Breakingviews Thu, 03 Nov 2016 08:27:49 +0000 en-US hourly 1 Scandal in Seoul masks bigger economic problems Thu, 03 Nov 2016 08:27:49 +0000 The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Seoul is in the grip of a “shamanistic” scandal. A row over a quirky confidante is buffeting President Park Geun-hye, prompting her on Nov. 2 to replace both her finance minister and prime minister. The depressing regularity with which such debacles rock South Korean business and politics highlights a problem with dodgy governance. But that is merely one aspect of a larger challenge: avoiding Japanese-style stagnation.

Even by Seoul standards, this has been an eventful few months, what with Samsung’s  exploding smartphones, a graft investigation at Lotte – another big conglomerate – and the collapse of container-shipping giant Hanjin Shipping. Now the focus is on Park’s ties with Choi Soon-sil. Choi’s father was influential earlier in Park’s life and was once described in U.S. cables as Korea’s Rasputin. “Shamanistic cult linked to president,” screamed one local headline.

At least investors are used to South Korean political blow-ups. Citigroup analysts note that leadership crises in the last 15 years or so have had a limited market impact. These episodes include relatives going to jail, a ferry catastrophe, and a presidential impeachment. And Park’s power was waning anyway. She lost control of parliament in April and had already started to look like a lame duck ahead of December 2017 elections.

But no-one should be too sanguine. As Gavekal economists argue, Korea looks awkwardly like Japan in the 1990s, with an ageing population, an overreliance on manufacturing, and rising financial leverage. Household debt totals 90 percent of GDP and public borrowings, considered broadly, another 75 percent, Gavekal says. Weak global trade and growth also hurt the country’s big exporters.

Tackling this head-on could require both government and central bank action. Morgan Stanley reckons the Bank of Korea could become the latest central bank to adopt so-called quantitative easing, a massive programme of government bond-buying, and may need to slash another 75 basis points from its policy interest rate – currently at 1.25 percent – by late 2017.

Shaking up Korea’s powerful conglomerates, or chaebol, would be an important plank of any structural overhaul of the economy. The silver lining to the latest bizarre scandal just might be that it moves public and political opinion towards deeper reform.

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Breakdown: Gauging the risks of a China crisis Mon, 31 Oct 2016 09:32:36 +0000 The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Can China avoid a financial crisis? That’s the question facing regulators and investors after a rapid rise in leverage in the world’s second-largest economy. The links between the official banking system and shadowy institutions have also grown deeper and harder for regulators to fathom. Breakingviews explains how the People’s Republic might avert a meltdown, but might find a credit crunch harder to dodge.

How big is the risk of a financial crisis in China?

The amount of debt in the Chinese system has exploded. Total non-financial credit has surged to around two and half times annual output by the first quarter of 2016, according to the Bank for International Settlements. Debt in the still-developing countryis now roughly the same relative to the size of the economy as in the richer United States.

Financial history shows that when debt outstrips GDP growth, accidents become more likely. But in China’s case, it’s not just the absolute increase in leverage that’s worrying. The speed at which debt has expanded also means there is an increasingly complex web of transactions and financial products which links China’s biggest banks with smaller peers and with shady financial institutions that operate outside the official safety net provided by the authorities.

So where are the trouble spots?

Chinese banks have added $7.1 trillion in new assets – equivalent to around two-thirds of GDP – since the end of 2014. Over the same period, deposits have only risen by around $3 trillion, according to official figures. Most of the increased lending is concentrated outside China’s four largest state-owned banks. That means smaller and medium-sized banks are competing hard for alternative sources of funding.

A few smaller lenders stand out. Industrial Bank, Zheshang Bank and Bank of Jinzhou now get almost half their funding from other financial institutions rather than depositors. That makes them more vulnerable to sudden shocks in confidence, which could prompt other banks to pull in lines of credit that are often rolled over on a daily basis.

Mid-sized and local city commercial banks are often the main sources of finance for local governments and property companies. Rather than relying on deposits, these banks frequently bundle up loans into wealth management products which are sold to retail investors or other financial institutions.

