Credit deflation and the reflation cycle to come (part 2)

[sancho panza]

2 hours ago, planit said:

You are getting closer but you are still missing something on the company financial statement 'equity' is.

 

Debt and Equity are both the same things on the balance sheet.

It is money that the company owes back to someone that has lent them money.

 

The only difference is that on the Debt side (liabilities), the company is obliged to pay the lender cash, even if they can't afford it.

Exactly the same loan would be equity if the agreement said the company only needs to pay the money if it can afford it. (normally, the equity also has a promise to a certain share of the company in return for having no promise of money) 

 

To illustrate the difference in value of market cap take this as an example:

I have knowledge in my head to be able to print free legal money. But I need a printer.

 

So I start a company and issue 100 shares of £1 each. You give me £50 for 50 shares and I also put in £50.

I buy the printer so the balance sheet looks like this:

Assets - (printer) £100

Equity - (ordinary share capital) £100

 

It is clear that your shares are worth much more than £1 as you have an expectation of millions in future earnings. 

So the market value of the shares might be £10m each, market cap £1bn.

The equity on the accounts still shows £100. The accounts are backwards looking and don't include the value the company adds or internally generated goodwill. If the accounts included 'everything' then you are correct, the market cap would equal the equity section and investing would be really boring.

 

Just realised I have recreated Teslas accounts in the example above, just that all the investors believe Musk has a printer and he doesn't LOL.

I appreciate the explanation there Planit.We're sort of talking around the same issue.To me,equity is what's left for the owners/shareholders after all teh debts have been paid ie if they cashed up the business and sold off the assets to pay liabilites.So whilst the notional value of the equity in the business might remain the same aside from rights issues,the equity would see a likely rise in retained earnings to which the common stock holders are netitled in a cashing up scenario

 

The key issue with UK banks is that they're claimed equity is signficantly higher than their market cap.So Mr Market is saying that those retained earnings sat on the balance sheet are likely going to needed to cover loan losses.Happy to be educated here as I'm a paramedic not an accountant.But as I see it there are periods when Mr market takes a dim view of the claimed equity eg when BT hit £1,but that pricing mismatch didn't last too long.

quick examples

company          market cap   equity(claimed equity)

HSBC               91bn              196bn

RBS                  24.3bn          44bn

Rio Tinto          100bn            47bn

BT                     18bn               12bn

GSK                   68bn              14bn

 

[Harley]

2 hours ago, planit said:

You are getting closer but you are still missing something on the company financial statement 'equity' is.

Debt and Equity are both the same things on the balance sheet.

It is money that the company owes back to someone that has lent them money.

The only difference is that on the Debt side (liabilities), the company is obliged to pay the lender cash, even if they can't afford it.

Exactly the same loan would be equity if the agreement said the company only needs to pay the money if it can afford it. (normally, the equity also has a promise to a certain share of the company in return for having no promise of money) 

.......

Honestly, not wanting to be "difficult", but IMO that is incorrect.  They are different both conceptually and in their financial accounting treatment.  It would take a reasonably long anorak session to explain so I'd rather not!

[sancho panza]

2 hours ago, JMD said:

That 3% (gross!) yield would give me sleepless nights i think.

SP, i've been meaning to ask before about a BTL'ers own residential home being at risk if he/she defaults on their BTL mortgage, but keep missing the opportunity, so here goes...

If the btl property is owned within a ltd company is that still the case? Or is it more nuanced, say for example if the BTL deposit funds came originally from remortgaging the residential property? Or maybe its just that all/most btl mortgage contracts have a 'nasty claw-back clause' in the small print?

No,any sane person doing BTL would use a ltd company imho,then the liability is li8mited to the assets within that company.The quid pro quo here is that that will lift your mortgage rates as the risk is different.

Quick example

LL owns his own home-£300k equity on a £500k pad.Buys two more for £200k in his own name both levered at 75% so borrowing £300k.

Recession hits,two BTL's drop by 30% because they're new build (16% new build premium and say 14% of love from Mr Market),so now worth £280k.LL loses tenants,can't funds mortgages,banks repo at a £20k loss on resale.

