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Brussels seeks to help banks offload rising tide of bad loans

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Brussels is planning to lay out a raft of proposals in a bid to make it easier for EU banks to offload soured loans as it anticipates the risk of a pandemic-related wave of corporate distress.

A European Commission paper due to be published in December will discuss ideas including boosting secondary markets for buying and selling non-performing loans (NPLs) and creating a network of national bad banks across the EU. It will also seek to tackle anomalies in the bank capital regime for distressed assets. 

Europe is braced for a surge in insolvencies once national business support programmes lapse next year. Brussels officials told the Financial Times that the commission wanted to avoid the mistakes made in the last financial crisis more than a decade ago, when a failure to quickly tackle NPLs impaired banks’ ability to bolster lending once the recovery gathered strength. 

“Drawing lessons from the last severe economic crisis, it is imperative to address a renewed build-up of NPLs on banks’ balance sheets — as early as possible — in order to combat the implications of the pandemic,” the commission said.

“Further structural measures” might be needed to “prevent the accumulation of NPLs over the medium term”, the commission said.

The report has not yet been completed and is expected to be released in the middle of the month. It is being spearheaded by new financial services commissioner Mairead McGuinness.

A key focus is on the private market for the sale and purchase of bad loans, as officials seek to ensure banks can offload NPLs and keep their books in order. 

The European Banking Authority has put forward data templates to help investors analyse NPLs, but these are not heavily used, and officials want to boost uptake and further enhance information available to investors — something the European Central Bank has long advocated.

Among the ideas in play are making the templates mandatory or creating a central data hub for the region. Brussels also wants to tackle discrepancies in the risk weights attached to NPLs in standard bank models, which can vary depending on whether the assets are being bought and sold. It will discuss best practices in national insolvency and debt recovery regimes.

Although it will float the idea of a network of national asset management companies, a proposal for a Europe-wide bad bank set out by Andrea Enria, chair of the ECB’s supervisory arm, has not won traction in Brussels. 

Bad banks were used to clean up Spanish and Irish banks after the 2008 financial crisis, but lawyers have questioned whether they could in some situations trigger more recent rules requiring bondholders to be wiped out before public money is used to rescue a bank.

Mr Enria warned in October that “in a severe but plausible scenario non-performing loans at euro area banks could reach €1.4tn, well above the levels of the 2008 financial and 2011 EU sovereign debt crises”.

Nicolas Véron, a senior fellow at the Peterson Institute for International Economics, said that while there was a plausible scenario under which there would be a jump in NPLs next year, it was hard to make a confident assessment in advance.

“There are certainly concerns at this stage that the secondary market for distressed assets is not functioning as well as it could, that there are not enough buyers out there,” he said. “The market is by no means frozen, or dead, but if you take steps like creating an optional public platform it can only help.”

The eurogroup of finance ministers will on Monday attempt to strike a deal aimed at bolstering the single currency area’s banking sector by agreeing on the early implementation of a long-awaited backstop to its bank resolution fund. 

One of the key questions remaining to be resolved is whether banks in southern Europe are deemed by northern capitals to have made sufficient progress in paring back risks on their balance sheets, including by reducing NPLs.

Total NPLs in the biggest 121 eurozone banks more than halved in six years to €506bn, or 3.2 per cent of their loan books, by the end of last year. But Greek banks still have NPL ratios of more than 30 per cent. 

The ECB warned in its twice-yearly financial stability review last week that “the economic fallout from the pandemic will likely continue to weigh on banks’ asset quality in the latter part of 2020 and into 2021”.



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Rio Tinto set to start negotiations over Mongolian mine

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Rio Tinto is set to start face-to-face negotiations with the government of Mongolia as its seeks to complete the $6.75bn expansion of a huge copper project in the Gobi desert. 

The Anglo-Australian group is sending a team of senior executives to the capital Ulaanbaatar to try and hammer out a new financing agreement so that the development timeline can be maintained and underground caving operations can start later this year.

The discussions will focus on a number of issues including tax, a new power agreement and benefit sharing, according to people with knowledge of the situation.

Some government officials want Rio to pay more than $300m of withholding taxes on income it has received from Oyu Tolgoi LLC, the Mongolian holding company that owns the mine. 

Rio receives a management service fee for running Oyu Tolgoi’s existing open pit and the underground project as well as interest on money it has lent the government to fund its share of the development costs.

However, the officials say it is “very difficult, if not impossible” to engage constructively on the issue because the payments are the subject of arbitration in London.

