CCT5907 International Financial Statement Analysis
Term 1, 2023
1
Topics and Key Learning Objectives
1. FREQ Liquidity
Liquidity v. Solvency
Traditional liquidity ratios not useful
Analyse the payment schedule
– China Minsheng
– Singapore Airlines
2. FREQ Solvency
Solvency: a different way to calculate leverage
3. FREQ Asset quality
Westpac 2018 full year
Westpac scenarios
– FREQ asset quality impact on FREQ solvency
4. FREQ Off-balance sheet items Citigroup 2008
5. Other perspectives: including system or country level
2
Liquidity risk FREQ : Short term cash crunch
China’s US dollar debt defaults climb as coronavirus, US tensions hit firms’ bottom lines
https://finance.yahoo.com/news/chinas-us-dollar-debt-defaults-093000880.html
Liquidity crunch FREQ default Solvency FREQ: “Evergrande Warns of Looming Cash Crunch,
Spooking Investors”
https://www.bloomberg.com/news/articles/2020-09-24/evergrande-warns-of-looming-liquidity-crunch-spooking-investors
Evergrande
FREQ solvency (already over-leveraged and restructuring stalled)
FREQ liquidity
Liquidity v Solvency: not the same thing
Liquidity: short term cash crunch, business may be okay
Solvency: too much debt, unable to service, bankruptcy risk
Liquidity crisis may lead to Solvency crisis
Solvency crisis may lead to Liquidity crisis
Acceleration of debt (why default may result in Solvency crisis)
Default of interest payment? must pay entire loan
Other lenders will want their loans paid back
All lenders wants their money back immediately
https://www.sapling.com/8012721/mean-accelerate-loan
(not for presentation or examinable but to explain “acceleration” a securities law concept)
Update Feb 2022: https://www.bloomberg.com/news/articles/2022-02-11/china-moves-to-ease-developer-cash-access-evergrande-update
Sept 2022: https://login.wwwproxy1.library.unsw.edu.au/login?url=https://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=159080721&site=ehost-live&scope=site
Jargons alert: Default Bottom lines Market Confidence Liquidity crunch Liquidity v Solvency Monetary easing
3
Traditional liquidity ratios may not be completely informative?
(From reference text Eg 6.9 Comparing cash cycles, p244)
INFERENCE (depends on traditional or modern view)
Which company has best operating cycle/ cashflow management? HP / Dell
Which company has best Current Ratio? HP / Dell
Traditional view
CA / CL ≥ 1, better if ≥ 2)
Rationale: in a liquidity crisis can fire sell CA (will get less than face value) to pay CL
Negative working capital
CA – CL < 0, CA / CL < 1
Use other people’s money to run your business. Examples: Customer’s money Unearned
Revenue (CL), drag out payment to suppliers (A/P ≡ CL)
FREQ: Liquidity crisis for Dell & Lenovo? Neither
Explanation: you would be wrong if you had traditional view
FY (note the FYE date) 2009 2008 2007
Days Sales Outstanding (DSO) 38 35 36
Days Inventory on Hand (DOH) 8 7 8
Less: Days payable outstanding (DPO) (82) (67) (80)
Dell (36) (25) (36)
Lenovo (30) (23) (28)
Hewlett Packard 14 20 24
Receivables turnover
=Sales/Average Debtors
Inventory turnover
=COGS/Average Inventory
(Use Sales if COGS not available)
Payables turnover
=(COGS+OPEX)/Average
Payables
(Excluding D&A, interests and tax)
Days = 365/Turnover
Cash Conversion Cycle Days =
Receivables Days + Inventory
Days – Payable Days
(The shorter, the better the performance,
in general)
4
Alternative? Analyse payment schedule
Liquidity concerns both operating and financing payments
Traditional current and quick ratios, and cash conversion cycle may
only indicate liquidity to meet operating payments for goods and services
For financing related payments, identify when interest or principal
payment will fall due and if Company has sufficient cash/cashflow to cover.
This is especially true where term loans or listed debts exist.