Those funds are then repackaged – often many times over – and traded between banks and other financial outfits such as asset management firms. This game of pass-the-parcel enables small banks to support lending in excess of their official balance sheets, while skirting rules that force them to set aside chunky provisions for loans that go bad.

What can go wrong?

The interbank market connects strong banks with weaker counterparts and shadowy lenders. Analysts estimate that over 80 percent of interbank lending is done on an overnight basis. The People’s Bank of China is trying to force banks to borrow for periods of seven or 14 days while making overnight funding more expensive. But it’s hard to tell whether the central bank has succeeded as banks don’t release data on the tenor of their interbank lending and borrowing.

Assume that China suffers a sharp correction in its dizzy property sector, or that a poorly run asset management firm collapses. Such a shock could hit the value of wealth management products issued by a smaller bank, prompting customers to withdraw funds or demand compensation.

This in turn could lead larger banks to scale back their interbank exposure to smaller lenders they perceive to be most at risk. Overnight borrowing costs would spike, forcing small banks to call in loans or launch a fire-sale of assets to meet maturing funds.

But won’t the PBOC come to the rescue?

China’s central bank can flood the market with liquidity and order state banks to keep lending to each other. But banks and non-bank financial institutions have become so entwined that regulators might not immediately know where the problems were.

Banks’ claims on non-bank financial institutions in China have surged from 11.2 trillion yuan ($1.65 trillion) at the end of 2014 to 25.2 trillion yuan at the end of August this year, according to thePBOC. The central bank could pour liquidity into the market as a whole, but wouldn’t be able to inject funds into the specific problem areas.

To see what might go wrong, take Shengjing Bank in the rustbelt province of Liaoning, which has seen the value of wealth management products it sells rise by 754 percent since the end of 2014, according to an analysis by Rhodium Group. Those products aren’t issued by the bank itself but by asset management companies or securities firms. Moreover, the principal isn’t guaranteed.

Nevertheless, the underlying assets are tied to the local economy, which is in recession. Though the wealth management products can be cashed in at short notice, the loans have a much longer life. Any disturbance could leave a funding squeeze.

So can China avoid a financial crisis?

It depends what you mean by a crisis. The PBOC can prevent the Lehman-style collapse of a major financial institution. It would also step in swiftly to halt a run on any bank – sending trucks full of cash to reassure depositors their money is safe. The government has the power to force banks, brokerages and insurance firms to help prop up troubled firms – much as it organised the stock market bailout in the summer of 2015. And as China has comparatively little overseas debt, the risk of foreign creditors suddenly yanking their loans is also quite small.

But if credit continues to explode, a correction looks increasingly likely. A decline or even a slowdown in lending could trigger a cascade of defaults starting in the non-banking financial sector, and then spilling over into smaller banks and the real economy. Whether you call it a crisis or not, that will certainly be painful.

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GE joining M&A frenzy would be no shocker Fri, 28 Oct 2016 17:24:10 +0000 The author is a Reuters Breakingviews columnist. The opinions expressed are his own. 

General Electric says it’s not planning to acquire Baker Hughes, contrary to news reports. But shareholders shouldn’t be shocked by the idea that the industrial conglomerate might take a look at the $23 billion oil-services firm. Since the panic of 2008 sparked an existential crisis at GE, the $258 billion GE has been on a massive diet plan. Today the company led by Jeff Immelt is fit for an offensive.

Since the crisis, GE has offloaded some $200 billion of financial assets, in the process shedding its designation as a systemically important financial institution, subject to intense regulatory and capital requirements. It also sold its appliances unit to Haier of China and NBC Universal to Comcast.

In eyeing up Baker Hughes, GE says it’s only considering possible partnerships, but it isn’t a crazy acquisition target. The oilfield specialist agreed to sell itself to rival Halliburton before U.S. antitrust watchdogs scuttled the combination earlier this year. Though that left Baker Hughes in the lurch – and worth less than the $35 billion Halliburton had offered – it pocketed a huge $3.5 billion break fee. And since then, energy prices have mostly stabilized.

Investing in the oil and gas industry now would make sense if GE really is positive on the long-term outlook for the sector, as it indicated in its third-quarter earnings discussion last week. What it called a “challenging environment” in the short term is equally an opportunity to get in early before an upturn. GE’s energy unit, led by Lorenzo Simonelli, accounted for just $3 billion of revenue in the quarter, less than half the top line of GE’s power division.

