Serta SimmonsSometimes companies have a lot of debt and run into trouble. A bad thing happens and they cannot handle their debt anymore. Maybe they'd like to have less debt, and they go to their lenders and say "can we pay you back less than we promised?" Maybe they'd like to have more debt—that is, they need money—and they go to their lenders and say "hey I know we are overleveraged and blowing our covenants but can we borrow more money anyway?" Maybe they'd like more time to pay back their debt, or they'd like to pay less interest. On first principles the way to deal with this problem is to go to all your lenders and explain how it's in everyone's interest to renegotiate the deal. "If you forgive some of our debt (or lend us more, or extend our terms, or whatever), we will survive and be able to pay you back the rest; if you don't, we'll go under and you'll be tied up in bankruptcy and recover much less," is the basic pitch. The lenders evaluate this pitch and, if they think it's correct, they agree to help you out. This is a positive-sum game, or I guess a minimizing-of-negative-sums game; a solution can be in everyone's interest. On second principles the way to deal with this problem is to go to some of your lenders and say "hey if you help us out we'll give you a good deal, which we'll fund by giving the other guys a bad deal." Schematically, if you owe $1 billion and you can only pay back $600 million, you go to the lenders who own 51% of your debt and say "we'll give you $600 million for your $510 million of debt, if you'll vote to amend the loan documents so that we don't have to pay the other 49% anything." This is a zero-sum game: You take value from some lenders, give it to other lenders, and use that transfer to persuade the other lenders to agree to your deal. To be clear, the schematic thing I said in the last paragraph isn't really allowed. Any credit agreement or bond indenture will say something like "this agreement can be amended by a majority vote, except that some things can't be amended unless every single lender agrees." The things that can't be amended are fundamental things like how much money gets paid back. You can't actually get 51% of the bondholders to vote to give the other 49% nothing; that's obviously cheating, so it's something that can't be changed by a bondholder vote. Still, most bond restructuring disputes are more complicated variations on that idea. An "exit consent" is: You offer bondholders a good (decent) deal if they agree to vote to amend the old bonds to make them much less valuable, just before swapping into new bonds; anyone who agrees to the swap gets valuable new bonds, but anyone who doesn't is stuck with broken old bonds.[1] The "J. Crew" trade is: You sneak the valuable assets of the company into a new subsidiary that the old bonds have no claim on, and you borrow new money by giving the new lenders good security in the new subsidiary while leaving the old lenders without the security they thought they had. A lot of the credit-default-swap shenanigans that we have talked about over the years are of the form: You do something that will blow up CDS sellers (or buyers), which creates value for CDS buyers (or sellers), and you go to the CDS buyers (or sellers) and get them to give you favorable financing in exchange for that value. The basic tension here is that when you are setting up the documents—when a company is issuing bonds or taking out loans—everyone wants the first-principles, positive-sum approach. Everyone agrees in advance, when things are good and people want to lend, that it would be bad for a company to stiff some of its creditors and reward others if it runs into trouble. On the other hand, once the company runs into trouble, (1) the company wants to stiff some creditors and reward others (since that's cheaper than stiffing no creditors) and (2) the creditors who will be rewarded also want that to happen. (The creditors who will be stiffed don't.) The lenders want one thing ex ante and another thing ex post. The lending documents are long and complicated and cannot foresee every possibility. They are written by very good lawyers ex ante to minimize the risk of creditors being unequally stiffed, but then ex post even better lawyers comb through them to see if they can find a way to unequally stiff creditors anyway. Serta Simmons Bedding LLC had a lot of debt, ran into trouble (Covid, etc.), and wanted to renegotiate that debt.