It didn’t take long for the euphoria on the US bailout to evaporate. Uncertainties about the plan will continue to dog markets, not only because details of the bailout are still sketchy, but also depending on the news about its execution.
But there’s one more reason for the markets to be skittish. The conversion of investment banks Goldman Sachs Group Inc. and Morgan Stanley into commercial banks also means they will be allowed lower leverage, or use of borrowed funds to finance investments. Reports indicate that when it collapsed, Lehman Brothers Holdings Inc. had about a 30:1 debt-to-equity ratio. Morgan Stanley also has a debt-to-equity of 30:1, and Goldman Sachs, about 22:1.
Also See Fear Gauge (Graphic)
Commercial banks have much lower leverage ratios. The question is: Will the two investment banks have to sell assets to lower their leverage? If so, it will exacerbate the ongoing deleveraging. These worries sent the US KBW Bank index down 10.5% on Monday, though it’s still way above its lows in mid-July. The US volatility index, or Vix, known as the fear gauge, closed Monday at an elevated 33.85, well below the high of 42.16 (intra-day) hit during the panic Thursday last week, but still high.
The impact of the uncertainty on Asian and Indian markets can be seen from widening bond spreads. At the beginning of September, the spread on the ICICI Bank Ltd five-year bond was 435 basis points; on Tuesday, the spread had widened to 537 basis points. The iTraxx Asia ex-Japan high-yield index, a key measure of risk aversion, has widened to 660 basis points, from 560 on 1 September. One basis point is a hundredth of a percentage point.
The Reserve Bank of India has done what amounts to a token attempt to increase external commercial borrowing inflows by increasing the cost ceiling on maturities of more than seven years from 350 basis points over six months Libor (London interbank offered rate) to 450 basis points only for borrowers in the infrastructure sector. Many infrastructure projects have maturity periods of less than seven years.
While the objective is to ensure finance for infrastructure is readily available, there’s no reason why the relaxation wasn’t made for shorter periods and also borrowing for corporate purposes. Market reports indicate bidding for the so-called third-generation radio spectrum auction may have something to do with it.
The move was perhaps also aimed at stabilizing the rupee and continues the central bank’s attempts to do so by hiking deposit rates on non-resident Indian deposits and intervening in currency markets.
But it’s unlikely to have much impact, says A.K. Prasanna of ICICI Securities Ltd, not only because of capital outflows on account of risk aversion, but also because investors would like to wait and watch for policies that a new government will put in place after the elections.
Jaguar-Land Rover financial numbers look surprising
Auto maker Tata Motors Ltd disclosed the much-awaited financial details of Jaguar and Land Rover (JLR) in its rights issue prospectus. The income statement is fraught with extraordinary adjustments, so it makes more sense to look at earnings before interest, tax and exceptional items. The chart alongside shows that the performance has been improving consistently over the past five years. In 2004, JLR had losses amounting to more than 10% of revenues. In the first six months of this year, it has reported a profit of about 9% of sales.
Based on these numbers, much of the markets’ fears about the acquisition look unfounded. Many analysts had assumed that JLR was loss-making. JLR’s latest offering, the XF sports sedan, helped boost volumes. It accounted for more than 57% of all Jaguar sales in the first half period.
But some analysts are still taking the reported numbers with a pinch of salt and wonder if the profit margin for the first half is sustainable. With the state the world economy, particularly the high-paying financial sector, is in, demand for luxury cars is expected to take a hit. Worse still, cost-cutting opportunities are limited because of the agreements Tata Motors has with JLR employee unions.
Also See Impressive Climb (Graphic)
One disappointment about Tata Motors’ latest disclosure is the lack of a cash-flow statement and a management discussion on the financial performance. One of the qualms the investor community has had about the JLR acquisition is the lack of availability of financial details. While the rights prospectus does provide new financial information, there are some things investors would still like to know.
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