It’s the power arm, under Steve Bolze, that is showing GE’s board and its investors that the company is ready to return more fully to the M&A game with its handling of last year’s $13 billion acquisition of Alstom. GE has more than doubled its expectations for cost savings to $3 billion a year.

No wonder other divisions might see the chance to get involved. GE is bidding for Swedish 3D-printer maker Arcam and snapped up Germany’s Concept Laser. These are relatively small deals, but it’s only a matter of time before GE’s oil and gas business joins the action in a bigger way.

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Britain’s Brexit airbag can’t cushion everyone Fri, 28 Oct 2016 13:31:08 +0000 The author is a Reuters Breakingviews columnist.  The opinions expressed are his own.

Britain has an enchanted airbag that will cushion the impact of leaving the European Union. How it works is a mystery. But Japanese carmaker Nissan, which just agreed to increase production in its Sunderland factory because of unspecified reassurances from Prime Minister Theresa May, has had a glimpse. Not everyone affected by Brexit will be so lucky.

Carmakers in Britain exported vehicles worth 12 billion pounds to the EU in the 12 months up to the end of August, according to HM Revenue & Customs. Perhaps a quarter of that was Nissan, based on a Reuters analysis of the company’s filings. Maintaining access to the single market will be part of the horse-trading over Brexit. But assume that Britain is kicked out from 2019 and that all automotive exports to the continent are subject to the standard 10 percent tariff. In that worst-case scenario, May’s government would need to find 1.2 billion pounds a year to ensure the auto industry is protected.

Dishing out those kinds of subsidies would be a change of direction for the UK government. But they are doable. The narrow cost of offsetting car tariffs isn’t huge when compared with the 240 billion pounds the government plans to spend this year on social welfare. An equal levy on the 30 billion pounds of cars that Britain currently imports from the EU would more than cover the cost. A bung could be structured as a regional tax break, or a reward for creating new employment, to avoid trade partners slapping down punitive tariffs for perceived subsidies.

The question isn’t whether Britain can help Nissan, but whether it should. Helping out carmakers alone isn’t a terrible decision. While the northeast of England creates less value per job than the national average, the transport manufacturing sector creates far more – 76,100 pounds per person in 2013, compared with just under 50,000 pounds for the average UK worker, according to the Office for National Statistics.

By that measure the City of London ought to rest easy. The average financial services worker produces more than 100,000 pounds of output each year. The truth, though, is that saving banking jobs is less politically appealing. Use of the airbag is likely to be not for who produces most but who shouts loudest – and who gets in first. Picking winners means picking losers too.

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Emperor Xi gets new clothes Fri, 28 Oct 2016 09:10:04 +0000 The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

China’s president Xi Jinping has a flashy new title. The Communist Party has named him as its “core” leader – a moniker previously granted to icons like Mao and Deng but denied to his predecessor Hu Jintao. But Xi needs more than titles to implement tough reforms; he needs provincial allies and a viable vision for economic policy.

Xi’s control over the armed forces and security forces is stronger than that of any leader in decades, but his economic power is weak. That’s partly because officials are unclear about what he really wants. For example, state-owned enterprises are supposed to strengthen internal political controls. They are also supposed to improve market efficiency.

There’s also confusion over the wider economic restructuring plan. President Jiang Zemin presided over a painful overhaul of the state sector that put around 40 million people out of work. But Xi appears unwilling or unable to do anything similar; this time officials seem hysterically frightened of layoffs, even though an economic restructuring away from manufacturing into services should naturally entail a degree of temporary unemployment.

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The massive corruption crackdown has won plaudits from a public weary of graft, but it hasn’t produced the hoped-for economic yield. As in previous Chinese purges, the campaign focused on personalities, not institutions. But Xi can’t arrest his way to economic revival.

The Chinese president has yet to publicly elucidate a clear vision for economic policy, and the confusion shows. Under his regime, state-owned enterprises are consolidating and getting bigger. But they aren’t getting more efficient.