[2] The debt consisted of secured term loans, a $1.95 billion first-lien loan with a first-priority claim on Serta's assets, and a $450 million second-lien loan with a second-priority claim on those assets. When it ran into trouble, Serta quite sensibly talked to two different groups of creditors about, essentially, stiffing each other. "In the midst of a global pandemic, SSB constructed a competitive process between competing lender groups … to provide the Company with much-needed liquidity and a corresponding path to deleverage its balance sheet," is how its lawyers put it. One group of lenders, with long experience and great skill at stiffing other lenders, included Apollo Global Management Inc. and Angelo Gordon & Co. They proposed a classic "J. Crew" lender-stiffing transaction[3]: You take valuable assets that are currently collateral for Serta's secured loans, you move them into a subsidiary that does not secure those loans, and you borrow new money out of that subsidiary. Apollo and friends would exchange some of their existing loans into debt of that subsidiary, and would lend it some new money; they'd have good security for their new loans, while the other lenders would be stuck with their original loans but with much worse security. Serta's total debt would go up, but it would have some new money to tide it over. The other group of lenders included Eaton Vance Corp. and Invesco Ltd. and, usefully, they owned a majority of the term loan. They proposed a simpler lender-stiffing transaction: There would be no new subsidiaries or transfers of assets; instead, Serta would just create two new categories of secured debt that would rank ahead of the existing first-lien loans. The ranking would be new "super-priority 'first out' debt," then new "super-priority 'second out' debt," then the old first-lien loans (now, effectively, third), then the old second-lien loans (now fourth). Eaton Vance and friends would contribute some new money in exchange for the super-priority first-out, and they'd exchange some of their old first- and second-lien loans for the new super-priority second-out, but at a discount. (They'd get 74 cents on the dollar for first-liens and 39 cents for second-liens.) The result is that Serta would get new money and reduce its debt. The trick—and it's not much of a trick, not nearly as complex as the J. Crew stuff—is that the existing credit agreement, of course, doesn't allow Serta to issue new debt that has priority over the first-lien loans. That's what "first-lien" means. The existing loan was secured by a first claim on all of Serta's assets, and specifically forbids Serta from issuing new loans that have a better (zeroth-lien, one-halfth-lien, "super-priority first out," whatever) claim on those assets. But! The credit agreement can be amended by consent of a majority of the lenders, and the Eaton Vance group included a majority of the lenders. So they agreed to amend it, as part of this deal. There are some fundamental things that can't be amended by majority vote—you can't amend the agreement to say "we don't have to pay these bonds anymore," etc.—but the prohibition on new senior liens isn't one of them. It's just, there's a list, and that's not on the list. It could be, but it isn't. It's sort of a borderline-fundamental thing; some credit agreements allow it to be amended and others don't. The Eaton Vance group's lawyers say: The Credit Agreement does not include a frequently used 100% Exception referred to as an "anti-subordination" provision, which would require all affected lenders to agree to any amendment that subordinates the loans governed by the underlying credit agreement to other new or existing loans. Credit agreements often contain this bargained-for exception. When a Borrower has negotiated away its ability to incur senior indebtedness, the language in the credit agreement is clear.
So if Serta could get 51% of the lenders to vote to allow "super-priority" debt, and it could, then it could issue that debt.[4] It could give the super-priority debt to the group of lenders who agreed to the deal (as a reward/incentive), and stiff the other lenders (as a way to improve its financial position). The Eaton Vance group now owns less Serta debt than it used to, but with a first claim on Serta's assets; the Apollo group now owns all the Serta debt it used to, but with a third claim on the assets. Apollo of course is mad, and sued to stop the deal, and lost, and the Eaton Vance group's deal closed on June 22.[5] Conceptually it is sort of easy to sympathize with Apollo here. This is pretty close to my bad schematic idea of "pay 51% of the lenders a bonus to get them agree that you don't have to pay back anything to the other 49%."[6] Lending shouldn't work that way; if you can do that, then lending is a war of all against all, and nobody can trust that their collateral is worth what it's supposed to be. Bloomberg's Sally Bakewell wrote yesterday: The ruling could turn the Serta Simmons transaction into a playbook for restructuring debt that undermines a central tenet of credit markets and hands distressed borrowers a source of leverage over lenders, just as the pandemic sparks a surge in showdowns between the two sides. For all the perceived ugliness in Apollo and Angelo Gordon's distressed deal-making approach, it differs in one big way from the Serta Simmons transaction. They generally give all existing creditors the option to take part in any new loan and, as a result, skip to the front of the repayment line alongside them if the borrower falls into bankruptcy. That's been the market convention. The Serta Simmons financing, which it got from firms including Eaton Vance Corp. and Invesco Ltd., gave only some investors that opportunity. And so if creditors can now be pushed down the repayment pecking order without notice and have no recourse to fight back, they will be forced to reassess risk -- and potentially demand higher interest rates -- when granting loans and buying certain kinds of bonds.
