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Yuan Convertibility and the CMBS Market - July 31st, 2020

The London Brief

Yuan Convertibility and the CMBS Market

July 31st, 2020

In July, I visited Seokgurum Grotto, a Unesco site in Gyeongju, Korea. The grotto, constructed in the 8th century under the Silla Kingdom as tribute to the king’s parents from a previous life, is nestled at the top of a mountain, shrouded in mist. It’s like ascending into the clouds. At the top of a long flight of stairs stands a statue of Buddha staring out into the sea, which is visible from the top of the mountain. The grotto was abandoned for many centuries until it was rediscovered in 1909 by a traveling postman who happened upon it by chance. During a brutal mountain storm, he sought shelter in what he thought was a cave only to look up and be comforted by the stone Buddha.

Sometimes when it’s most cold and dark, light is hidden when you least expect it. At the moment, we are confronting second waves in parts of Europe and the U.S. But buried within the gloom are pockets of opportunities as seen by this month’s M&A activity and this should grow larger as time moves on.

This month’s brief starts with some thoughts on yuan convertibility and the reserve status of the dollar, delves into concerns in the CMBS market and surveys the current M&A trends for July.

Yuan Convertibility and the Reserve Status of the Dollar

Donald Trump signed an end to the special status of Hong Kong in response to China’s implementation of its sweeping national security law. Trump decided against a more extreme measure to undermine the Hong Kong dollar’s peg to the greenback according to Bloomberg.

With the risk of sanctions, voices in China have been calling for a move away from the dollar. Fang Xinglai, a top official at China’s security regulator, said, “our ability to defend against potential decoupling will be enhanced significantly” through yuan internationalization.[1] Ray Dalio of Bridgewater said in a talk that the dollar’s reserve status is at risk.

However, yuan globalization is tied to convertibility. Yu Yongding, a former advisor to the PBOC, said, “Yuan globalization is largely hinged on convertibility under the capital account – which China is not yet ready for. China is facing a severe challenge of a series of potential U.S. financial sanctions and we can’t even rule out the possibility that they may freeze China’s financial assets one day.” Chinese companies have almost $1 trillion in offshore bonds and loans and $1.1 trillion in state-owned bank liabilities. Half of Hong Kong deposits are denominated in foreign currencies and Chinese banks have $747 billion in foreign deposits. In short, China is still beholden to the current monetary system.

Furthermore, China and its central bank enjoy the optionality of printing money to smooth over economic troubles as much as the next central bank. Stable employment and a strong economy are its deal with the Chinese people. By creating rival monetary systems, it would make it much harder for central banks to do their magic.

If Joe Biden wins the next election, as is currently likely, it would likely focus on rebuilding alliances and confronting issues around technology theft rather than using sanctions and monetary tools. This would allow the current monetary regime to last awhile longer.

But given the fraying political dynamics between the world’s two largest economic states and several players within both states that believe politics trumps monetary policy, the risk a political decision that undermines the dollar’s reserve status is not a 0% probability.

CMBS Market

Blackstone closed a real estate fund that used leverage to buy CMBS. The fund had about $1.1 billion of assets and suffered a 24% decline in March. With CMBS delinquencies surging from 1.46% in May to 3.59% in June, they decided to liquidate the fund and return cash to investors.

CMBS is the most transparent part of the $3.4 trillion commercial and multifamily mortgage industries. About $80 billion CMBS is issued each year. According to Wells Fargo data, at the end of 2018 there were $492 billion of CMBS bonds outstanding. Much of this collateral, even before the coronavirus crisis, had been weakening due to structural issues caused by Amazon and online retailing. Real estate underpinned by rents such as malls have been valued too highly and are cracking. In the UK, for instance, Intu Properties and Hammerson sold songs and dreams for years, but finally their markets cracked, and it’s been a steady death-march in EPRA valuations since. Now the coronavirus crisis has hit hotels. According to the Financial Times, 25% of owners failed to make payments on their mortgages. As hotels have emptied out to contain COVID, it has put pressure on the property owners’ ability to service their mortgages, ricocheting through to CMBS deals backed by those loans. Only 76.3% of hotel properties in CMBS deals were up to date on their mortgage payments in April, according to data tallied by JPMorgan. In March the share was 95.8%.

