Monthly Archives: December 2013

The End of Cheap Money.

On Wed 18th of December, the America’s Central Bank, The US Federal Reserve started to reduce the QE programme.

Currently The Fed is buying $85 Billion = £52 Billion = £52,000 million a MONTH in US Treasury Bonds (T-Bonds) to fight unemployment, and stabilise the US economy.

There have been many consequences of Quantative Easing, by driving interest rates down, financial asset prices have risen.
When money is earning 0.5% on deposit, perhaps the growth in the stockmarket has been driven by money moving from cash to buy shares.
Perhaps the rise in house prices is down to the fact, one may get a better return by putting money into property.

Another less reported consequence is the effect on high quality companies. They have been given the ability to borrow (by issuing bonds) at very low interest rates to fund their day to day business operations.

Verizon was able to borrow $49 Billion = £30 Billion to fund the purchase of Vodafone’s 45% stake in Verizon Wireless. They raised the cash via issuing bonds.

Exxon Mobile [] have been able to borrow billions at interest rates of less that 2%. This of course is a triple AAA rated company, but with new cash from bond issues at very low interest rates, it has been able to lock in cash to fund the business.

On the horizon, interest rates are going to rise, so during the period of low interest rates, corporates and individuals have been able to lock in low rates and secure a well-funded future.


The State Pension

The Institute if Fiscal Studies recently published some figures about a single-tier pension.

I then under took some of my own research, and the cost to the state for just paying state pension, the numbers are vast.

11.58 million pensioners living in the UK. The basic state pension is £110.15 a week

Thus each year the UK pays £110.15 x 11,580,000 x 52 = £66,327,924,000 a year = £66,327 million

That is £66 Billion. (if everyone gets a basic pension of the £110.15 a week, some obviously get more, due to their higher national insurance contributions or in the State Enhanced Related Pension, known as SERPS), my number of £66 Billion is a much lower calculation.

The Institute if Fiscal Studies stated that today HM government actually pays £94,000,000,000 a year = £94,000 million = £94 Billion today in state pensions, the 2nd largest government expenditure after funding the NHS. The issue also is that is paid for by taxation and national insurance. There is no fundamental investment asset yielding an investment return, to pay for the state pension.

People deserve good pensions, the cost to the state is huge. But how huge ?
Government expenditure is about £700 billion.

Thus 13% (at least) of government spending is on state pensions today, and this is only going to rise as life expectancy rises, and also one has to accept that the basic state pension is simply not a living wage. Pensioners deserve good pensions. HM Government have no underlying asset to pay for our pensioners. The tax payer has to meet this payment, and to be honest, £110.15 a week is simply not a living wage.

The Importance of Debt: The Miller-Modigliani Theorem

The Modigliani–Miller paper and theorem is a well-regarded axiom on the capital structure if a business. It is effectively the cornerstone of modern corporate finance, in the same way was Newton’s 3 laws of motion are to modern physics.

It is states:

(1) In an environment, where there are no taxes, default risk or agency costs, capital structure is irrelevant.
(2) The value of a firm is independent of its debt ratio and the cost of capital will remain unchanged as the leverage changes.

It is quite a complex theorem that has come from papers in the 1950’s and 1960’s. However the world does have taxes, and the cost of doing business (agency costs) are real. So what this then means, under that under some conditions, the optimal capital structure can be complete debt finance due to the preferential treatment of debt relative to shares (equity) in a tax code. For example, in the UK and most other market economies interest payments on debt are excluded from company taxes.

Thus what this means, is a company carrying debt, is worth more to investors, as it pays less tax (interest payments are off set against tax, thus create something called the tax shield).
Thus companies took out debt (issuing bonds) to finance the business also have the advantage to be able to reduce its tax bill and thus enhancing its overall value to investors.

The importance of this cannot be under-estimated, companies that have issued debt, are helping to pay for pensions (buyers of the bonds are investors like pension funds who need the interest [coupon payment] to pay their deserving pensioners).

However there are always pros and cons to debt.

Advantages of Borrowing:

1. The Tax Benefit:  (the tax shield): thus, higher tax rates mean greater tax benefit to the company
2. Added Discipline: (got to meet debt payments, focusses the business on delivering cash flows)

Disadvantages of Borrowing

1. Bankruptcy Cost: If fail to meet bond payments then the business is made bankrupt.
2. Agency Cost: (2 sets of people to please, shareholders and creditors) thus a greater the separation between shareholders & lenders which mean thus a higher cost of business
3. Loss of Future Financing Flexibility: If carrying debt, then harder to borrow more, which means more uncertainty about future financing needs


UK Asset Resolution (The Bad Bank = holding toxic assets)

UKAR is the HM Government company, that is effectively the bad bank loans of Northern Rock, Mortgage Express and the Bradford and Bingley.
The owner of UKAR is UK Financial Investments (UKFI) that manages the assets on behalf of HM Treasury.
It is UKFI, that also owns the 30% or so shareholding of Lloyds Banking Group and The 83% stake in The Royal Bank of Scotland.

Today UKAR has a large balance sheet.

Assets are £623,000 million = £62.3bn, so this is referring to the mortgages outstanding.
Total number of mortgages are 554,000, so this equates to an average mortgage size of about £112,000.

93%, are up to date with their mortgages payments. So these are not really bad loans at all.

