September 2019 – Nick Corbishley

Metro Bank Teeters after Bond Sale Fails. Shares Collapsed 95%

Hedge-fund manager Steven Cohen and Michael Bloomberg are among those ruing the day they bought the crushed shares of the UK bank touted as a “bargain.”

Even by its own recent standards, Metro Bank has had a torrid week. On Monday, shares of the British retail bank tumbled 5%, on Tuesday, 25%, on Wednesday, 5%, and on Thursday, 4.5%, before staging a brief comeback in the final hours of trading on Friday, to end the week 35% lower. By Friday morning, it was the second most-shorted stock on the FTSE all shares index, behind the collapsed travel & vacation-giant Thomas Cook.

The main trigger for this week’s rout was the bank’s failure on Monday to raise a much-needed £250 million by issuing non-preferred bonds that deeply skeptical investors spurned. Despite trying to lure buyers with an interest rate of 7.5%, double the rate of similar offerings, Metro only attracted £175 million worth of orders, prompting the embattled lender to pull the plug on the bond sale.

“Failure to get enough support for a product that is yielding 7.5% is quite remarkable when you consider how investors are struggling to find generous levels of income in the current market,” said Russ Mould, the investment director of AJ Bell. “It suggests that investors don’t trust the bank or they believe the 7.5% yield is simply not high enough to compensate for the risks of owning such a product.”

Metro Bank opened for business in 2010, becoming Britain’s first new high street bank in over 100 years. One of a handful of so-called “Challenger Banks” — new retail lenders created after the crisis to provide a little more banking competition in a country where the five biggest banks control a staggering 85% of the market — Metro Bank proved particularly adept at luring disillusioned clients from the big banks.

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Thomas Cook Collapses, up to 600,000 Travelers Stranded in Hotel & Airline Chaos, Triggers “Biggest Peacetime Repatriation in UK History”

Rescue deal fell through at the last moment. China’s Fosun and other shareholders are toast. Creditors get to fight over the debris.

Thomas Cook, the global travel & vacation-giant with its own airline and hotels, with 21,000 employees globally — 9,000 of them in the UK — and a 178-year history, ceased operations with immediate effect early Monday morning after failing to raise the £200 million of additional funds being requested by its main creditors to complete its rescue. The British government also refused to step in at the last minute to bail out the company.

The travel group has been placed into compulsory liquidation, as opposed to administration, meaning the business will be wound down. The immediate result has been chaos in holiday destinations across Europe, North Africa and North America. As many as 600,000 holidaymakers — 150,000 of them Brits — were left stranded abroad, many of them not knowing how they’re going to get home or whether they have a hotel room left to stay in.

Hotel groups are normally paid by tour operators two to three months after the travelers have already taken their holidays. Now that Thomas Cook is no longer a going concern, some hotels may ask holidaymakers either to leave, or cough up extra to remain in the hotel. In Tunisia, holidaymakers at one resort said they were barred from leaving unless they paid a £1,680 fee to cover the costs of their trip.

Thomas Cook package holiday customers are covered by Atol – Air Travel Organiser’s Licence – which protects accommodation and return flights, but payment can take some time to materialize. The UK Civil Aviation Authority said it is contacting hoteliers and other companies likely to be hit by the Thomas Cook collapse to assure them they will get reimbursed.

The government is also mobilizing its largest ever peacetime repatriation plan, code-named Operation Matterhorn, which will involve planes chartered from other airlines including British Airways and easyJet and is expected to set taxpayers back at least £600 million.

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“Hidden Debt Loophole” Becomes Popular with Australian Corporations

Situation already so bad that hiding debt becomes a priority?

Australian engineering group UGL, which is working on large infrastructure projects such as Brisbane’s Cross River Rail and Melbourne’s Metro Trains, recently sent a letter to suppliers and sub-contractors informing them that as of October 15, they will be paid 65 days after the end of the month in which their invoices are issued. The company’s policy had been, until then, to settle invoices within 30 days.

The letter also mentioned that if the suppliers want to get paid sooner than the new 65-day period, they can get their money from UGL’s new finance partner, Greensill Capital, one of the biggest players in the fast growing supply chain financing industry, in an arrangement known as “reverse factoring”. But it will cost them.

Reverse factoring is a controversial financing technique that played a major role in the collapse of UK construction giant Carillion, enabling it to conceal from investors, auditors and regulators the true magnitude of its debt.

Here’s how it works: a company hires a financial intermediary, such as a bank or a specialist firm such as Greensill, to pay a supplier promptly (e.g. 15 days after invoicing), in return for a discount on their invoices. The company repays the intermediary at a later date. This effectively turns the company’s accounts payable into debt that is owned a financial institution. But this debt is not disclosed as debt and remains hidden.

