Malt Liquidity 8
Bonds, Debt, Stocks & Mistakes
Would you like to buy a valuation?
Over the past couple weeks, I have highlighted what Salesforce and Tesla have been doing to convert their public market valuations into value for their business. But for all the focus on equity markets, it is commonly brushed over that plenty of cash is raised through debt offerings.
While speculation is that debt offerings will slow down dramatically in 2021, it is important to note that capital was raised through debt at record rates in 2020.
If you have been following Fed policy this makes sense! Colloquially, volatility is just a measure of uncertainty, and when traders are uncertain, they are wary of trading, and bid/ask spreads widen. But a key requirement of bond offerings is that it’s not like taking a collateralized loan - even though bonds are loans at the end of the day, bond offerings require purchasers of corporate debt. So when an institution with an unlimited pocketbook announces they will be buying bonds and bond ETFs (thus giving the ETF providers capital to purchase the bonds for said ETF), it makes logical sense to raise capital through bond offerings.
The question then becomes, why is this capital being raised, and what is there to do with it? After all, this cash is being stockpiled as emergency provisions, and isn’t actually accumulating a return. And with people piling into equities at higher and higher rates,
Exchange traded funds attracted record inflows of $121bn in November, a jump of 14.5 per cent on the previous best month for new business...
The huge monthly haul brings net global inflows in the first 11 months of this year to $659.3bn, 15.4 per cent more than the $571.1bn gathered over the same period in 2019, according to ETFGI, a London-based consultancy
the writing is on the wall that without the Fed as a buyer, there is a lot of uncertainty surrounding bond market liquidity - namely, whether the volume of private buyers is sufficient. Enter the stock buyback: while the practice remains controversial politically, it is simply logical, financially speaking. Firstly, it circumvents the double taxation of dividends, which is just cash returned to shareholders, at the end of the day. Doesn’t it make sense to return cash to the shareholders who want it by buying back their stock, rather than having earnings taxed and then the shareholders taxed on the capital returned to them? Mathematically, you could return the same amount of capital to shareholders at a discount of their personal tax rates. Second, if I see that there is a high demand for my stock, but I don’t want to dilute the company’s stake in, well, itself, I can buy back stock now and hope to sell it when the valuation runs up, thus converting capital funded by debt of uncertain levels of liquidity into capital eventually able to be raised through highly liquid equity. At least with regards to capital, antonyms arise through reflections over the plane of liquidity.
Reading between the lines
An odd pair of headlines this morning: China Borrows at Negative Rates for the First Time and Investors are Learning to Live with China's Corporate Defaults. A quick primer: negative rates on bonds simply mean that on expiry of the loan, you pay back more than was given to you initially. (Non-junk) Government bonds are seen as the most secure financial instrument, at the end of the day - you have a nation-state and a central bank backing its payout. As such, the “risk-free rate” refers to the yield on some sort of Treasury bond. When the yield is negative, it can be viewed as the government trying to raise short-term funding. The goal is to encourage the large financial institutions that need the liquidity of government offerings to facilitate their cash flow to lend more and not sit on debt that will ensure a negative return. So, inherently, issuing negative yield debt is the government’s way of inducing growth by negative reinforcement through penalizing savings, rather than the positive reinforcement of cutting taxes, which would cost the government funding. Which is why this quote struck me as odd:
Beijing is allowing a wave of defaults by state-linked companies in the country’s $15 trillion credit market. This week, prominent chipmaker Tsinghua Unigroup Co. defaulted on $450 million of dollar debt triggering cross-defaults on another $2 billion -- equivalent to almost two-thirds of the total defaulted debt in China’s offshore bond market in 2019…
While this may be bad news for the weakest state-owned enterprises, it’s an improvement for investors, the credit market and China overall. A more accurate pricing of risk gives buyers of bonds greater transparency in a relatively opaque economy. That would boost the allure of Chinese debt, drawing more inflows, which in turn would help reduce the reliance of the nation’s capital markets on the government.
In isolation, this quote makes it seem like a positive that high yield debt is finally being allowed to default instead of being propped up by the government, but what if this is a gamble taken by the Chinese government to sell a short term funding crisis as “transparency”? While there is a lot of speculation on what negative yield debt means, because it hasn’t really been undertaken until now, the actual mechanics are pretty predictable as it’s attempting to induce inflation through debt issuance rather than debt raising. The confusion arises when one starts to wonder what happens when interest (heh) in these bonds dries up. To be fair, banks, for example, have no other alternative other than to purchase government debt, as it is the only market with essentially endless depth, practically speaking, but it certainly is startling to think that if people aren’t buying your government bonds, a central bank’s ability to add to their balance sheet is essentially neutered. While transacting in government debt is the most stable, boring market to be involved in, one can’t help but feel like this is a bit of a gamble.
The larger the interest payment, the higher probability of error?
The saga of Citi’s $900 million loan repayment error
…an Aug. 11 incident where Citigroup mistakenly wired $893 million to Revlon’s lenders, appearing to pay off a loan that was not due until 2023, rather than a planned $7.8 million interest payment.
never fails to disappoint:
The transfer was wired on Aug. 11. By late afternoon on Aug. 13, Farrell and Zeigon still seemed hopeful they’d be able to reclaim most of the money.
“Well 15% back on day 1 is good ish,” Zeigon said. “Let’s hope to get 50% by tomorrow..will lessen the pain for you and i.”
In finance, moreso than anywhere else, size matters. A $90 dollar bank error in your favor must be returned, and isn’t worth arguing over (along with being explicitly illegal to keep), but a $900 million error in your favor from the intermediary responsible for facilitation is absolutely worth arguing over in court! Perversely, “just losing 800 million instead” really isn’t so bad at the end of the day - after all, it’s still 9 figures in savings! It is particularly amusing that the argument for not returning the money to Citi is simply “I can’t say if they meant to do that”:
“Can you think of any reason why Citibank would send out approximately $900 million on Aug. 11 and the next day send out notices saying, ‘We made a mistake, please give it back?’” Baughman pressed. “Why would they do that?”
“I have no idea,” Frusciante said. “I don’t work for Citi.
It’s brilliant! The onus is on Citi to explain why they paid out the full debt total rather than an interest payment that was supposed to be less than 1% of that amount. At the end of the day, “we messed up” isn’t enough here, because as a bank you are paid fees to assure that nothing goes wrong - as such, any responsibility for an error naturally should be yours! By refusing to admit that the payment was erroneously made, Citi is put in a catch-22 of proving an error occurred that they were obligated to be responsible for that was over money they oversaw the transfer of that they weren’t responsible for!
On that note…