| Programming note: Money Stuff will be off tomorrow, back on Thursday. Trading is good now On the whole, it is not a great time to be a bank right now. I mean, it's not a great time to be anything right now, and you could do a lot worse than a bank; it's a much worse time to be, say, a cruise line or a restaurant or a supermarket worker. Banking is less directly affected by the coronavirus than a lot of other businesses, and the Federal Reserve has been a lot faster and more generous in propping up the banking system than the government has been in propping up other industries. But the basic business of banking is that you lend people money and expect them to pay it back out of their income, and if their income disappears then a lot of those loans won't get paid back and you will lose a lot of money. On the other hand, right now is a really great time to be a trading desk at a bank. Or at least, some trading desks at some banks. Here are Alex Morrell and Dakin Campbell at Business Insider: As rainmakers in other divisions like investment banking moved to work from their living rooms, some of Wall Street's most important traders have still been trekking into the office. ... But some, even those around during the 2008 financial crisis, are also catalyzed by the recognition that this is likely the seminal moment in their careers — and they may never again see such eye-popping trading revenues. "This is the best run I've ever had," the senior trader said. He added: "You'll have to drag me out of there." ... Many Wall Street trading desks are minting enormous revenue hauls amid the frenzied selling. … Barclays' earned roughly $250 million across its trading businesses on a single day in March, Business Insider reported. The haul, in part from equity derivatives trades, came the Monday after the Federal Reserve's surprise move to cut rates to nearly zero, on March 16. JPMorgan Chase, the top equity-derivatives trading operation on Wall Street, according to industry rankings by Coalition, has raked in huge revenues on the volatility trades. JPMorgan Chase's global equity-derivatives team has made over $1.1 billion since volatility first shot up February 24, according to people familiar with the matter. … Some individual trading desks are posting numbers in excess of $100 million in a given day that are unlikely to be repeated in their careers .... After the 2008 financial crisis, a consensus developed that trading operations made banks riskier, and that government-backstopped banks should have their trading activities restricted. This was always sort of a weird consensus. When a financial crisis happens, banks tend to lose money in their banking operations: Borrowers stop paying back their loans, etc. But financial crises are often good for the trading businesses. There is high variance—a lot of trading desks will make bad calls and lose a lot of money—but all in all right now is a good time for banks to make money in trading. Which makes banks less risky: Trading operations are a hedge, an insurance policy against losing money in regular banking. If you just run a regular bank and lend a lot of money to businesses that now can't pay it back, this crisis is unmitigated bad news. If you run a universal bank with a big trading business that is minting money, this crisis is, you know, mitigated bad news. "Bank revenues are expected to decline in aggregate," write Morrell and Campbell, "as these firms absorb rising loan losses, decreased consumer spend, and the impact of rock-bottom interest rates." But "in the near term, markets operations are helping neutralize the pain, and most banks are expected to produce stellar revenues compared with a typical quarter." Why? The simplest explanation is that banks' trading operations are basically in the business of market making, buying from people who want to sell and selling to people who want to buy. They are structurally greedy when others are fearful and fearful when others are greedy, and when markets bounce around a lot, that can work out really well. "Those are the numbers that limit up/down for a week can produce," one trader told Morrell and Campbell about the big profits: When the market is down as much as possible one day and up as much as possible the next, you are going to be buying a lot of stuff at the lows from people who are desperate to sell, and then selling it at the highs to people who are desperate to buy. This is not a wholly sufficient explanation; when the market is down as much as possible one day and then down as much as possible again the next, you are going to be catching a lot of falling knives. Still the basic idea is that bank traders are in the business of providing liquidity to investors, and right now liquidity is in very high demand. When there's a lot of demand for your product, you can charge a lot for it, so banks do. There are other answers. Reading the article, I was struck by the simple informational advantage of being a global bank with trading floors everywhere. If your colleagues in Hong Kong all work from home for a month to avoid a plague, you might take that plague more seriously than everyone else in New York does: Trading desks that anticipated the chaos that enveloped China in January and February would migrate to Europe and the US positioned their books accordingly. … "Everybody kept brushing it off like this would never happen here," an equity derivatives trader said. "So we put on protection trades that worked out." Anyone could have done that sort of thing, and lots of people did, but global banks whose trading desks hand off the book to colleagues in different time zones every evening might just have a more global perspective than other investors. But there are also more general informational advantages to being a bank trader. Your business is not just responding to client flows—selling to buyers and buying from sellers—but also understanding and anticipating those flows. That is, you have to know who owns what, what they plan to do, and what they might be forced to do. So Morrell and Campbell write about volatility-targeting funds: They're forced to sell assets into an already falling market, further intensifying the markets move. The dynamic, involving options that account for how rapidly the underlying asset changes in price, is known as a gamma trap. ... If banks held the opposite of that trade consistently, they'd lose money. But the extreme bouts of volatility in March have led to massive paydays for astutely-positioned trading desks that serve the clients racing to keep their gamma hedges up to date. Basically if you know your clients, and you know "hey we have a lot of clients who will have to sell a lot of stock today," you can position yourself not to own a lot of stock that day. This is "front-running" (which is bad) if the clients give you orders to sell and you sell for your own account first, but it is just good risk management—even good client service!