Credit crunch may mean chips down for Macau’s VIP tables

Published in: Latest Intelligence  

Macau’s casinos may be starting to feel the pinch of a double squeeze. China is tightening credit, and has even precipitated a recent credit crunch. At the same time, the U.S. Federal Reserve has indicated plans to “taper,” or slowly cut down, its extensive program of quantitative easing in the face of an economic recovery there.

The impact of China’s tightening is obvious for casinos and junket operators, threatening funding for the lucrative segment of VIP gamblers. The Fed’s influence is less direct but no less significant. Economists say its plans to taper asset purchases are significantly negative for emerging economies such as China and Macau, causing U.S. investors to repatriate money, raising the risk premium on emerging markets and prompting “hot money” flows generated by easy monetary policy in the West to reverse out of Asia.

None of those trends suggest easy borrowing. Macquarie Capital analysts Gary Pinge and Roger Tse note that the junket system has been stressed since the second half of last year and suggest that markets like Macau that have seen the greatest VIP growth in the last four or so years are now likely to suffer the most, while mass-market gambling destinations are likely to fare better. They’ve moved to an underweight stance on Macau casinos and favor the stocks of operators in Singapore, Malaysia and Korea instead.

In fact, they note that VIP rolling chip volume has increased only 6 percent this year in Macau. Casino operators have responded by using their own balance sheets to lend to VIPs – a trend they expect to stop if capital flows out of the region and economic risks in China increase. The Chinese economy is already slowing down, and the government has set a full-year target of 7.5 percent GDP growth for 2013, down from 7.8 percent last year – which was the slowest pace in the last 13 years.

The crunch in China came as the central bank, the People’s Bank of China, started squeezing money out of circulation as of the second half of June, in an effort that many economists and China watchers say is aimed at causing a shakeout in the country’s “shadow banking” system. The central government is concerned that banks have pushed liabilities into little-regulated trust companies and wealth-management products, masking the extent of their lending and their bad-loan exposure.

The most immediate effect was a sudden spike in bank-borrowing rates. The Shanghai Interbank Offer Rate, or SHIBOR, reflecting the price banks charge each other for short-term loans, shot up to 13.4 percent on June 20 for an overnight loan. One other interbank rate hit 25 percent, reminding many of the credit freeze that happened in the United States in 2008. Rumors that banks were struggling to meet obligations started to swirl.

The June numbers for Macau’s casinos were still relatively good, with overall revenue up 21 percent compared with the same month a year ago, according to government figures. But there are signs within the data that there’s a shift underway, with high-margin mass-market gambling revenue up 31 percent, compared with 18 percent growth for VIP gamblers, according to figures from JP Morgan.

Tighter liquidity typically takes one to two months to filter through to the point where it cuts into VIP gambling turnover. As a result, the investment bank said investors will be watching the next set of monthly numbers very closely, and it is likely that gambling stocks will continue to fall.

Tony Tong, the director of strategic investment at Tak Chun Finance Group, an affiliate of the Macau junket operator Tak Chun, said June numbers were “still very nice” for his company, which does between HK$30 billion and HK$40 billion in junket business each month. Profits were good.

Still, he too is waiting to see if there’s fallout from the credit crunch in the second half of the year.

“All the agents are aware of the Shanghai interbank rate and the liquidity issue, so they are becoming more conservative in lending credit to players,” Tong said. “I don’t know what’s going to happen in July yet.”

Other industry players have already responded to the credit-crunch threat. Nasdaq-listed Asia Entertainment & Resources, which promotes VIP gambling rooms that are mainly devoted to high-stakes baccarat in five casinos, opted to cut the credit it extends to junket agents in June.

It said it was taking that step “due to its conservative view on the Chinese economy,” resulting in a 3 percent decline in the company’s rolling chip turnover, from which it derives its commissions, compared with June 2012. Turnover in the VIP rooms at the five casinos where the company operates hit US$1.33 billion, down from US$1.37 billion 12 months ago.

For its part, Tak Chun is stepping up the pace of its collection efforts for gamblers with outstanding debts, in case the credit crisis continues. And there are signs that cash is in shorter supply in China, with debtors forced to settle with other kinds of collateral.

“Sometimes if they don’t have money to pay we will ask them to settle with properties,” Tong explained. “Recently I have seen an increase in property-related settlements for debts.”

Macau Legend, which was forced to scale back its initial public offering from the original HK$787 million it was seeking to raise just HK$283 million due to poor market conditions, noted another headwind for VIP gambling.

“In response to incidents of Chinese government officials accumulating large gambling debts in Macau and signals from the Chinese government to increase scrutiny over the illegal flow of money out of China, the Macau government has taken steps to further monitor VIP gaming in Macau,” Macau Legend noted in its prospectus. Macau’s gambling regulator “may now increase scrutiny over or approve additional instructions on VIP gaming, which could deter current and potential VIP players from patronizing casinos in Macau.”

Macquarie’s analysts predicted that, with casinos starting to offer credit to the high-end mass market, potential VIP customers will avoid those rooms in an attempt to outwit potential surveillance.

It remains to be seen how committed Beijing really is to reining in credit over the long term. In light of the barrage of news over the spike in SHIBOR, the central government started to backtrack, attempting to calm markets and stem the negative headlines.

At the start of July, the Communist Party’s propaganda department sent a directive to reporters telling them to stop “hyping the so-called cash crunch,” according to the Financial Times. Such missives are common on sensitive topics, with propaganda officials going so far as to outline which words to avoid.

The notice directed journalists to bolster market confidence, report the positives in the current economic situation and “avoid malicious hype. Media should report and explain that our markets are guaranteed to have sufficient liquidity.”

The 21st Century Business Herald was forced to issue an apology on its Web site after it ran a report saying the Bank of China had defaulted on an interbank payment. Vice Premier Ma Kai has reportedly ordered an investigation into that rumor.

Tong at Tak Chun feels the credit crunch is likely to be temporary, since the central government has shown little staying power in enforcing previous austerity measures.

“In China, it seems that in the past government measures turned out to be not very long lasting,” he said. “Even the corruption and bribery campaign turned out not to have too much impact.”

Not all analysts have shifted to the negative stance adopted by Macquarie. Optimists may then find the correction in casino stocks a good entry point.

CLSA analyst Aaron Fischer believes the longer-term outlook is positive, with tight industry supply and new casinos on the Cotai Strip due to open in 2015. He favors Melco Crown and SJM as his top picks. Fischer also notes that the Macau gambling sector is the highest-yielding in Asia, generating a good cash stream for investors.

All bets may, quite literally, be off if those July and August numbers start to look shaky and reflect a real slowdown, particularly in high-end trade.