last quarter’s,when we warned the number was not nearly enough.
How did Wells get to this $8.4BN number? Well, the bank first laid out its total allowance for credit losses, which was a paltry 2.19% of the $935BN in loans outstanding, of just $20.4BN, meaning that the full losses will be orders of magnitude higher…
… which then prompted the following frentic discussion, attempting to justify the surge in reserves… which unfortunately will not be nearly enough.
It’s about to get much worse, though, because as Wells conveniently highlighted it has some $146BN in commercial real estate loans, most of which will be impaired in the coming months amid a record delinquency and default wave.
But wait, there’s even more, because as of Q2, JPM also has $32.7BN in total oil and gas loan commitments, of which $12.6BN are currently outstanding.
Finally, the cherry on top is that all this is happening as Wells Net Interest Margin just plunged to the lowest ever as rates are preparing to go negative.
With all that in mind, perhaps nobody summarized Wells’ dismal quarter better than CEO Charlie Scharf:
“We are extremely disappointed in both our second quarter results and our intent to reduce our dividend. Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter.”
Scharf also said the dividend cut to 10 cents, half the consensus estimate, reflected “current earnings capacity assuming a continued difficult operating environment, evolving regulatory guidance, and protects our capital position if economic conditions were to further deteriorate.” Plus, “regulatory commitments” remain the bank’s top priority, Scharf said.
To be sure, the stock was just as disappointed:
What can help the stock here? Probably nothing… except perhaps for Buffett to fully liquidate his entire holdings.
* * *
Here is the full Q2 earnings slideshow (pdf link)
“There seems to be something wrong with out stock markets…”
A few weeks ago I was sucked into the positive vibe of surprisingly strong economic numbers and a sense the virus was diminishing.I was expecting stocks to have hit new record levels in June. For a moment on Monday, it felt like they did as the S&P turned briefly positive on the year… but then it faded. It felt like the last bloom of a fading rose….
Markets feel tired – I expect we’re in for long summer stuck in a rut. The economic data looks more sobering while the virus is still burning its way through the sunshine states, and threatens a southern hemisphere resurgency. Expectations aren’t quite what they once were…. For the meantime…
As Q2 Earnings season accelerates… just how painful could it get?
Not at all if Governments have any say:
The US budget deficit has topped $3 trillion, 14% of GDP, the largest share since WW2. In June, US government spending touched $1.1 trillion, as tax revenues crashed by 28% to $241 – a deficit of $864 bln! Over $3.3 trillion. Of Federal cash has already been earmarked to support recovery, but the economy is still wheezing badly. A rising tide of corporate crisis, and renewed shut-downs in the US, means Congress will support yet another round of emergency spending to keep the economy from collapse later this month when the first round of emergency measures end.
Europe will be having a make or break meeting later this week to push the €750 bln recovery plan. Merkel has put her credibility behind it – but the Frugal five northern countries are set to say “Non”. The whole thing is effectively an Italian bailout – and like all plans intending to resolve Italian debt it will prove too small, never-ending and ineffective.
Here in the UK, Rishi Sunak has already thrown the kitchen sink at the crisis and is now stripping lead off the roof for the next bailout. Apparently wearing masks is going to allow us to reopen the economy, and we’ve all got to go back to work… Yep.. I am so looking forward to queuing to get on a train (20% max capacity) and then waiting even longer to get on a lift (3 people max per lift…)
These are three very different perspectives of the crisis highlighting;
i) the enormous fiscal implications across the occidental economies of massive government spending (we still don’t know how it will be paid for),
ii) the political ramifications, and
iii) the actual practicalities of reopening economies when we need to socially distance.
I could write much more about broken supply chains and the effects of such large swathes of the economy remaining shuttered… but we all know it.
What happens next?
What’s the glue holding markets together in these fractious times? Clearly that’s the amount of liquidity the global central banks are providing though QE Infinity and other support programmes. Some investors characterise these as Central Bank puts on the market – and believe it gives unlimited upside to stock markets.