In the retail sector, the number of up-to-date borrowers dropped from 96.3% in March to 88.5% in April, while office properties showed a less than 1% decline. JPMorgan noted that the amount of loans moving to “special servicing” status — where a loan is transferred from the company responsible for passing mortgage payments to investors to a third-party chasing late payments — increased to $10.4bn in April, from just $800m in March, across the entire CMBS market. Fitch Ratings expects this number to rise in May as payments due in April become more than 30 days past due, tipping them into delinquency.

However, the Federal Reserve sees these problems and has maintained a steady purchase of securities allowing for liquidity in the market. The Fed is buying investment grade securities for the most part. The result is that so far there has not been panic selling in the market, but the Fed cannot fix solvency if assets are fundamentally worth less.

Mergers are Down Not Out

Any way you slice it, merger activity is in the doldrums this year. According to Dealogic data, global M&A activity was down 50% during the first six months of 2020 to $1.1 trillion (FT, July 7th, 2020). Refinitiv showed companies have struck $485 billion of deals since the beginning of April down more than 50% from the same period last year. In the U.S. overall acquisitions dropped 90% from a year ago to only $75 billion. “Economic uncertainty caused by the pandemic seems to have had a far greater negative impact on the ability of U.S. companies to initiate and successfully complete M&A negotiations” said a report by Willis Towers Watson. The report also indicates that deals are taking 8% longer to close on average and “this trend is likely to endure”. For pre-COVID deals, there have been an unusually large number of deal breaks with forty four U.S. deals pulled since April.

Mitsubishi’s CEO, Takehiko Kakiuchi, one of Japan’s most active deal-makers, says, “We need to make clear to our stake-holders that any M&A under consideration will in no way undermine our financial position. I can’t imagine a complete V-shaped recovery, and it will be more like going back and forth at the bottom of a U-shaped recovery.” Similarly, Peter Weinberg, co-founder and chief executive of boutique investment bank Perella Weinberg Partners, said, “Phase one for clients was getting their wits around them and understanding what business was going to be like in a COVID world. Phase two was, and is, making sure the capital structure strategy is appropriate for these times. M&A is phase three and we are not there yet. M&A will return when companies and boards have both confidence and clarity on what the future will hold.”


Yet signs of life appeared throughout July. For the U.S., it was the busiest month of the year with $105 billion of transactions announced. The oil and gas sector reported opportunistic purchases with Berkshire Hathaway spending $4 billion to buy pipeline and storage assets from Dominion Energy. Chevron bought Noble Energy for $5 billion in stock in order to bolster its presence in the Permian Basin. Marathon Petroleum has revived plans for a potential sale of gas station operator Speedway that could receive $15 billion. Allstate acquired National General Holdings for $4 billion as the insurance sector continues its consolidation. TMT was the largest sector in deal-making standing at $45 billion or about half of last month’s total. Uber Technologies bought Postmates for $2.65 billion, a deal culminating after months of negotiations. Analog Devices acquired rival Maxim Integrated for $20.9 billion in stock. Adevinta acquired Ebay’s classifieds business for $9.2 billion.

In Japan, Itochu launched a $10 billion offer for remaining stake of FamilyMart it didn’t own, following through on the Japan government’s mandates to deal with listed subsidiaries and further better corporate governance. Similarly, Fujitsu did a smaller deal to purchase the remaining shares of Fujitsu Frontech.

Nordgold and Shandong made competitive offers for Cardinal Resources, a small gold-miner listed in Australia. There continues to be excitement around gold and cryptocurrencies as central bankers continue to use accommodative monetary policy to stop the market from falling.