It does seem like an uncomfortable precedent, that a company can get some of its lenders to effectively strip collateral away from others in privately negotiated deals without offering the exchange to all holders. It is mitigated a bit by the fact that you can just write the credit agreement to require unanimous consent to allow new senior liens, but of course there are other bad things that a majority of lenders can do to reduce the minority's value, and it's hard to catch all of them. So, right, conceptually you can sympathize with Apollo. Otherwise it is sort of hard to sympathize with Apollo here because, you know, hahahaha Apollo. Bakewell also wrote: When Apollo Global Management Inc. and its allies sued struggling mattress maker Serta Simmons Bedding for giving an unfair advantage to creditors providing fresh cash, many on Wall Street snickered. Apollo has earned a reputation over the years for cutting distressed-debt deals that hurt existing creditors, and some bankers delighted in the role reversal.
And to be fair, that is not just Apollo's general reputation: Cutting a distressed-debt deal that hurts existing creditors is also what the Apollo group wanted to do here. The Eaton Vance group's lawyers argued: Plaintiffs demanded that Serta—desperate for cash—enter into an aggressive and predatory proposal to the exclusion of all other lenders. Plaintiffs' proposed transaction would have purported to require Serta to transfer a large portion of collateral (including the Company's "crown jewel" intellectual property worth at least several hundreds of millions of dollars) away from the 1L Lenders to a newly formed subsidiary that would not be a party to the Credit Agreement and would benefit Plaintiffs alone, (the "Predatory Proposal").Such a predatory transaction would likely have resulted in prolonged litigation for the Company and Sponsor, damage to the Company's relationship with its lender base and its ability to raise further capital, and damage to the Sponsor's market relationships and ability to raise capital, in addition to the negative press and publicity it would have generated.
I don't say that to suggest that Apollo is evil and Eaton Vance is good. It's just that this is the game they are both playing: Serta had a lot of debt and it ran into distress, it talked to two groups of lenders about alleviating its distress by favoring one group and stiffing the other, and it chose the group that gave it the better deal. If that's the game that you're playing, you can't feel too aggrieved when you lose. Big shortA lot of people want to buy Tesla Inc. stock. It is up about 15% so far this week, 29% so far this month, 233% so far this year; it trades at a record high; it is the most valuable car company in the world; it is worth as much as Toyota and Ford and GM and Fiat Chrysler put together; etc. When a lot of people want to buy a thing, manufacturing that thing is a good business to be in. If you can manufacture Tesla stock right now, you can sell it for a lot of money. There are two sorts of people who are in the business of manufacturing Tesla stock. One is Tesla. It's a company, it can just sell shares in itself. It did this back in February: The stock was also on a crazy tear then, and Tesla did a $2.3 billion stock offering. The stock is up 82% since then. We talked the other day about how Tesla could get a lot of money by selling more stock now. It seems good. The other people who are in the business of manufacturing Tesla stock are short sellers. If you are a short seller and you short Tesla stock short to me, what happens is that I have bought a share of Tesla stock that you created. Our transaction creates a new Tesla shareholder, me, who owns Tesla stock that was issued not by Tesla but by you. If 100 people each own 100 shares of Tesla stock, for a total of 10,000 shares, and then you short 100 shares to me, then 101 people each own 100 shares of Tesla stock, for a total of 10,100 shares. In a sense there are more shares now. In another sense there aren't, because you actually own negative 100 shares, so the net total is unchanged, but the gross total—the number of people who walk around pleased with themselves for owning some Tesla shares—has gone up.[7] Since there is a lot of demand for Tesla stock, and since Tesla is only occasionally and halfheartedly stepping up to meet that demand by selling more stock, other sellers—short sellers—have stepped up to meet some of the demand.[8] Specifically there is about $260 billion (Tesla's market capitalization) of Tesla stock out there manufactured by Tesla, but there is also about $20 billion of Tesla stock out there manufactured by short sellers: Tesla Inc.'s skeptics are undeterred by Elon Musk poking fun at them over the carmaker's stock surge, with the amount of shares being sold short heading for a milestone. The Model 3 maker's stock is poised to be the first to hit a short-interest level of $20 billion, according to research firm S3 Partners. The value of shares that have been sold short has climbed recently to $19.95 billion.