They get CCJ against LL, put a charge on his house for the £20k.They look at the £200k first charge on his main family home,look at the 30% loss(the LL also bought a new build so 16% NBP and 14% Mr market) work out his hosue is now worht £350k(LL still owes £200k-that hasnt changed) and force a sale to get their £20k back( the reason they'd do this while there's £150k equity is that if you force a sale as second charge,if the fisrt charge sufgfers any losses,you're laible for them-so say they forced a sale of his hosue and it only went for £180k,they'd owe the firest charge £20k plus nurse their own loss of £20k)

Hope that explains it.

 

 

Edit to add:this is classic Fisher's theory of debt deflation,forced asset sales force asset prices down which begets more forced aset sales.

The clearing out of the zombie players.

[Castlevania]

10 minutes ago, sancho panza said:

No,any sane person doing BTL would use a ltd company imho,then the liability is li8mited to the assets within that company.The quid pro quo here is that that will lift your mortgage rates as the risk is different.

Quick example

LL owns his own home-£300k equity on a £500k pad.Buys two more for £200k in his own name both levered at 75% so borrowing £300k.

Recession hits,two BTL's drop by 30% because they're new build (16% new build premium and say 14% of love from Mr Market),so now worth £280k.LL loses tenants,can't funds mortgages,banks repo at a £20k loss on resale.

They get CCJ against LL, put a charge on his house for the £20k.They look at the £200k first charge on his main family home,look at the 30% loss(the LL also bought a new build so 16% NBP and 14% Mr market) work out his hosue is now worht £350k(LL still owes £200k-that hasnt changed) and force a sale to get their £20k back( the reason they'd do this while there's £150k equity is that if you force a sale as second charge,if the fisrt charge sufgfers any losses,you're laible for them-so say they forced a sale of his hosue and it only went for £180k,they'd owe the firest charge £20k plus nurse their own loss of £20k)

Hope that explains it.

The flip side is that once inside a limited company it’s a commercial loan. There can be a myriad of terms that wouldn’t apply for a buy to let mortgage e.g. a minimum amount of equity/loan to value ratio must be held at all times. Plus it’s easier for a bank to call in.

[Majorpain]

26 minutes ago, sancho panza said:

The key issue with UK banks is that they're claimed equity is signficantly higher than their market cap.So Mr Market is saying that those retained earnings sat on the balance sheet are likely going to needed to cover loan losses.Happy to be educated here as I'm a paramedic not an accountant.But as I see it there are periods when Mr market takes a dim view of the claimed equity eg when BT hit £1,but that pricing mismatch didn't last too long.

quick examples

company          market cap   equity(claimed equity)

HSBC               91bn              196bn

RBS                  24.3bn          44bn

Rio Tinto          100bn            47bn

BT                     18bn               12bn

GSK                   68bn              14bn

Yes, HSBC has near 3T of assets and its only takes a small writedown for that 196bn of equity to be wiped out.  It doesn't help that in the current zero interest rate environment banks are struggling for profitability.

[Harley]

29 minutes ago, sancho panza said:

The quid pro quo here is that that will lift your mortgage rates as the risk is different.

Directors can still be asked for personal guarantees?

[sancho panza]

12 minutes ago, Castlevania said:

The flip side is that once inside a limited company it’s a commercial loan. There can be a myriad of terms that wouldn’t apply for a buy to let mortgage e.g. a minimum amount of equity/loan to value ratio must be held at all times. Plus it’s easier for a bank to call in.

Absolutely CV.I know little about the T+C's of commerical loans.

One aspect of life as a BTLers that isn't consdiered much is how T+C's LTV ratios can force the pace of asset sales the famed 'margin calls' of paddles on ToS.

Never used yet still in the T+C's of most BTL mortgages.

I would asusme the margin requirements for commerical loans would be sginifcantly higher than BTL loans?

Does make me wonder how a bank like RBS will be able to weather a 10% drop in hosue prices and CRE let alone a 20% drop.