20161028 Asset-rich

Thus despite plans to cut steel capacity, output has risen year on year for the past seven months. Coal mines have also cranked up output when capacity cuts caused a spike in prices. Much of the recovery China enjoyed this year was led by ramped-up state-led investment, fueled by fresh credit expansion, not efficiency dividends.

The president might be able to command more loyalty within the party with his new title, but until the top stops sending mixed signals, economic reform can’t make much headway. Confusion at the core means glacial progress at the periphery.

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Viewsroom: AT&T’s dog of a deal Thu, 27 Oct 2016 18:54:25 +0000
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CEO Randall Stephenson’s $85 bln offer for Time Warner lacks strategic rationale, has politicians of all stripes criticizing it and has destroyed shareholder value while denying owners a vote. All it lacks – so far – is an activist shareholder demanding it be scrapped.

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AT&T deal may yet help more indie M&A shops Thu, 27 Oct 2016 18:00:08 +0000 The author is a Reuters Breakingviews columnist. The opinions expressed are his own. 

AT&T’s audacious $85 billion acquisition of Time Warner may yet help more independent M&A shops. The year’s biggest merger enlisted the services of boutiques Perella Weinberg and Allen & Co, alongside their bigger Wall Street brethren. If it emboldens other chief executives, the likes of Lazard and Moelis should benefit. They could use the help amid a patchy advice market.

Third-quarter results released this week have held up well despite a 22 percent decline in annual global deal volume, according to Thomson Reuters data. Only Greenhill reported a drop in M&A-related revenue from the end of June. It was nevertheless the boutique’s best showing in a while and top-line growth was 52 percent higher than a year ago. Lazard and Moelis, however, experienced little or no growth in merger fees from 2015.

The falloff from a record year of wheeling and dealing has taken its toll. Market values for Lazard, Greenhill and Moelis are each down by at least 10 percent this year. Meanwhile, shares of two of the top three M&A advisers – Morgan Stanley and JPMorgan – are up around 5 percent, while those of the third, Goldman Sachs, are down only slightly. Evercore stock, thanks in part to an industry-beating one-third increase in advisory revenue so far this year, is flat.

An uptick in new deals would help reverse this decline. The impact of merger fees on earnings is, after all, easier to divine than the ups and downs of trading stocks, bonds, currencies and commodities.

This week’s slew of announced transactions, including Qualcomm’s $47 billion agreed takeover of rival chipmaker NXP Semiconductors – which included Evercore, Centerview and Frank Quattrone’s Qatalyst among the list of advisers – is already having an effect. Lazard’s stock, for example, has jumped by almost a tenth since last Thursday’s market close. For investors, a few more mega-mergers could be enough to seal the deal.

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Resilient UK growth adds to policymakers’ quandary Thu, 27 Oct 2016 11:58:47 +0000 The author is a Reuters Breakingviews columnist.  The opinions expressed are her own.

The British economy barely broke its stride after the country voted to leave the European Union. This piece of good news poses a dilemma for finance minister Philip Hammond and Bank of England Governor Mark Carney. A quick dose of hefty stimulus becomes harder to justify, yet waiting to see whether things take a turn for the worse is a risky policy.

UK GDP expanded by 0.5 percent in the third quarter, according to data released on Oct. 27. The first official snapshot of how the overall economy performed after the EU referendum shows a slight slowdown from an unusually strong 0.7 percent rate of expansion in the second quarter. Yet it surpassed economists’ expectations and defied the doom-laden predictions that a “leave” vote would tip Britain into recession. Indeed, Britain’s national statistics office said there was little evidence of a pronounced economic impact in the immediate aftermath of the decision.


Strong expansion in the dominant services sector, particularly in consumer-focused industries like film and television, more than compensated for declines in production and construction. This gives Hammond fewer obvious reasons to deliver a big spending boost, while also diminishing the case for Carney to cut policy rates from already-record lows.

The problem is that things may get worse once Britain formally triggers the process of leaving the EU next year. The preliminary GDP reading – which is subject to revisions – gives no details of how business investment fared. This will be crucial in determining how fast the economy grows in the future and the potential for companies to take on new workers. Moreover, consumer spending may be an unreliable driver of growth if inflation picks up as sterling’s rapid slide boosts the price of imports. Rising prices will squeeze households’ spending power. Since they have already reduced their savings ratio, they could be forced to scale back consumption.