—if you set yourself up appropriately in anticipation of the orders that you think your clients might give you. One other, somewhat counterintuitive explanation worth mentioning is that, in 2020, banks have more robust funding than a lot of other investors. I have spent much of the last week or so writing about margin calls: Investors have borrowed money to own stuff, often stuff that they think is good and will work out well for them, or even stuff that is hedging other stuff in an almost riskless way, but the price of the stuff has gone against them, their banks are demanding more money, and money is hard to come by. So they are forced to sell positions at unfavorable prices, because they do not have secure funding. Margin calls are the classic form of this problem, but there are other forms. A well-known worry about mutual funds is that they own long-term stuff (bonds, etc.), but have short-term funding: Anyone can ask for their money back from a mutual fund on one day's notice. So big stable mutual funds that don't use any leverage at all nonetheless can have their funding vanish quickly and have to sell a lot of stuff, and in the current crisis there are in fact heavy withdrawals at bond mutual funds. Classically people would tell the same story about banks: Banks use short-term funding (deposits) to fund long-term investments (loans, etc.). But that story isn't quite true about universal banks in 2020. Post-2008 regulatory reforms require them to have much more long-term funding than they used to (higher equity capital levels, more long-term debt). They're also required to put that money into more safe short-term stuff ("high quality liquid assets"), reducing the pressure on them to sell if funding dries up. Also the Fed's barrage of market-support programs tends to focus on the banking sector; if you are a big dealer bank you can get money from the Fed in lots of different ways (the Primary Dealer Credit Facility, expanded repo facilities, the discount window, daylight overdrafts, just selling bonds to the Fed through its various new asset-buying programs, etc.). You are not, as a bank, going to run out of dollars, which is not so clear for a lot of your counterparties. If there is stuff that you want to buy, you can buy it; if there's stuff that you don't want to sell, you don't have to sell it. If everyone else is being forced to sell stuff they like and can't find the money to buy new stuff, that gives you a nice advantage. Cruising, not so much Man! Carnival Corporation & plc (NYSE/LSE: CCL; NYSE: CUK), the world's largest leisure travel company, today announced that Carnival Corporation (the "Corporation") has commenced an underwritten public offering of $1.25 billion of shares of common stock of the Corporation. The Corporation intends to grant the underwriters an option to purchase up to $187.5 million of additional shares. The Corporation expects to use the net proceeds from the offering for general corporate purposes. The Corporation also announced by separate press release that it has commenced private offerings to eligible purchasers of $3 billion aggregate principal amount of first-priority senior secured notes due 2023 and $1.75 billion aggregate principal amount of senior convertible notes due 2023 (or up to $2.0125 billion aggregate principal amount if the initial purchasers exercise in full their option to purchase additional convertible notes). Carnival's market capitalization, as of this morning, was about $8.3 billion; Bloomberg tells me its enterprise value was about $19.3 billion. So raising another $6 billion—$3 billion of equity and equity-linked securities and $3 billion of secured debt—is rather a lot, and it comes on top of drawing down a $3 billion revolver earlier this month. The bonds somehow seem to have investment-grade ratings, but not really: While Carnival is still rated investment grade by Moody's Investors Service and S&P Global Ratings, its existing unsecured bonds have been trading at distressed levels in recent weeks. The new secured debt sale is being managed by banks' high-yield syndicate desks, the people said. And the (three-year, secured) bond is being marketed with a 12.5% coupon. You can … see … why. The new offering comes with some pretty hair-raising additions to Carnival's risk factors; a sampling: We have implemented a voluntary pause of our global fleet cruise operations across all brands and such pause may be prolonged. … Due to the outbreak of COVID-19 on some of our ships, and the resulting illness and loss of life in certain instances, we have been the subject of negative publicity which could have a long term impact on the appeal of our brands, which would diminish demand for vacations on our vessels. … We have received, and expect to continue to receive, lawsuits from passengers aboard the Grand Princess voyage in February 2020. … We have a total of 16 cruise ships scheduled to be delivered through 2025, including four during the remainder of fiscal 2020. … We have never previously experienced a complete cessation of our cruising operations, and as a consequence, our ability to be predictive regarding the impact of such a cessation on our brands and future prospects is uncertain. ... "We have shut down our business, we don't know when it will reopen, we don't know if anyone will want it when it does reopen, and by the way we're on the hook for a bunch of ships"—even if financial markets were generally calm and investors were coming to the office normally looking to deploy a lot of capital, it would not be the most appealing pitch! I will say that this trade sort of makes sense, though? A whole lot of companies have basically this profile: - They were doing fine a month ago.