In its letter to suppliers, UGL trumpeted that the payment changes would “benefit both our businesses,” though many suppliers struggled to see how. One subcontractor interviewed by The Australian Financial Review complained that the changes were “outrageous” and put small suppliers at a huge disadvantage since they did not have the power to challenge UGL. Some subcontractors contacted by AFR refused to be quoted out of fear of reprisal from UGL.

Reverse factoring is that it can be used by companies to create the illusion of cash flow, reduce the appearance of debt, and mask the true state of their leverage ratios. UGL’s massive parent company, CIMIC, has been accused of doing just that by Hong Kong research group GMT. Since the allegation went public, in May, CIMIC’s shares have lost 38% of their value.

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Who’ll Rescue Thomas Cook, the Collapsing Vacation-Travel-Airline Giant with 21,000 Employees?

Shareholders are already toast. Would China’s Fosun conglomerate follow the time-honored principle of throwing good money after bad?

Following yet another bleak week of trading, the shares of 178-year-old British global travel & vacation-giant and airline Thomas Cook, with 21,000 employees globally — 9,000 of them in the UK — are down to 5 pence, down 96% from 130 pence in May last year. At that time, Thomas Cook Group was worth £2.5 billion. Today, its worth a paltry £75 million.

The company now has just one lifeline left: a proposed £900 million rescue deal that would see its biggest shareholder, Chinese conglomerate and investment giant, Fosun, inject £450 million in return for a 75% stake in the group tour operator and a 25% stake in the group airline. Banks and bondholders would match that amount with a debt for equity swap in return for control of 75% of the equity of the Group Airline and up to 25% of new equity in the group tour operator.

Current shareholders would be virtually wiped out by the restructuring despite the company’s reassurances that they would “continue to retain an investment in the Company.”

Thomas Cook says it needs at least an additional £750 million to pay its suppliers and tide it over this winter. That’s on top of a £300 million credit line it already took out in May. Now, the company’s creditors are asking for more.

But there are still no guarantees that the refinancing and debt restructuring deal will work. In a court filing dated August 30, Thomas Cook warned that it was running out of time to secure its future. “The serious liquidity issues within the group have led to an urgent need to complete any restructuring within September.” According to a Sky News report published on Thursday, the deal needed to secure the restructuring looked “harder and more complicated than it did a few days ago.”

There appear to be three main obstacles:

One, a clutch of hedge funds that hold credit default swaps (CDS) on Thomas Cook’s debt are considering derailing the rescue plan in order to ensure they receive payouts on their CDS. According to Bloomberg, the proposed debt-for-equity swap, if successful, could wipe out compensation on their default insurance.

Two, Thomas Cook’s pension fund is also clamoring for improved terms in exchange for backing the recapitalization. Sources cited by Sky News said trustees of the pension fund are “seeking equity in the restructured company, funding guarantees and a commitment from the new owners to continue existing annual contributions of more than £25 million.”

Three, lenders are now demanding that Thomas Cook seek additional funding beyond the £900 million outlined last month to cover its £1.6 billion debt overhang. According to Sky, the company will need to raise an extra £100 million to close the deal.

Whether it comes up with that money will depend on how committed Fosun is to the restructuring deal.

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Contagion from Liquidity Crunch at Junk-Bond Funds to Trigger “Material Second Round Effects”: EU Securities Regulator

The costs of dodging negative interest rates.

In the event of a market shock, 40% of European funds focused on junk-rated bonds — ironically named “high-yield” funds — would not have enough liquid assets on hand to meet investor withdrawals, even if the withdrawals in one week amount to only 10% of the fund’s net asset value, the European Securities and Markets Authority (ESMA) warned this week, raising yet more concerns about the risks associated with the liquidity mismatch at funds that offer daily redemptions while holding illiquid assets that can take much longer to sell at survivable prices.

In the wake of liquidity problems at H2O Asset Management and the recently gated £3.7 billion Woodford Equity Income Fund, two UK-based firms that remain under ESMA authority until (or unless) the UK leaves the European Union, central banks and financial regulators have issued a string of warnings about the liquidity risks posed by open-ended funds.

Bank of England governor Mark Carney caused consternation in the fund industry by saying that open-ended funds like Woodford’s are “built on a lie, which is that you can have daily liquidity for assets that fundamentally aren’t liquid.” They could even pose a systemic risk, the Bank of England warned in July. Similar concerns have been raised in recent weeks by the European Systemic Risk Board, the Bank for International Settlements, the International Monetary Fund and the G20’s Financial Stability Board.