“Cash-strapped China Minsheng Investment seeks money from its
employees”
https://www.reuters.com/article/us-china-minsheng-funding/cash-strapped-china-minsheng-
investment-seeks-money-from-its-employees-idUSKCN1SG11U?il=0
China Minsheng Investment Group (CMIG), among the country’s largest private
investment firms, is raising funds from its employees (?Company is desperate) as
it seeks to combat a liquidity squeeze
According to Refinitiv data, CMIG has 12 outstanding yuan bonds worth 29.75
billion yuan ($4.37 billion). It has also issued bonds worth $800 million through
Boom Up Investments Ltd, a subsidiary domiciled in the British Virgin Islands.
Note due Nov 2019: market thinks will default so bond price fallen below face
value
5
Another example: Singapore Airlines
Great analysis, concluding liquidity crisis and predicting a government bailout
‘SINGAPORE AIRLINES LTD (SGX: C6L) IS IN DEEP TROUBLE AND RIGHTS ISSUE CALL IS IMMINENT”
https://blog.investingnote.com/singapore-airlines-ltd-sgx-c6l-deep-trouble-rights-issue-call-imminent/
Check out the liquidity analysis of payment schedules of bond maturities
What was the outcome since a year has passed?
Subsequent event review….
See Singapore Airlines Limited 31 March 2021 Q4
presentation slide 26 (research exercise)
6
Solvency FREQ : How to calculate leverage
Deutsche Bank 'horribly undercapitalized' - U.S. regulator
https://www.reuters.com/article/us-financial-regulation-deutsche-
idUSBRE95D0X620130614
“A top U.S. banking regulator called Deutsche Bank's capital levels
"horrible" and said it is the worst on a list of global banks based on
one measurement of leverage ratios. … using a tougher leverage
ratio measurement - which compares a bank's shareholder equity to
its total assets without using risk-weightings … Deutsche's leverage
ratio stood at 1.63 percent, according to Hoenig's numbers, which
are based on European IFRS accounting rules as of the end of
2012.”
Basel III Leverage ratio framework – executive summary
https://www.bis.org/fsi/fsisummaries/b3_lrf.pdf
https://www.investopedia.com/terms/l/leverageratio.asp
(2 URLs to present together)
7
Solvency: How to calculate leverage (cont’d)
Accounting equation: A = L + E
Leverage as combination of any two items, eg
– A/E : accounting textbook preferred
– L/A : finance textbook preferred
– A/L, L/E : news articles sometimes
– E/A (in %)
Income statement: interest coverage
Will not be covered in this course
E/A: Hoenig prefers, previous slide (DrL agrees)
Capital adequacy regulatory requirements expressed in this way
although using regulatory definitions and not accounting definitions
(see Westpac material)
Lecture03 BalanceSheet.xlsx
See “My Balance Sheet”
Simplistic illustration of solvency analysis
8
Asset quality FREQ
measurement quality and liquidity quality
FREQ Asset quality
‘S&P Global expects coronavirus to cost banks $2.1 trillion”
https://www.reuters.com/article/us-health-coronavirus-banks-creditlosses-idUSKBN24A2B2
Expected credit loss model : Financial instruments for doubtful loans and receivables: Not examinable (taught in ACCT5943), but analyst should
understand the basic concept of (a) 12-month expected credit loss and (b) life-time expected credit loss for asset quality provision measurement.
https://www2.deloitte.com/content/dam/Deloitte/au/Documents/audit/deloitte-au-audit-applying-expected-credit-loss-model-trade-receivables-using-provision-matrix-030519.pdf
9
Why Westpac? Riskiest of Australia’s Big 4 banks
… also because it is where DrL put his paltry savings, so he did his homework to see if he
would lose his savings if a crisis occured
#2, 23% of Australian mortgage market (Presentation, p.37)
“Westpac to address asset quality, big mortgage switch”
https://www.afr.com/business/banking-and-finance/westpac-to-address-asset-quality-big-mortgage-switch-20180504-h0zo08
(AFR accessible via UNSW Lib, otherwise quotes below are sufficient)
“Westpac is more focused on mortgages than ANZ and NAB, and is the nation's largest lender to landlords.”
“Westpac is also the most sensitive of the big four banks to a sharp rise in short-term funding costs that appear to
have been triggered by US policy changes.”
Asset quality:
“Westpac was the subject of a bearish UBS research, which cut its recommendation to "sell" on concerns
about the bank's mortgage quality.”