[sancho panza]

Just now, Harley said:

Directors can still be asked for personal guarantees?

as @Castlevania has pointed out,tehre are a raft of downsides potentially for commercial laons,I was merely pointing out that if I was BTLing on a leveraged basis,I'd opt for the Ltd co route,even if I made less money.

If they asked me for a personal guarantee,then I'd look a the risk reward

[jamtomorrow]

12 minutes ago, Majorpain said:

Yes, HSBC has near 3T of assets and its only takes a small writedown for that 196bn of equity to be wiped out.  It doesn't help that in the current zero interest rate environment banks are struggling for profitability.

The gearing on that is incredible - market only needs to update its estimate of the bad loans in that 3tn by 1% to move the share price by 30%

[sancho panza]

Great Lyn Alden interview here.So much in it but at the 1hr mark she has a 'if Lyn was in charge' section where she talks about the difficult choices that will be faced and then says best solution is fiscal spending very much along lines @DurhamBorn has pushed from day one.,.

 

 has some other sections on oil-supply issues building,loooks good for decade,market fragility issues etc.gold etc

 

So good,too much for me to go through in written form.

 

 

5 minutes ago, jamtomorrow said:

The gearing on that is incredible - market only needs to update its estimate of the bad loans in that 3tn by 1% to move the share price by 30%

Eye watering isn't it?It's like the High St is buzzing with footfall and people are in bidding wars for office floor space in the city.

[Harley]

13 minutes ago, Majorpain said:

Yes, HSBC has near 3T of assets and its only takes a small writedown for that 196bn of equity to be wiped out.  It doesn't help that in the current zero interest rate environment banks are struggling for profitability.

I've previously mentioned the bad state of the balance sheets of many large companies.  IMO, not all assets are equal and many companies are just shells, unless you have a fetish for goodwill  and the like.  I'm expecting a balance sheet bloodbath at some point on the basis we get one every now and then as we cull the accumulated excesses.  Market wide, not just banks by a long way.  That's how I invest atm. 

[Harley]

12 minutes ago, sancho panza said:

as @Castlevania has pointed out,tehre are a raft of downsides potentially for commercial laons,I was merely pointing out that if I was BTLing on a leveraged basis,I'd opt for the Ltd co route,even if I made less money.

If they asked me for a personal guarantee,then I'd look a the risk reward

It was a question.

[Noallegiance]

4 hours ago, Green Devil said:

If i was starting again, id go down the benefits route.

In the nicest possible way, I don't believe you.

This forum is to the brim with people trying to be their own solution rather than adding to the problem. That takes something many of the masses don't possess. I'm not even sure how one sets about 'getting' whatever that thing is. 

The irony of you being here to post such a thing is not lost!

Please accept my virtual hug. I, too, have felt many times over the past few years where "Fuck it and join 'em" has crossed my mind. But I never do. In fact, I double down in the opposite direction.

What a world humanity is.

[Castlevania]

46 minutes ago, sancho panza said:

 

Does make me wonder how a bank like RBS will be able to weather a 10% drop in hosue prices and CRE let alone a 20% drop.

Banking book accounting. You don’t mark to market. So generally speaking they will only write down the value of the loan once the borrower has failed to make a payment.

[Castlevania]

51 minutes ago, Harley said:

Directors can still be asked for personal guarantees?

They can, although not sure if it’s prevalent as a condition of a buy to let loan within a limited company. 

[Mapper]

1 hour ago, sancho panza said:

The clearing out of the zombie players.

Ahh, takes me back!