- They are doing terribly right now.
- If the economy recovers in a few months, they will be doing fine again; if it settles into a recession they will be doing less well, but still "fine" in a recession-adjusted way.
If you are a company like that, you should try not to issue a lot of equity at depressed prices, or sell a lot of bonds at very high rates. (If you can sell bonds at tolerable rates, sure, do that.) Picking the panicky nadir (you hope!) of the crisis to raise money just seems like a mistake. Of course if you desperately need the money, you do what you have to, but if there are short-term ways to preserve money, or Fed loans or government bailouts on offer, you probably go with those first before selling permanent equity now. But that is not especially Carnival's story? Carnival's story is, it was doing fine a few months ago, and now it is doing especially terribly, and we are heading into a new world in which the prospects for Carnival's industry are, as it says, very unsettled. There are worse things than "unsettled"! The global shutdown is a bad time for normal companies, but it is at least possible that it's the best time Carnival is going to get; if the economy reopens and everything goes back to normal except that cruising ends, Carnival will have an even harder time raising money. At least now when everything is shut you can appeal to people who like a gamble; if you wait until the gamble is settled it might be too late. By the way, Carnival's bonds seem to be technically investment grade and have a three-year maturity: Do they fit into the Fed's criteria for its Primary Market Corporate Credit Facility, which will buy four-year-or-shorter bonds directly from companies? Are the high-yield syndicates calling up the Fed to place these 12.5% bonds? Sadly I suspect not; that facility is limited to "U.S. companies headquartered in the United States," and Carnival is incorporated in Panama and England. Hung bridge A basic problem in mergers and acquisitions is that, if you need to borrow a lot of money to buy a company, you can't really borrow the money before you buy the company, and you can't really buy the company before you borrow the money. Bond investors won't lend you billions of dollars to do a deal if the target hasn't agreed to be bought, and the target won't agree to a deal if you don't have the money lined up. There are a couple of potential solutions to this problem, but the dominant one is the bank commitment letter and bridge loan. While you are negotiating the deal, you sign up a bunch of banks who agree to lend you the money to do the deal, and you can show that promise—the commitment letter—to the target to assure it that you have the money. In exchange, you pay the banks a big fee, and you promise to do everything in your power to prevent them from having to lend you the money. Their commitment is a backstop: Once you sign the deal, you will go out and market bonds and loans to try to finance it, and you'll pay the banks another nice fee to lead the bond offering. If all goes well, you'll sell enough bonds to pay for the acquisition, and the banks will never have to put up any money. If all goes poorly: A group of sixteen banks will have to provide $23 billion of loans to T-Mobile US Inc. in order to allow the mobile carrier to close its planned acquisition of Sprint Corp., after the Covid-19 outbreak disrupted plans to sell the debt to third-party investors. The banks were formally notified Monday that they will need to make the funds available on April 1, so that the two companies can finalize their long-awaited merger. ... Even though T-Mobile and Sprint are junk-rated, the financing for the merger has been structured in a way to receive investment-grade ratings, the people said. As such, it's considered less risky than debt arranged by banks to finance leveraged buyouts and other corporate takeovers by high-yield companies. Still, it's the largest acquisition financing deal to get stuck on banks' balance sheets since the 2008 financial crisis, according to data compiled by Bloomberg. ... Banks will provide $19 billion through a 364-day bridge loan that is expected to be refinanced by investment-grade bonds and a $4 billion seven-year term loan that is also expected to be rated high-grade, the people said. Of course it's the biggest hung deal since 2008; that is the nature of the thing. In general banks underwrite these deals to work; they are able to change the terms and interest rates of the bonds and loans to make them easier to sell. Changing market conditions or investor dislike of a particular deal shouldn't be enough to hang a bridge loan. The way a big bridge loan gets hung is that you sign it up in the months before a giant financial crisis. Timing is key there. If you sign it a little earlier, you place the bonds and avoid the crisis. If you sign it a little later, the crisis has started and you just … obviously don't sign it? Elsewhere in M&A: Overall merger volume, which was already having a sluggish start this year, has come to a virtual standstill in the past two weeks. The value of announced mergers in the first quarter