The problem for UK policymakers is that if they wait to act until there’s clear evidence of a slowdown, their response may come too late: Hammond currently only has two opportunities each year to tweak the fiscal levers. Giving the UK economy a hand before it’s crying out for help may still be the most prudent option.

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Samsung heir’s new job comes with tough to-do list Thu, 27 Oct 2016 08:17:54 +0000 The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Jay Y. Lee has a tough job ahead. Shareholders of Samsung Electronics voted on Oct. 27 to put the scion of the controlling family on the board. That makes his leadership role official just as the electronics giant grapples with the Galaxy Note 7 fallout and an activist investor’s demands. Lee’s accountability and signs of greater transparency come at the right time.

At first glance, Lee’s new role changes little at the $219 billion maker of everything from smartphones to chips. The 48-year-old had already been making key decisions at the company since his father and group patriarch suffered a heart attack in 2014. But as an executive director, Lee will now be under greater scrutiny and more directly accountable to shareholders.

His top priority will be to contain the financial and reputational damage from the Galaxy Note 7 debacle. The phones, some of which exploded, have now been discontinued. The episode dragged operating profit at Samsung’s mobile unit down to a near-eight-year low in the three months to September. And regaining consumer confidence in Samsung’s brand will be hard: with a new flagship device expected to launch in March, the company said it didn’t yet have an explanation as to what caused the overheating of the Note 7.

Lee will also have to face U.S. hedge fund Elliott Management for the second time. Just over a year after opposing a merger of two companies in the broader Samsung group, the activist investor earlier this month launched another attack on Samsung Electronics specifically. This time, Elliott is demanding that the crown jewel of the family-run conglomerate splits into two and pay out a special dividend, amongst other things.

Samsung Electronics is showing signs of greater transparency on both fronts. The company on Oct. 27 disclosed more information about the botched Note 7 recall, including for the first time naming the battery supplier of the initial faulty devices. And unlike in the earlier skirmish with Elliott, Samsung appears more willing to engage this time and said it would respond to the fund’s proposals by the end of November.

Western companies are usually more open, but in the conglomerate-dominated South Korea such conciliatory talk is a rare and encouraging departure. The next test will be Lee’s actions.

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Comcast schools AT&T on media M&A Wed, 26 Oct 2016 17:38:02 +0000

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

Comcast is schooling AT&T on media M&A. The $155 billion cable giant now gets more than a third of its revenue from NBC Universal, a deal it concluded in early 2013. The regulatory and political climate was more accommodating and Chief Executive Brian Roberts’ strategy sound. AT&T’s $85 billion bid for Time Warner, by contrast, is a dog’s breakfast.

The top line at NBC Universal, home to the Peacock Network, MSNBC and a giant movie studio, jumped 28 percent to $9.2 billion. Granted, the unit got a huge lift from broadcasting the Olympics in the United States. But even after stripping out the sporting event, revenue increased nearly 6 percent thanks to strong growth at its theme parks.

Comcast’s two-part deal for NBC Universal, which it bought from industrial conglomerate GE, was prudent by today’s standards. Regulators insisted on a variety of conditions before approving the deal, including that Comcast take a passive role in its ownership of video-streaming service Hulu. GE’s then-huge finance division was also under duress thanks to the financial crisis and the parent was eager to rid itself of media assets that made little sense in its portfolio of jet engines and capacitors.

By contrast, AT&T is paying a whopping $20 billion above Time Warner’s undisturbed market value. The cost savings cited by AT&T, some $1 billion, barely cover a third of the premium. The telecommunications giant also has little experience in producing TV shows and movies.

Roberts himself has learned some hard deal lessons. Comcast’s earlier attempt to take over Walt Disney was a failure. So too was his proposal to buy Time Warner Cable after trustbusters denied the union. AT&T argues it will have no problem sailing through the review process. Based on Time Warner’s shares, which are now trading $20 below the offer price of $107.50, AT&T may want to dial down the cockiness.

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