“… the bank's lending standards was worse than previously assumed. The other banks fared better in
that [PwC] 2016 assessment.”
10
Westpac 2018 earnings announcement
Westpac 30 September 2018 Full Year Results
Overall Information Page
https://www.westpac.com.au/about-westpac/investor-centre/events-and-presentations/2018-presentations-and-agm/
Results Announcement (Management Discussions and Analysis - MD&A)
https://www.westpac.com.au/content/dam/public/wbc/documents/pdf/aw/ic/ASX_2018_Full_Year_Profit_Announcement.pdf
Overview structure: PR cover, ASX form cover, media release (asset quality, p.v; outlook, p.vi), results
(p.1-142)
Statutory net profit (GAAP) vs Cash earnings (p.iii); cash earnings description (p.5)
“While earnings were flat, our balance sheet remains strong across all dimensions of asset quality, capital
(=solvency), and liquidity.
“Westpac’s mortgage book remains fundamentally sound, with around 70% of Australian customers
ahead on repayments 2 and 90 day delinquencies remaining low.
Mr Hartzer said Westpac continues to focus on addressing issues that have been highlighted during the
Royal Commission into Misconduct in the Banking, Superannuation, and Financial Services Industry.
Presentation Pack
https://www.westpac.com.au/content/dam/public/wbc/documents/pdf/aw/ic/1H18_WBC_presentation_and_IDP.pdf
Note on p.61 income down 3% margin decline, customer remediation
11
Westpac’s Leverage Ratios
(See Results– MD&A document ,p.40-41)
Common equity Tier 1 capital ratio (CET1) 10.63%
Understanding movements
YoY: 30 Sep 2017: 10.56% ↗ 30 Sep 2018: 10.63%
HoH: 31 Mar 2018: 10.50% ↗ 30 Sep 2018: 10.63% (Half)
QoQ: 30 Sep 2018: 10.63% ↘ 31 Dec 2018: 10.4%
APRA leverage ratio: 5.84% (Results, p.141 definition)
Accounting (Hoenig): 64,573/879,592=7.34%
Leverage ratio using Basel: 6.48% (p.41, bottom table)
We know investors seem to focus on CET1 because it is discussed in the news
Reconciliation of regulatory and accounting capital (p.44)
Note what is deducted: goodwill, deferred tax assets, capitalised expenses
Because intangibles or accruals cannot be sold off separately in a solvency crisis, or are worth nothing
Regulatory to Accounting reconciliation is not examinable, but understanding why some items are deducted is
examinable
12
Westpac’s asset quality threats
Composition of Australian mortgage (presentation pack, p.18): See the I/O (interest only) trend reduction
Principle & interest: 61%
Interest only (investors): 35%, capacity to pay once I/O resets to P/I
I/O reset: $292b in mortgages
“Thousands of Australians face financial strain as interest-only period comes to an end”
https://www.domain.com.au/news/thousands-of-australians-face-financial-strain-as-interest-only-period-comes-to-an-end-930218/
“ 'Liar loans' surge to record highs, despite mortgage lending crackdown: UBS report”
https://www.abc.net.au/news/2019-09-30/liar-loans-record-high-mortgage-lending-property-crackdown-ubs/11559440
32-36% of total mortgages, worth $500b
Can assume Westpac has about a quarter (23% market)?
COVID: have Australian banks made sufficient loan loss provisions?