For its part, Rio believes the issue of withholding taxes is dealt with in the separate investment and shareholder agreements that cover its operations in the country.

The underground expansion of Oyu Tolgoi ranks as Rio’s most important growth project. At peak production it will be one of the world’s biggest copper mines, producing almost 500,000 tonnes a year.

Although Rio runs the existing operations and is in charge of the underground expansion project it does not have a direct stake in the mine.

It’s exposure comes through a 51 per cent stake in Turquoise Hill Resources, a Toronto-listed company. TRQ in turns owns 66 per cent of Oyu Tolgoi LLC, with the rest controlled by the government of Mongolia. 

The project has been beset by difficulties and is already two years late and $1.5bn over budget. The government said earlier this year that if the expansion is not economically beneficial to the country it would be necessary to “review and evaluate” whether it can proceed.

To that end the ruling Mongolian People’s party and its new prime minister Luvsannamsrain Oyun-Erdene are trying to replace the Underground Development Plan with an improved agreement.

Signed in 2015, this sets out the fees that Rio receives for managing the project as well as the interest rates on the cash Mongolia has borrowed to finance its share of construction costs.

However, it was never approved by Mongolia’s parliament and has become a focal point for critics who say the country should receive a greater share of the financial benefits.

Rio, which recently appointed a new chief executive, has told the government it is prepared to “explore” a reduction of its project management fees and loan interest rates as well as discuss tax.

However, analysts are sceptical that the two sides will be able to put a new agreement in place by June when a decision on whether to start caving operations must be taken if Oyu Tolgoi is to meet a new target for first production in October 2022.

Rio is also at loggerheads with TRQ on how to fund the cost overruns at Oyu Tolgoi. Last week, TRQ’s chief executive resigned after Rio said it planned to vote against his re-election at its annual shareholders’ meeting.

In a statement, Rio said it was committed to working with TRQ and the government of Mongolia to enable the successful delivery of the Oyu Tolgoi Project

“Aligning and co-ordinating our joint efforts to resolve the concerns of the Government . . . going forward is of the highest priority,” it said.



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Value investor John Rogers sees an end to Big Tech’s stock market dominance

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The veteran value investor John Rogers predicted the US is headed for a repeat of the “roaring twenties” a century ago that will finally encourage investors to dump tech stocks in favour of companies more sensitive to the economy.

The founder of Ariel Investments told the Financial Times in an interview that value investing “dinosaurs” like him stood to win as higher economic growth and rising interest rates took the air out of some of the hottest stocks of recent years.

Rogers, who has spent a near four-decade career focused on buying under-appreciated stocks, said the frenzied buying of special purpose acquisition companies, or Spacs, signalled frothiness in parts of the market, even while a coming economic boom underpinned other share prices.

“This will be a sustainable recovery. I think there’s going to be kind of a roaring twenties again,” Rogers said, adding that the strength of the economic recovery would surprise people and challenge the Federal Reserve’s ultra-dovish monetary policy.

The US central bank is “overly optimistic that they can keep inflation under control”, he said, and higher bond market interest rates would reduce the value of future earnings for highly popular growth stocks such as tech companies and for the kinds of speculative companies coming to market in initial public offerings or via deals with Spacs.

“Spacs are a sign that growth stocks are topping. A signal that the market is frothy,” said Rogers, a self-styled contrarian and famed for his Patient Investor newsletter for clients that debuted in 1983.

Value investing is based on identifying cheap companies that are trading below their true worth, an approach long espoused by Warren Buffett. Value stocks and those sensitive to the economic cycle boomed after the internet bubble burst in 2000, but the investment strategy has been well beaten over the past decade by fast-growing stocks, led by US tech giants. 

“We’ve been looking like the dinosaurs for so long,” said Rogers. “We’ve been waiting for that booming economic recovery since 2009.”

Proponents of value investing believe that the combination of expensive growth stock valuations and a robust recovery from the pandemic will cause a significant switch between the two investing approaches.

Higher bond market interest rates reduce the relative appeal of owning growth stocks based on their future earnings power.

When 10-year bond yields rise, “growth stocks look way, way too expensive versus value,” said Rogers. “Value stocks are going to come out of the recovery very strong, they’re going to have a tailwind from an earnings perspective. Their earnings are going to be here and now, not 20, 30 years down the road.”

The Russell 1000 Value index outperformed the equivalent growth index by 6 percentage points in February, rising 5.8 per cent versus a drop of 0.1 per cent for the growth index. That was the biggest outperformance for value since March 2001, according to analysts at Bank of America.