Tesla might be the world's biggest car company (by market cap), but … let's call it Anti-Tesla … is apparently the biggest synthetic company ever, the largest pool of shares ever manufactured by people betting against a company. It's no Toyota, but Anti-Tesla is bigger than Fiat Chrysler Automobiles NV; the market value of Tesla stock produced by short sellers is larger than the market value of an entire real car company. That's … something. I don't know. It's easy to scoff that Tesla, a young and still-niche company that has not produced a lot of profits, is more valuable than these big mature car companies; but even that scoffing itself is more valuable than some of those companies. Finance is weird. By the way, in the abstract "you should sell a product that people want to pay a lot for" is good advice, but actual life for Tesla short sellers right now is bad. It's easy for Tesla to manufacture Tesla stock; it just prints it. If a short seller manufactures Tesla stock, though, she has to pay whatever Tesla is worth, and if that number keeps going up things will be unpleasant for her: With Tesla shares more than tripling this year, short sellers—investors who have bet against the stock—have lost $17.89 billion on paper during the period, according to Ihor Dusaniwsky, head of predictive analytics at S3 Partners. In July, the bearish investors are down more than $4 billion, with shares up 2.1% on Thursday. ... The recent stock surge has reduced the short sellers' ranks to the hardest core, said Mr. Dusaniwsky. "These losses have squeezed out most of the less rabid short sellers, leaving only those most dogmatic short sellers in the trade," he said Wednesday. Short-seller interest in Tesla has fallen to less than 10% of its stock, compared with more than 20% about a year ago.
See, Anti-Tesla has been doing a lot of stock buybacks even as its value has gone up. What?What? Wirecard executive Jan Marsalek touted secret documents about the use of a Russian chemical weapon in the UK, as he bragged of ties to intelligence services to ingratiate himself with London traders. The documents, which have been reviewed by the Financial Times, included the formula for novichok, the world's deadliest nerve agent. His use of the documents in meetings in the summer of 2018, which were described by two traders who attended, show the mysterious connections and bizarre tactics of a man who helped run the German payments group for a decade before it collapsed last month in a fraud scandal.
What? Honestly my first question was of course how the chief operating officer of Wirecard AG got the formula for a deadly nerve gas (unclear! shady!), but my second question was, wait, why would the COO of a public company be meeting with traders? His job is to run a payments business, not to chat up stock traders. But here's the answer to that one: Mr Marsalek disappeared last month in the run-up to Wirecard's collapse. Before then he had presented himself as an international man of action, using secret documents to forge links with traders in a years-long operation to identify speculators betting against the Wirecard share price.
Yeah no that's ... that's not operating. If your COO is having shadowy spy meetings to try to root out short sellers, something has gone wrong. If your COO is simultaneously (1) trying to root out short sellers and (2) in possession of the formula for a deadly nerve gas, something might be about to go very wrong! I am glad all the Wirecard short sellers are okay. The other great thing about this story is, I must say, if you are trying to titillate and impress stock traders, giving them the formula for a deadly nerve agent is, yes, that's just about right. If you are a spy and you know some cool spy stuff, you should think about going into a career in equity sales; I bet a lot of people would give you a lot of business in exchange for the occasional cool spy anecdote Errata: Rap stuff"Hamilton" has been so much in the public eye recently that, when we talked yesterday about Shopify Inc.'s corporate parody rap video "10 Slack Commandments," I immediately assumed it was an homage to the song "10 Duel Commandments" from "Hamilton." But the "Hamilton" song is itself an homage to Biggie Smalls's "Ten Crack Commandments," and Shopify's is clearly referencing Biggie's original, not the "Hamilton" one. I apologize to Shopify for saying that they had made a "a corporate 'Hamilton' pastiche about workplace productivity software," when in fact they just made a regular corporate rap pastiche about workplace productivity software. Errata: Ice stuffAlso yesterday I criticized some JPMorgan Chase & Co. strategists' metaphor about liquidity. They wrote that liquidity is "skating on thin ice," and I objected: No, see, the way that skating on thin ice works is that the skating occurs on top, and then below the skating there is the ice, and then, below the ice, is the liquid. The liquidity doesn't go on top of the ice, that is just chaos.