Those were the days

[planit]

2 hours ago, sancho panza said:

I appreciate the explanation there Planit.We're sort of talking around the same issue.To me,equity is what's left for the owners/shareholders after all teh debts have been paid ie if they cashed up the business and sold off the assets to pay liabilites.So whilst the notional value of the equity in the business might remain the same aside from rights issues,the equity would see a likely rise in retained earnings to which the common stock holders are netitled in a cashing up scenario

 

The key issue with UK banks is that they're claimed equity is signficantly higher than their market cap.So Mr Market is saying that those retained earnings sat on the balance sheet are likely going to needed to cover loan losses.Happy to be educated here as I'm a paramedic not an accountant.But as I see it there are periods when Mr market takes a dim view of the claimed equity eg when BT hit £1,but that pricing mismatch didn't last too long.

quick examples

company          market cap   equity(claimed equity)

HSBC               91bn              196bn

RBS                  24.3bn          44bn

Rio Tinto          100bn            47bn

BT                     18bn               12bn

GSK                   68bn              14bn

 

You need to separate banks from other companies, their business is money so it is nearly 100% recognised on the balance sheet. This is different from most other companies.

 

When you take those assets and adjust them for perceived risk then you end up with the negative value.

The more risk a bank takes, the more money is should make in the future but also the assets are more risky so the discount on those items might be more.

 

 

[JMD]

2 hours ago, sancho panza said:

No,any sane person doing BTL would use a ltd company imho,then the liability is li8mited to the assets within that company.The quid pro quo here is that that will lift your mortgage rates as the risk is different.

Quick example

LL owns his own home-£300k equity on a £500k pad.Buys two more for £200k in his own name both levered at 75% so borrowing £300k.

Recession hits,two BTL's drop by 30% because they're new build (16% new build premium and say 14% of love from Mr Market),so now worth £280k.LL loses tenants,can't funds mortgages,banks repo at a £20k loss on resale.

They get CCJ against LL, put a charge on his house for the £20k.They look at the £200k first charge on his main family home,look at the 30% loss(the LL also bought a new build so 16% NBP and 14% Mr market) work out his hosue is now worht £350k(LL still owes £200k-that hasnt changed) and force a sale to get their £20k back( the reason they'd do this while there's £150k equity is that if you force a sale as second charge,if the fisrt charge sufgfers any losses,you're laible for them-so say they forced a sale of his hosue and it only went for £180k,they'd owe the firest charge £20k plus nurse their own loss of £20k)

Hope that explains it.

 

 

Edit to add:this is classic Fisher's theory of debt deflation,forced asset sales force asset prices down which begets more forced aset sales.

The clearing out of the zombie players.

Thanks SP, just Googled and last year 'only' half of btl purchases were purchased via ltd co's, which did surprise me. And this was apparently the highest % ever. So if one included previous purchases, the vast majority of btl properties must be held outside of a ltd company structure.

Good discussion i think, first came zombie companies (infected by zombie debt), now we have zombie landlords (feasting off furloughed/zombie tenants)!! ... a true Dawn of the Dead economy, eh?

 

[JMD]

2 hours ago, Harley said:

I've previously mentioned the bad state of the balance sheets of many large companies.  IMO, not all assets are equal and many companies are just shells, unless you have a fetish for goodwill  and the like.  I'm expecting a balance sheet bloodbath at some point on the basis we get one every now and then as we cull the accumulated excesses.  Market wide, not just banks by a long way.  That's how I invest atm. 

Harley, would you have a min. tangible/intangible asset ratio, maybe even for the different individual sectors, that you'd care to share? Just asking because you have previously, for example, mentioned your min. 3% divi. preference. Only i'm currently reviewing my 'BK shopping list' for if/when we get a BK, and of course so many companies are beaten up debt-wise, so i am finding it difficult to decide what is/isn't acceptable.    

[Talking Monkey]

4 hours ago, Don Coglione said:

Which one?

Atlas Shrugged is pretty hard going at times.

The Mandibles is a must-read. Lionel Shriver gets it.

The Mandibles I looked it up earlier today sounds a bit like how I expect the 2030s are going to be, hopefully reality turns out not as bad as the book

[TNS]

5 hours ago, Noallegiance said:

In the nicest possible way, I don't believe you.

This forum is to the brim with people trying to be their own solution rather than adding to the problem. That takes something many of the masses don't possess. I'm not even sure how one sets about 'getting' whatever that thing is. 

The irony of you being here to post such a thing is not lost!

