Ramsey,
Given some of my bearish posts in the past, I am not shy about expressing negative views and I do not think the Mexican debt situation should simply be ignored. However, I have been a direct participant in the banking sector since my partner and I acquired a publicly-traded thrift (Local Federal HQ'd in Oklahoma City) in 1989 and then proceeded to "roll-up" several insolvent institutions through FSLIC-assisted transactions. Having spent several years working out problem loans of all sorts, I can assure you that the points of differentiation are not as clear as you portray them. As a matter of fact, it was a deadly mix of deregulation, tax reform and fraud/gross stupidity that created the thrift crisis in the first place.
To wit, many of the troubled thrift loans in Texas were associated with real estate development (there is a subtle difference). Developers borrowed money to purchase raw land, fund infrastructure improvement and, yes, build out the bricks and sticks. Development loans exposed the institution to a very different risk profile compared to single-family or multi-family (i.e. apartment) credits. How would you classify loans to nursing homes or ACLFs (adult congregate living facilities)? Sure, there was a real estate asset collateralizing the credit, but when we took over, Local Federal has roughly $15mm of nursing home loans that were on the books for somewhere between 35K and 40K per bed. No sane person would (or could) spend $30,000 per bed to build a nursing home, so clearly the thrift had made a business loan disguised as a real estate loan.
Few people understand the role that federal tax reform played in the crisis. Prior to the tax bill, marginal rates were much higher but individuals were allowed to deduct passive losses dollar-for-dollar. As a result, many real estate projects (particularly office buildings) were undertaken with a business plan that contemplated cash-flow breakeven and reported losses after depreciation charges. So a $10mm office building, built with minimal equity, 10% debt and depreciated over 20 years, would have a rental income budget of something like $1.3mm. $1mm would go to the bank for interest, $300K would pay day-to-day operating expenses and taxes and the operation would net out cash flow breakeven. Reported net income, however, would be a loss of $500,000 after depreciation expense. Prior to tax reform, the bank was happy (it got repaid), the owners were happy (they got a $500,000 tax deduction worth $400,000 on a tax-adjusted basis) and lessees were happy (there was plenty of cheap office space around). Unfortunately, after tax reform, the tax benefit disappeared and the economy dipped a little bit. Suddenly the building's owners had no return on their investment and were forced to go out of pocket for operating and interest expenses as occupancy dropped. So they bolted and put the building back to the bank/S&L. The bank had to then find a new owner and this person wanted a positive cash-on-cash return. Assuming that the building was still generating $1.1mm to $1.2mm in rental income, and deducting $300K in operating expenses, such a buyer would probably pay no more than $4.5mm to $5.5mm for the asset. So the S&L saw $5mm "disappear" on a "safe" $10mm real estate loan.
The Japanese situation is different and structurally worse. A financial bubble led buyers to bid real estate prices to ridiculous levels--tulip mania plain and simple--aided and abetted by 90% to 100% financing. Post bubble, this same real estate is worth 70%-80% less than the loans against it. Meanwhile, the cross-linkage between banks and business created a situation where uneconomic businesses were not allowed to fail, and even worse, were given additional capital to expand. The result is a surfeit of excess, uneconomic industrial capacity and a black hole of bad loans the extent of which the Western world can only guess about.
As I keep saying, the Mexican situation is just not that bad. Yes, there is corruption, and yes, the government got stuck with a bunch of bad loans, but the underlying economic fundamentals are much healthier. The same corporations that are looking to shutter capacity in North America and Asia are simultaneously looking to relocate this production to countries like Mexico. Yes, the economy has taken a hit due to falling commodity prices, particularly oil. But the problems are not as deeply structural nor as intractible. And, as I keep repeating, the U.S. government cannot, and will not, allow a Mexican financial collapse ala Asia. We understand that such a collapse would put more Mexicans over the border, and that we would end up on the hook financially anyway (i.e. through social benefits, reduced American employment etc.).
If your objective is to be worried, then there is nothing I can say to change your mind. But I really believe that Mexico will work through these problems and that its debt crisis will have little to no impact on Qualcomm.
Best regards,
Gregg |