“Although rising rates triggered the rotation, we see a host of other reasons to prefer value over growth,” the analysts wrote last week, “including the profit cycle, valuation, and positioning that can drive further outperformance.”

Rogers said he expected higher overall stock market volatility from rising interest rates this year but value should reward investors as it did “20 years ago once the internet bubble burst”. Ariel is bullish on “fee generating financials” and Rogers said preferred names included KKR, Lazard and Janus Henderson, while it was also bullish on traditional media, including CBS Viacom and Nielsen.

Chicago-based Ariel is one of the few large black-owned investment companies in the US, with $15bn of assets under management. It manages the oldest US mid-cap value fund, dating from 1986. 



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High-priced tech stocks sink further into bear market territory

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Some of the hottest technology stocks and funds of recent months have fallen into bear market territory and investors are betting on more turmoil to come, as rising bond yields undermine the case for holding high-priced shares.

A Friday afternoon stock market rally notably failed to include shares in Tesla and exchange traded funds run by Cathie Wood, the fund manager who has become one of the electric carmaker’s most vocal backers.

Shares in Tesla fell 3.6 per cent on Friday to close below $600 for the first time in more than three months, although it had been down as much as 13 per cent at one point. The stock is down 32 per cent from its January peak, erasing $263bn in market value.

Wood’s $21.5bn flagship Ark Innovation ETF — 10 per cent of which is invested in Tesla shares — also closed lower on Friday. It is now down 25 per cent and in a bear market, defined as a decline of more than one-fifth from peak.

Clean energy funds run by Invesco, which were last year’s best-performing funds, are also in bear market territory, along with some of the highest-flying stocks in the technology and biotech sectors.

“Bubble stocks and many aggressively priced US biotechnology stocks have been the hardest hit segments of the equity market,” said Peter Garnry, head of equity strategy at Saxo Bank.

The tech-heavy Nasdaq Composite index fell into correction territory — defined as a decline of more than 10 per cent from peak — earlier this week but rebounded 1.6 per cent on Friday as bond yields stabilised.

The yield on 10-year US Treasuries yield briefly rose above 1.6 per cent early in the day after a robust employment report for February buoyed confidence in a US economic recovery. Yields were less than 1 per cent at the start of the year.

Rising long-term bond yields reduce the relative value of companies’ future cash flows, hitting fast-growing companies particularly hard.

These type of companies figure prominently in thematic investing funds run by Wood at Ark Investments. The performance of Ark’s exchange traded funds has abruptly reversed after they recorded huge inflows and strong gains for much of the past 12 months.

“The speculative tech trade is in various stages of rolling over right now,” said Nicholas Colas, co-founder of DataTrek, a research group.

Bar chart of  showing Hot stocks and funds enter bear market territory

RBC derivatives strategist Amy Wu Silverman said investors were still putting on hedges in case of further declines in high-flying securities, including options that would pay off if Tesla and the Ark Innovation fund drop in value.

The number of put options on the Ark fund hit an all-time high on Thursday, according to Bloomberg data. By contrast, demand for put options on ETFs such as State Street’s SPDR S&P 500 fund — which reflects the broader stock market — have fallen as stocks have dropped.

Demand for options normally slides as a stock or ETF slumps in value, given there was “less to hedge, since you got your down move”, Silverman said. The elevated put option activity on speculative tech stocks and funds was “suggesting investors believe there is more to go”, she said.

Even after the declines, stocks in the Ark Innovation ETF remain highly valued, with a median price-to-sales ratio of 22 versus 2.5 for the broader stock market according to Morningstar, the data provider.

Two of the fund’s other big holdings, the streaming company Roku and the payments group Square, were also lower on Friday, extending recent declines.

Ark’s other leading ETFs have also retreated sharply as air has come out of Tesla and other hot stocks. Tesla is the largest holding in Ark’s $3.3bn Autonomous Tech and Robotics fund and its $7.2bn Next Generation Internet ETF.

Wood has also taken concentrated holdings in small, innovative companies. Ark holds stakes of more than 10 per cent in 26 small companies across its five actively managed ETFs, according to Morningstar.

“These large stakes raise concerns around capacity and liquidity management,” said Ben Johnson, director of passive funds research at Morningstar. “The more of a company the firm owns, the more difficult it will be to add to or reduce its position without pushing prices against fund shareholders.”

Ark did not respond to a request for comment. The Ark Innovation ETF is still sitting on a performance gain of 120 per cent for the past year. It bought more shares in Tesla when the carmaker’s shares began falling last month.



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