Please accept my virtual hug. I, too, have felt many times over the past few years where "Fuck it and join 'em" has crossed my mind. But I never do. In fact, I double down in the opposite direction.

What a world humanity is.

This, as long as the masses conform (much like the covid bollox) nothing will change. Houses are the be all and end all of the UK. Nothing else matters. 

Disclaimer, Joined the rat race in 2018.

[Harley]

4 hours ago, JMD said:

Harley, would you have a min. tangible/intangible asset ratio, maybe even for the different individual sectors, that you'd care to share? Just asking because you have previously, for example, mentioned your min. 3% divi. preference. Only i'm currently reviewing my 'BK shopping list' for if/when we get a BK, and of course so many companies are beaten up debt-wise, so i am finding it difficult to decide what is/isn't acceptable.    

Nice question.  That's not the main ratio for me but I get there by looking at other ratios and data.  I wrote a post going through the process for one of the stocks someone mentioned as an example but didn't post it in the end!  I do that sometimes so as not to bore, etc!

But the process in a nutshell....

Step #1 - run a stock screener each week against my exchanges of interest:

. .....

. Price to book ratio < 3 (but only to catch outliers, aim for 2)

. Any sector/industry

. ......

Step #2 - review fundamentals:

. ......

. Balance sheet intangible assets c.10% of total equity max

. Shareholder equity positive net of intangibles

. ......

Step #3 - consult Simply Wall Street

. ......

Step #4 - perform a technical analysis

. ......

Step #5 - update results to make next week easier!

Basically a sniper waiting for the right target to come into view!  Very conservative and not for the adventurous types but I've had me time!   Needs to be tuned to individual circumstances and goals so do ya own.  That said, many of these ratios would have been considered reckless a few years ago!  I don't buy much especially atm, and very little tech!  The killer ratio for me is price to tangible (not total) book value but not all brokers provide that so I jump through some extra hoops to get a similar result.

 

[Majorpain]

6 hours ago, Harley said:

I've previously mentioned the bad state of the balance sheets of many large companies.  IMO, not all assets are equal and many companies are just shells, unless you have a fetish for goodwill  and the like.  I'm expecting a balance sheet bloodbath at some point on the basis we get one every now and then as we cull the accumulated excesses.  Market wide, not just banks by a long way.  That's how I invest atm. 

Just spotted this, good timing!  I can see how you think the majority of US Market is of dubious value, intangibles are worth little in an insolvency situation, especially goodwill. 

[UnconventionalWisdom]

On 06/06/2021 at 16:05, DurhamBorn said:

These wages are nowhere near enough when you consider you can get a job putting a few bolts in for £23k a year.There is going to be a huge skill shortage going forward,employers have had all the cards for 30 years,but not anymore.

Why is this? I'm seeing a lot of people moving jobs at the min. Has the been a big shift in skillset over the past few months? Or just the extra liquidity due to QE is making companies hot up? I just got poached by a startup in london. Alright money, share options and the company has just raise $15million. I pulled out of talks at Xmas as i had a medical setback and needed an op. I thought they'd move on but contacted me again 3 months ago. They are hiring a lot but think they are struggling to find the right people.

[sancho panza]

4 hours ago, JMD said:

Thanks SP, just Googled and last year 'only' half of btl purchases were purchased via ltd co's, which did surprise me. And this was apparently the highest % ever. So if one included previous purchases, the vast majority of btl properties must be held outside of a ltd company structure.

Good discussion i think, first came zombie companies (infected by zombie debt), now we have zombie landlords (feasting off furloughed/zombie tenants)!! ... a true Dawn of the Dead economy, eh?

 

According to a 2018 parliamentary asset paper on BTL it was then around the 94% in individual names.The reason it's lifted so high is that section 24 has bascially neutralized the tax advantage to holding in an individuals name.That figure of 50% would also be from a lower total as less people piling into it now.

here it is.Loads of good stats in it.

Interesting to see as well how many own multiple properties pushing them into the 40% tax braket with S24.

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/775002/EPLS_main_report.pdf