£8.3 Billion has been repaid.

Note, that these mortgages are generating interest, to actually what is never reported by the mainstream media, is that HM Treasury are making money on these loans.


FTSE-100 Distortion: The Top Five Titans

The UK’s benchmark index is the Financial Times Share Index 100, commonly known referred to as the FTSE-100.
Oddly enough 100 of the UK largest corporates are what make up the FTSE-100.

What is not widely known is the real distortion of the index by the 5 top UK company titans:

Shell, HSBC, Vodafone, BP and GlaxoSmithKline totally dominate the index. The size of these companies based on their market capitalisation explain the level of distortion of the FTSE-100.

Shell: [Shell A plc] £79,742m + [Shell B] £53,458m = £133,200m = £133 bn
HSBC: £123,609m = £123 bn
Vodafone: £111,879m = £111 bn
BP: £88,851m = £88 bn
GlaxoSmithKline: £77,995m = £77 bn

Total Value = £535,534 million = £535 Billion = £0.535 Trillion

However the % weighting of these 5 companies on the FTSE-100 shows how this £535 Billion skews the FTSE-100.

Shell: = 6.18 % of the FTSE-100
HSBC: = 6.17% of the FTSE-100
Vodafone: = 5.32% of the FTSE-100
BP: = 4.09% of the FTSE-100
GlaxoSmithKline = 3.79% of the FTSE-100

(Shell: = 6.18 % + HSBC: = 6.17% + Vodafone: = 5.32% + BP: = 4.09% + GlaxoSmithKline = 3.79%) = 25.55% of the FTSE-100 = £535 Billion

So the top 5 corporates make up over 25% of the FTSE-100. (thus the ‘other’ 95 companies make up the remaining 75%.

Also with 2012 UK GDP = £1.495 Trillion and the value of the top 5 companies being worth £0.535 Trillion, then the value of Shell, HSBC, Vodafone, BP and GlaxoSmithKline equate to 35% of the annual GDP of the UK.

Useful answer if anyone asks the value of the UK’s top 5 companies.


5 More Years of Continued UK Budget Deficits

Yesterday (Thur 5th Dec 2013) HM Government, announced spending plans, and also the public spending numbers for the next 5 years.

The numbers are very clear, HM Government will continue to spend more money than it earns, and for the next 5 years will run a budget deficit each year, and thus have to borrow to bridge the gap between income and expenditure.

2013-2014 = £111,000 Million = £111 Billion
2014-2015 = £96,000 Million = £96 Billion
2015-2016 = £79,000 Million = £79 Billion
2016-2017 = £51,000 Million = £51 Billion
2017-2018 = £23,000 Million = £23 Billion

∑ (£111bn + £96bn + £79bn + £51bn + £23bn) = £360 bn

So the structural debt of the nation will grow over the next 5 years by only £360 bn.

The OBR (Office of Budget Responisbility) predict in the year 2018-19 that their will be a potential budget surplus (income from taxation is greater than government expenditure) of £2.2 bn. The last time the UK government had a budget surplus was in 2001.

What no one ever mentions that it will take decades to repay the outstanding debts.

HM Government November 2013 Borrowings…

Another month, guess what, take a wild guess, it is the same old story, HM Government, spends more money than it receives via taxes. Another deficit month, thus to bridge the gap, needs to borrow on the bond market.

In November 2013, the HM Government had to borrow money to meet the difference between tax revenues and public sector expenditure. The term for this is The PSNCR: The Public Sector Net Cash Requirement.

There were “only” 5 auctions of Gilts (UK Government Bonds) by the UK Debt Management Office ( to raise cash for HM Treasury :-

28-Nov-2013 3¼% Treasury Gilt 2044 £2,749.8680 million
21-Nov-2013 1¾% Treasury Gilt 2019 £4,750.0000 million
19-Nov-2013 2¼% Treasury Gilt 2023  £4,124.4880 million
14-Nov-2013 4¼% Treasury Stock 2036 £2,474.9590 million
05-Nov-2013 0¼% Index-linked Treasury Gilt 2052  £1,252.0000 million

When you add the cash raised:-

∑(£2,749.8680 Million + 4,750.0000 Million + £4,124.4880 Million + £2,474.9590 Million + £1,252.0000 Million) = £15,351  Million

£15,35  Million = £15.351 Billion

On another way of looking at it, is in the 31 days in November HM Government borrowed:-

£511 million each day for 30 days. We are fortunate, while the global banking and financial markets still has the confidence in HM Government to buy the Gilts. The budget deficit keeps rising. What is also alarming, is the dates these bond mature, 2019, 2023, 2036, 2044 and 2052. All long term borrowings, we are mortgaging our futures.

UK Consumer Debt

I discovered this figure.

Total UK consumer Debt is £1,429,624,000,000.


It has been appearing in the UK media for the past few days.

This reports that the total debt carried by UK citizens (not HM Government) is £1.429 Trillion = £1429 Billion.

To quantify this number:

UK GDP = £1.495 Trillion (£1495 Billion)

This Consumer Debt to GDP as a ratio = 95%

Of course the bulk of the debt is in outstanding mortgage debt. But what this shows is that consumers are carrying massive amounts of debt.

Thus this explains the levels of assets held by banks. (Assets of the bank are the outstanding loans to consumers, such as loans and mortgages)