Newly announced mergers into China surpassed Chinese outbound deals in both volume and value for the first five months of the year, the first time this decade according to research by Baker McKenzie and Rhodium. Experts say it may be due to a generally optimistic forecast on the outlook for the Chinese economy and a relaxation of foreign investment restrictions. Pepsi acquired Chinese snack brand Be & Cheery for $700 million. JP Morgan took full control of a Chinese mutual fund joint venture taking advantage of the scrappage of limits on foreign equity thresholds in fund management companies. Chinese outbound deals faced limitations as Spain, France and Australia introduced rules intended to limit foreign acquisitions to protect assets in their countries. Chinese outbound deals are down 93% to $1.4 billion in Europe and 89% to $700 million in North America.

Marco Caggiano of JP Morgan, co-head of North American M&A said, “At the beginning of this in March, companies were all about raising capital but now the tone of the conversations is moving back to M&A. Whether all those conversations will turn into deals remain to be seen and year-to-date volumes still remain muted. But our pipeline is strong and we are encouraged by the signs of a rebound.” Moelis Australia joint CEO Chris Wyke said, “Even as the health-care impact has subsided, the economic impact is yet to play out. Businesses continue to recalibrate their business models based on changing and resetting demand and supply. There’s a fair few live situations.”


Private equity (PE) emerged as active dealmakers accounting for 16% of world-wide activity in the first half, the highest level since the mega PE deals of 2007. The PE industry is sitting on $2.5 trillion of dry powder. KKR, Providence and Cinven bought Masmovil for €5 billion. KKR also bought Viridor in the UK for £4.2 billion. European M&A is only down 15% year on year as a result of these deals. Scott Moeller, director of M&A Research Centre at City, University of London said, “This points to the long-term trend for larger deals outside the U.S. as international markets mature. It also appears COVID is hitting the U.S. more strongly, which is impacting the ability to do deals despite the large amounts of unspent money available to PE funds.” TA Associates managing partner said, “Europe experienced the virus earlier and is now coming out of it earlier. This improvement gives financial sponsors more visibility on future earnings and increasing confidence.”

The SPAC market continues to generate opportunities with a number of companies listing through the vehicles. Pershing Square raised $4 billion in a SPAC designed to list a unicorn. It was well over-subscribed and trading 6% over the cash value of the SPAC. However, the nature and feeding frenzy in the space indicates a bubble-like mentality. Most investors are flipping the rise in the SPAC prices on deal announcements to retail investors. As liquidity tightens and potential tech listings through SPACs start being more carefully vetted, the space may revert back to mean.

According to data compiled by Bloomberg, U.S. shareholder activism was down 50% by the number of campaigns on targets of $1 billion market cap or above for the first half of 2020. Goldman Sachs head of shareholder advisory and activist defence thought activists were steering clear of campaigns while companies focus on staying afloat and protecting employees. Yet Kai Liekefett, partner of Sidney Austin’s shareholder activism practice said, “We’re going to see a high, if not a record number, of special meetings, proxy fights and consents solicitations in the back half of the year unless a second wave hits corporate America so hard activists don’t feel comfortable going forward.”

End Note

About 70% of South Korea is mountains. It’s very picturesque, but it meant Korea could not excel in agriculture due to limitations in arable land. Nor did it have any resources of note. Instead South Korea specialized in manufacturing and later semiconductors, epitomized by the story of Samsung. A recent book by Geoffrey Cain called Samsung Risinggoes into this history more deeply.[2]

One secret of Samsung’s and Korea’s technological success is gaeseon or the process of ‘incremental innovation’ also known as kaizen in Japanese. Samsung’s founder also valued unity, a lesson he took from his travels to Japan. “[The Japanese] steadfastly valued loyalty and prioritized the cosmic self over the individual and the public over the private. The Japanese capacity for unity and diligent work comes from that patriotism, which values a greater public cause.”

I think this combination of learning from past virus scares such as SARS and MERS and a focus on unity helped South Korea weather the COVID storm pretty well. There are certainly lessons here that the West could learn.

Omar Sayed


[1] Bloomberg, “China Presses Global Yuan Role as U.S. Tensions Spread Into FX”, July 13th, 2020

[2] The ‘sam’ [three] in ‘Samsung’ symbolizes the big, the many and the strong, and is a number that our people like the most. ‘Sung’ [‘star’] means to shine brightly, high above, its light pristine for all of eternity. Be big, strong, and eternal’.

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