If that’s true.. then we really are in trouble.
Financial markets have been the cornerstone of Capitalism’s success by efficiently allocating scarce capital to the best businesses. Private enterprise was disciplined to ensure returns to attract capital. Markets worked. The private sector proved vastly superior at generating wealth than government bureaucracies that squandered it. The failure of command and control economies (from Russia to France) highlighted just how attractive market economies could be.
But, accelerated by the last few months of Coronavirus, we’ve seen the complete breakdown of the financial markets as efficient allocators of capital. Markets have become little more than parasites, feasting on government bailouts and central bank QE Infinity programmes. The massive disconnect between the real economy and looming recession versus frothy global stock markets is unprecedented. Rising stocks suggest record earnings, while tumbling bond yields send the contradictory signal of economic calamity.
Equity players are no longer focused on the strength of company managements, their earning potential, their credit worth or their ability to pay dividends. All that matters is how much prices will continue to rise as governments rescues and central bank money buoys them up through unlimited monetary policy distortions.
Fund managers are blithely buying corporate bonds, junk bonds and emerging market debt on the expectation they will all tighten, rising in price, as a result of Central Bank QE. They aren’t particularly worried about the coronavirus recession, or whether it will be V, U, W or L shaped. They don’t particularly care about company risk metrics either. As long as the Central Bank is prepared to buy, then they are effectively guaranteed against default.
These are very dangerous assumptions for any investor to make.
I reckon the toughest job on the street today is probably being a corporate credit investor.
No matter how much glue you slather over the broken structure of markets, eventually they will be just too broken. I suspect we might be getting to that stage in corporate debt. There is only so much money that can be uselessly thrown at Zombie bust companies.
Bankruptcies across retail businesses are bound to leave a mark – for each high-street store that goes bust, a landlord is left with an unpaid rental, and a bank has to up its expected LGDs and provision on its corporate mortgage lending. Each company that’s fully drawn down all its bank lines, managed to raise a cheeky bond issue during April’s debt orgy, has taken advantage of every single government bailout/lending scheme, but is still facing a lack of parts to reopen its factories, and finds its customers are still shut, is facing a simple dilemma – how long can it remain solvent? Its choices are limited… cutting costs by shedding staff…
Shareholders might think the rising stock markets will bail them out as earning crash out – but when the solvency equation runs flat… they will be wiped as debtors carve up the bones of the company. If you are wondering why distressed debt is the best paid gig in town – that’s why.. The DD vultures are circling Zombie companies looking to pick up cheap debt – and expect first dibs at the carcass when the inevitable happens.
Despite all the liquidity central banks are chucking at the system – corporate defaults are going to soar…More and more companies will tumble into fallen angel status – losing investment grade status the longer the economy remains partially closed.
So…. it might sound perverse to suggest that corporate debt might also be a highly attractive market in which to invest. As I’ve written above, there is a massive Zombie sector, but there is also a healthy vibrant SME sector – where debt is proving difficult to access; because banks won’t lend, these companies are too small for public or private debt markets, and government schemes too byzantine to access.
There are a number of credit funds doing direct lending into the SME sector. One of the top performing SME funds is our own Shard Credit Partners – happy to introduce you to them – institutional investors only. By focusing on strong-credit fundamentals and the underlying business the SME lenders illustrate the real issue:
The coming crisis in Corporate Debt is not sudden, it’s a long-term disease that’s been developing for years – since the last crisis.Ultra-low interest rates and QE has sustained too many broken companies for years – crowding out smaller, more nimble, smarter and fundamentally sound SMEs.
If you want a healthy corporate herd, you need to weed out the infirm, the sick and weaklings – brutal, but necessary.We need space for new, vibrant firms more likely to create jobs, growth and generate overall wealth. That’s the way market capitalism should work.