through Monday is down 33% from a year ago to $572 billion, a seven-year low. In the U.S., the decline is even more acute at more than 50%. … "Almost every variable is changing, whether it be CEO and board confidence, the availability of plentiful financing or stock prices," said Steven Baronoff, Bank of America Corp.'s chairman of global mergers and acquisitions. And elsewhere in bridge lending, the same basic process occurs in lots of places: Big banks that help asset managers package risky loans into investment products are sitting on billions of dollars of debt linked to companies most exposed to an economic downturn. Lenders on both sides of the Atlantic have upwards of 100 open credit lines to vehicles known as collateralised loan obligations, which are among the biggest sources of funds for businesses that do not have top-quality credit ratings, according to people familiar with the arrangements. ... Investment banks still have exposure, however, as they provide so-called "warehouse lines" to CLO managers that help them build portfolios of loans. Such assets have plummeted in value this month, due to growing doubts over the ability of heavily indebted companies to withstand big hits to the economy. In the long run, the U.S. financial system involves a lot of capital-markets-based financing; if you are packaging mortgages or corporate debt, or doing acquisitions, you will end up getting your funding by selling securities to investors in the capital markets. But you will probably briefly borrow money from banks, to fund you more flexibly between the time you do the thing and the time you can package it neatly and sell it to the capital markets. And when the markets collapse overnight, the banks will end up holding a lot of those loans and wishing they didn't. Front-run the Fed This is fun: Traders crowding into a BlackRock Inc. credit fund to front-run Federal Reserve purchases may be in for a rude awakening, warns Peter Tchir of Academy Securities. There's no guarantee the world's biggest monetary balance sheet will buy the $38 billion ETF as part of its historic stimulus, Tchir says. In his contrarian view, both the fund's trading premium and the weighted-average maturity of the bonds it tracks may fall foul of the criteria the Fed has laid out so far in its indicative asset-purchase plan. ... In describing which bonds the central bank will purchase, the Fed primer says it will be limited to securities with maturities of five years or less. If applied to ETF purchases, LQD's weighted average-maturity of more than 13 years wouldn't meet the grade, said Tchir. Ken Monahan of Greenwich Associates has a different read of that language. "The ETF section is distinct from the straight bond section so there is no reason to think the rules for the latter apply to the former," said the senior analyst covering market structure and technology. Policy makers also say they'll avoid buying any ETFs trading with a "material" premium to their net asset value. Though LQD's premium has come down from its record high of 5% last week, it was still trading 1.6% higher than its portfolio of bonds as of Friday's close. That could make the Fed wary, according to Tchir. There is a pleasing limits-to-arbitrage story here. Let's assume: - The Fed will buy bonds only if they have maturity of five years or less.
- The Fed will buy bond ETFs no matter what their underlying maturities are.
- The Fed will not buy bond ETFs at a substantial premium to the underlying bonds.
If the ETF trades at a big premium, the Fed will not buy it. If the ETF trades at a big premium, the sensible trade for an arbitrageur is to (1) buy the underlying bonds and (2) sell the ETF until the discount narrows. But if you do that arbitrage and it works, then you will own a lot of the underlying bonds (which the Fed can't buy) and be short a lot of the ETF (which the Fed now can buy). That is not a great position to be in: You own the stuff the Fed doesn't want and are short the stuff the Fed is (maybe) buying. The Fed isn't just a potential buyer of the ETF, it is on the other side of that arbitrage, so why would you do the arbitrage? Things happen The Fed Transformed: Jay Powell Leads Central Bank into Uncharted Waters. Coronavirus Pummels Hedge Funds of All Stripes. Justice Department Investigating Lawmakers for Possible Insider Trading. Shale Producers Ask Texas to Cut Oil Output. Shell secures $12bn credit facility to safeguard dividend. Court: Violating a site's terms of service isn't criminal hacking. WeWork is selling Meetup to AlleyCorp for a fraction of its 2017 price. General Electric Workers Launch Protest, Demand to Make Ventilators. China's Divorce Spike Is a Warning to Rest of Locked-Down World. "The extortion of restaurants has fallen, with eateries ordered closed except for takeout and delivery, and construction rackets had been bringing in the bucks until Gov. Andrew Cuomo halted all non-essential projects on Friday." Astrophysicist gets magnets stuck up nose while inventing coronavirus device. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! | 
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