Now, it’s the turn of Europe’s top securities regulator to sound the alarm. As part of what it calls a “pure redemption shock simulation,” the regulator examined roughly 6,600 bond funds that were set up under UCITS (Undertakings for the Collective Investment in Transferable Securities), the EU regulatory framework for mutual funds. These UCITS funds had an aggregate net asset value (NAV) of €2.5 trillion. ESMA wanted to determine how these funds would cope if investors demanded redemptions worth the equivalent of 10% of a fund’s value in a week.

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These Incidents Raise New Questions about the Security and Operability of the Banking System in Mexico

For now, it’s deny, deny, deny.

For seven hours on Friday, three of Mexico’s four biggest banks, BBVA, Citibanamex and Banorte, suffered payment system failures at exactly the same time, leaving millions of consumers unable to withdraw money from ATMs, make payments with their credit or debit cards, or access their online and mobile accounts.

From noon, many of the banks’ customers vented their anger on social media, complaining that they could not carry out transactions of any kind, whether in physical cash (because there was no way of withdrawing money), with their cards or on mobile platforms. While the mayhem caused by the outage may have been short lived, the timing could not have been worse, coming on the Friday of the second quinzena (fortnight) of the month, when most of the country’s workers get paid and huge amounts of money are spent.

Rumors quickly spread that the outage was the result of problems with the Bank of Mexico’s SPEI interbank transfer system, an iteration of the SWIFT global payment system that already suffered a series of cyber attacks last year. BBVA, Mexico’s biggest bank, even said that its system had been disconnected from SPEI for 33 minutes, resulting in a massive pile up of interbank transfers.

The Bank of Mexico — Banxico for short — was quick to quash the rumors, insisting that SPEI was in perfect working order and that any problems that had occurred processing bank payments and transfers were the result of internal issues within the three banks. It was a bizarre claim, given that the chances of Mexico’s three biggest banks suffering virtually identical payment outages at virtually exactly the same time are minuscule.

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Bank of Mexico Raises Alarm About Mexico’s Economy

“Particularly worrisome” is that this slowdown “has taken place in a context where the US economy is growing above potential.”

The bad omens are stacking up for Mexico’s faltering economy as both domestic consumption and investment dry up while the challenges facing the country’s heavily indebted state-owned oil giant, Pemex, continue to rise. That’s the broad conclusion in the minutes of the latest meeting of the Bank of Mexico’s governing board.

Mexico’s benchmark index, the BMV IPC, has fallen 15% in the last year. For the first time since December 2018, the Mexican peso is once again below the all-important psychological level of USD$0.05 (or 20.07 pesos to $1), after having fallen by 6% in the last month, due in part to the emerging market jitters set off by Argentina’s latest woes, which resulted in yet another selective default on its debt that markets expect to expand to a full default on its foreign-currency debt.

Then, of course, there’s Pemex, whose $100 billion of debt is perilously close to receiving a downgrade from investment-grade to junk from the second ratings agency. If that happens, the state-owned company would become the largest “fallen angel” in history, which will probably lead to the forced selling of more than $10 billion of its bonds as well as a possible downgrade of Mexico’s sovereign debt.

As if all that wasn’t enough, the economy has stopped growing, having registered a barely perceptible 0.1% second-quarter rise in real GDP, after shrinking 0.3% in the first quarter. Following in the footsteps of U.S. rating agencies, the IMF and a clutch of domestic and international banks, the Bank of Mexico — Banxico for short — sharply revised downward its 2019 GDP forecast for Mexico, from a range of 0.8%-1.8% to 0.2%-0.7%. It was the fifth time this year it had slashed its growth forecast.

Some board members described the recent slowdown as “greater than anticipated”. While global economic pressures are partly to blame — in particular the risks posed by the China-U.S. trade war, Brexit, a slowing European economy, and continued failure to ratify the United States-Mexico-Canada Agreement (USMCA) — what is “particularly worrisome”, said one board member, is the fact that this slowdown “has taken place in a context where the US economy (Mexico’s biggest trading partner) is growing above potential.”

Mexican exports continue to perform fairly strongly. But domestic consumption and investment are both sliding. According to central bank data, consumption growth has been declining for years, from 4.3% in 2016, to 3.1% in 2017 and 2.3% in 2018, but the trend appears to be intensifying. At last count, in May 2019, the annualized rate of growth was 0%. The consumption growth of durable goods is already in negative territory for this year, pointed out one board member, despite robust growth in both remittances — transfers of money by workers of Mexican descent mostly in the US but also other countries to individuals in Mexico — and wages.

Private investment, particularly in construction and in the purchase of imported machinery and equipment, is falling sharply…

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