Well. Reader Ryan Quinn emailed to say "I'm sure you've had this loads today, but when ice skating the skate actually rides on a very thin layer of water." (In fact he was the first person to email about this, but not by any means the last; my readers keep me honest on matters of basic science.) So as a matter of, like, stacking of phases of matter, you can in fact have a thin layer of liquidity on top of a thin layer of ice on top of a lot more liquidity, when you are skating. I have lost track of whether this makes the metaphor make sense. I still don't think liquidity can skate on thin ice? Nonetheless I apologize to JPMorgan just in case. The lesson is, I should never make fun of anybody, which will make this newsletter a lot shorter going forward. Things happenBiggest U.S. Banks Set for Worst Quarter Since Financial Crisis. Companies Raised Record Amounts by Selling Stock During Covid-19 Crisis. US asset managers set to fight proposals on ESG investments. Wall Street Gets the Flack, But Tech CEOs Get Paid All the Money. Ackman's Blank-Check IPO Is Latest Stop on His Comeback Tour. Wall Street Pushes Back on U.S. Threats to De-list Chinese Firms. Cyber Attackers Hit Bond Giant TCW, MetWest Funds. Inside the Mind of a Young Retail Day Trader. Robinhood reportedly installed bulletproof glass after frustrated traders kept showing up at its office. 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! [1] Typically the way an exit consent works is that the new exchange bonds are a *worse* deal than the original bonds were, that is, the exchanging bondholders are still taking a haircut. But the old bonds, post-consent, will be terrible, so everyone has an incentive to take the new bonds (and consent to the amendment) instead. It is not so much "we'll give you a sweet deal if you agree to hose the other guys," more "you'll get hosed a lot unless you agree to get hosed a little." [2] I am basing this version mostly on the legal filings in the lawsuit, including Apollo et al.'s complaint, the responses of Serta Simmons and the defendant lenders, excerpts of the credit agreement and the judge's ruling denying an injunction. [3] For the J. Crew trade, here's Peter Coy at Bloomberg Businessweek, here's a law firm memo, and here's a Planet Money episode that uses the rhyming name that is commonly given to the trade. Incidentally, Bloomberg reports that Ryan Mollett invented the J. Crew trade at GSO Capital Partners and is now at Angelo Gordon, so the Apollo group's proposal had an impeccable intellectual lineage. [4] I use "51%" as a generic term for "a bare majority." In fact though Serta got holders of *50.1%* of its debt to agree to the deal (see page 6 of its filing), which is pretty cute. [5] A fun aside is that term loans can have "disqualified lists" of investors who are not allowed to buy them, and Serta claims that Apollo was on its disqualified list and so doesn't actually own the term loan that it's suing over. "Apollo," says Serta, "does not currently hold any SSB debt. Rather, Apollo attempted to purchase approximately [redacted] of SSB's First Lien Term Loans starting in March 2020, again at substantial discounts, but that transaction has not yet closed because Apollo is identified as a Disqualified Institution under the Credit Agreement and is not permitted to purchase any of that debt. … To attempt to circumvent this, Apollo attempted to hide its identity behind an affiliate—North Star—but was ultimately discovered by SSB." Apollo, on the other hand, argues that it was actually an original investor in the credit agreement, sold its loans in 2018, bought some back in 2020, and confirmed with the administrative agent at the time that it was not on the disqualified list. According to Apollo, Serta won't show anyone the disqualified list and is, essentially, just pretending that Apollo is on it. [6] It is not *that* close, insofar as (1) the favored (Eaton Vance) lenders aren't getting a bonus; in fact, they're doing their exchange at a discount, to reduce Serta's debt load, and (2) the disfavored (Apollo) lenders aren't getting zeroed; in fact, they are keeping the entire amount of their original claim, which at least Apollo seems to have purchased at a discount. If all goes well they will be paid back 100 cents on the dollar. It's just that if all goes poorly they'll be at the back of the line. I think to Apollo et al. it feels like "Serta rewarded 51% of the lenders to have them completely stiff the other 49%," but to the outside observer it may not really look that way. [7] This is the economic description; the actual mechanics involve you borrowing stock from some existing shareholder. People get very emotional and confused about these mechanics but they're not especially important for our purposes. Like a dozen people are going to email me to say "what you are describing is *naked short selling*, which is illegal; regular short selling is totally different." Please don't be one of those people! Borrowing stock before shorting it does not change anything fundamental about the transaction; you are still creating "new" shares in the sense that both the person you borrowed from and the person you sold to walk around thinking of themselves as Tesla shareholders. You've cloned shares rather than creating them ex nihilo, maybe, but you have certainly added to the gross total. [8] I once wrote: "The normal way that markets make prices correct is not through short selling but through supply; if widgets get irrationally expensive then you'd expect new entrants to set up widget factories and supply widgets until the prices go down. Short selling is a special case of that general process, a convenient way for financial-market participants to add to the supply of financial assets: If you think that Tesla Inc. stock is overvalued, you can effectively make more of it by borrowing and shorting it until the prices go down." | 
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