Deferred loans (a bland statement from Australian Banking Association - ABA)
https://www.ausbanking.org.au/6-month-loan-assessments-begin-as-australians-resume-loan-repayments/
NAB auditing loans
https://www.dailymail.co.uk/news/article-8754665/NAB-boss-reveals-warning-signs-Australian-banks-facing-huge-waves-loan-defaults.html
(To do these 3 as a single presentation – about the same issue)
13
Westpac’s asset quality scenarios
See Lecture03 BalanceSheet.xlsx, again
Accounting (Hoenig) leverage ratio: 64,573 / 879,592 = 7.34%
Identifying items 90 days past due, or otherwise in default, and not impaired (p.100)
? If impaired, adjusted leverage ratio: (64573 - 3023) / (879592 – 3023 ) = 7.02%
? Others in spreadsheet
As-is E/A leverage ratio = 7.34% Adjusted E/A leverage ratio = 7.02%
14
Off-balance sheet FREQ
Citigroup’s 2008 US$1 trillion in mysterious assets
http://www.smh.com.au/business/citigroups-mysterious-assets-20080715-3ffx.html
Lecture03 BalanceSheet.xlsx, again
High leverage led to solvency crisis requiring government bailout
“Citigroup gets massive government bailout”
https://www.reuters.com/article/us-citigroup/citigroup-gets-massive-government-bailout-idUSTRE4AJ45G20081124
Citigroup share prices https://yhoo.it/2FwSU2P
See stock price collapse Mar 2009, < $1 pre-split
Select Events > Stock Split to see reverse 10-1 on 05/01/2011 which obscures collapse in share price prior to
GFC
Recent accounting standards on financial instruments (AASB 7, 9, 132,139) and leases (AASB16)
Increasing accounting regulation has decreased the scope and risk of off-balancing financing
These are improving the completeness assertion of entities’ balance sheet and their risk assessment
There could still be other completeness and off-balance sheet risks an analyst should look out for.
Jargons alert: Off-Balance Sheet vs On-Balance Sheet Mortgage-backed Securities and CDOs Reverse Stock Split
15
Other perspectives: system or country level
Asset quality: evergreening loans and bad debts
https://www.mondaq.com/india/financial-restructuring/751730/ever-greening-of-loans-and-bad-debts--rbi39s-stand-and-its-implications
Off-balance sheet: Shadow Banking
Peer-to-peer: unregulated, a lot of (ponzi) scams
https://www.scmp.com/economy/china-economy/article/3039715/p2p-chinas-once-booming-lending-industry-must-close-within
Wealth management products; unregulated, implied guarantees when there is none
https://www.scmp.com/business/banking-finance/article/2102341/chinas-28tr-yuan-wealth- management-products-
under-mounting
China Local Government Financing Vehicles
https://www.scmp.com/news/china/economy/article/2142692/chinese-local-governments-us24-billion-concealed-debts-
revealed
China: difficult to do liquidity/solvency analysis (maybe other countries as well)
https://www.bloomberg.com/news/articles/2019-12-26/china-s-government-is-letting-a-wave-of-bond-defaults-just-happen
https://login.wwwproxy1.library.unsw.edu.au/login?url=https://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=140920797&si
te=ehost-live&scope=site
(same article, one might be behind paywall the other might be ok, if not get via UNSW lib)
“It’s incredibly difficult to do true credit analysis for most borrowers in China,” says Michel Lowy, chief executive officer at
Hong Kong-based banking group SC Lowy. “Ultimately it has a lot less to do with the quality of the businesses that are
underneath and a lot more to do with who is supporting them, who owns them, and what is the goal of their setup.”
But rising defaults also mean that global investors have to abandon some assumptions about which borrowers are safe.
It’s getting more dangerous to count on some companies being, in essence, too connected to
fail. (DrL changed the sequence of quotes for a more logical flow)
Enforceability is also a problem: see first article, e.g. about Founder Group
Jargons alert: Evergreen loans Peer to Peer Lending
16
Follow-up
on previously discussed entities, articles, concepts and short-selling trading strategy
“Carson Block of Muddy Waters with another 'short', plus some thoughts on analyst 'conflicts of interest'
https://remarkboard.com/m/cnbc-screamfest-culminates-with-muddy-waters-teasing- reveal/1f0c9jcoocsq8
“MW is Short Nano-X Imaging Ltd.”
https://www.muddywatersresearch.com/research/nnox/mw-is-short-nnox/
Muddy Waters setting up short selling video channel
https://www.zer0es.tv/
Free (for now) investment course
Is Tesla the Big Short 2.0?
https://www.philstockworld.com/2020/09/23/the-big-shorts-michael-burry-targets- tesla-in-series-of-tweets/
Another short, first identified by Hindenburg
https://hindenburgresearch.com/nikola/
All links on this page are not examinable, but are available for presentation. They are to provide your with an exposure to a financial
statements analysis outcome: where a firm is believed to be over-valued and share prices are expected to drop; and short-selling could be a
viable analyst’s recommendation. Recommend that you download/print the research reports for your own learning
Jargons alert: Sell-side vs buy-side analyst Short-Selling Conflict of interest (independent analyst)