Money Stuff: Would you borrow from the Fed?

Money Stuff

The Fed invests

The U.S. investment-grade corporate bond primary market is better than it has ever been, with issuance coming at a record pace and rates near record lows. If an investment-grade company wants to sell a bond, it hires bankers, the bankers call up big bond investors and say "do you want to buy this bond," the investors all say yes, and the bond is oversubscribed and sells at low interest rates. It is an easy and pleasant time to be a debt capital markets banker.

Now, though, those bankers will have a new complication, which is: Should they call up the Fed?

The Federal Reserve formally opened Monday its $500 billion lending program to support issuance of new debt by large corporations, the last of nine emergency programs it is running to backstop lending markets reeling from the coronavirus pandemic. …

The Fed is offering two ways for companies to participate in the program. The central bank will purchase eligible syndicated loans and bonds alongside other investors, and it will also buy eligible bonds as the sole investor.

Here is the term sheet for the Primary Market Corporate Credit Facility, and here are the Fed's answers to frequently asked questions. If you're a banker for an investment-grade company looking to raise shortish-term debt (the facility is limited to maturities of four years or less), what do you make of this?

One thing you could do is do your deal normally, call up investors, get a sense of demand and price, and then try to sell a chunk of the offering ("no more than 25 percent," says the term sheet) to the Fed alongside the other investors. I don't know why you'd do this. Like, the Fed will give you a little extra demand, but extra demand is not such a problem these days. The Fed is price-insensitive—it will just buy at the price that everyone else gets—though, again, most investment-grade investors are currently pretty price-insensitive. But the Fed wants a fee for its participation. The FAQ explains:

For eligible syndicated loans and bonds purchased at issuance, the PMCCF will receive the same price as other syndicate members, plus a 100 bps facility fee paid by the borrower on the PMCCF's share of the issuance. For example, in a syndicated bond issuance of $1 billion in which the PMCCF purchases 25 percent ($250 million), the issuer must pay a facility fee of $2.5 million at closing.

Is that … that's weird, right? In syndicated loans it is not uncommon for fancier syndicate members to get paid more fees than regular ones, but in bond offerings the way it normally works is that everyone buys the same bond at the same price. It seems a bit unsporting to pay one bond buyer an extra 1% just because that buyer is the Fed. If you actually did this, wouldn't other big investors start asking why they aren't getting "facility fees" for buying your bonds?

(Incidentally, if you actually did this, you wouldn't really call the Fed; you'd call BlackRock Inc., the investment manager of the Fed's primary credit facility. And then BlackRock would check your eligibility and charge you the fees and so forth.)

The other thing you could do is sell only to the Fed: Instead of being a regular buyer in a syndicated offering (for up to 25% of the deal), the Fed will buy your whole bond. Without a market check—without getting the same price as other investors—the Fed will make up its own pricing. From the term sheet:

Pricing will be issuer-specific, informed by market conditions, plus a 100 bps facility fee. Pricing also will be subject to minimum and maximum spreads over yields on comparable maturity U.S. Treasury securities, and such spread caps and floors will vary based on an eligible issuer's credit rating as of the date on which the Facility makes a purchase.

Presumably the Fed's facility will offer a whole-deal price, which could be higher or lower than what you'd get in the market. If the Fed will pay you more (charge you less interest) than the market will, place your whole deal with the Fed; if it will pay you less (charge you more interest), do a marketed deal (and maybe ask the Fed to take a chunk?). The term sheet's description is far too vague to know if the Fed's rate will usually be higher, lower or the same as the market rate, and I couldn't begin to guess which it is from first principles. On first principles the point of this program is to support the functioning of the corporate bond market. Charging below-market interest rates is a good way to support issuers, but it is not particularly helpful to actual bond investors, and presumably the Fed wants to support the normal functioning of the market (with investors) rather than just subsidizing borrowers. Charging above-market interest rates is good and central-bank-y ("lend freely, at a penalty rate," etc.), but means that this lovingly crafted facility probably won't get used. Charging market rates seems fine but pointless; if the corporate bond market is white-hot, what is the point of adding one more savvy investor?

There are more oddities. From the FAQ:

In order to be an Eligible Issuer for the PMCCF, a company must certify compliance with the eligibility criteria set forth in Regulation A and the CARES Act.  Under Regulation A or the express terms of the certifications, if a participant in the PMCCF has obtained credit by making a knowing material misrepresentation or a material breach of the use of proceeds provisions, all extensions of credit to that participant will become immediately due and payable.  In addition, an Eligible Issuer is required to make other certifications and/or representations in connection with its participation in the PMCCF, including information regarding its outstanding indebtedness, lack of participation in the Main Street Lending Programs, that it is not a depository institution or depository institution holding company (or a subsidiary thereof), and, in certain circumstances, the use of PMCCF proceeds, a material knowing misrepresentation or a material breach of which will result in all extensions of credit to that participant becoming immediately due and payable.

Accordingly, when the PMCCF purchases bonds at issuance, the Eligible Issuer will be required to enter into a CCF Letter Agreement ("Letter Agreement") (available here) under which it will agree to repurchase the bonds sold to the PMCCF upon demand, at the 100% of the outstanding principal amount plus accrued interest, in the event the participant has made any knowing material misrepresentation or there is a material breach of the use of proceeds provisions under the PMCCF program transaction-specific documentation.  A similar agreement will be required when the PMCCF participates in a syndicated loan transaction, and the form of agreement will be published at such time as the facility begins transacting in syndicated loans.  The indenture or loan agreement for bonds or loans in which the PMCCF is a co-investor or co-lender must provide that any payments to the PMCCF under the Letter Agreement are not subject to any sharing clause or similar provision requiring ratable application of recoveries from an issuer or borrower among noteholders or lenders.

There is a whole package of forms issuers need to fill out: The letter agreement, a CARES Act certification, a form for selling bonds, a "trade date issuer certification package." If those forms turn out to be wrong—for instance, if the issuer is getting certain other government support, if it's too levered, if it's a subsidiary of a foreign company and uses some of the money for its foreign affiliates—then the Fed can demand its money back. And if you include the Fed in your deal, your bond indenture needs to mention this possibility and specifically provide that, if it happens, the Fed gets all its money back early but your other investors don't. That, again, is weird, to give one investor special redemption rights, a little bit of seniority over the other investors. It's fine, maybe; the one investor is the Fed; maybe this will just become a standard provision in bond indentures, a technical legal requirement that no one thinks much about.

Or maybe no one will ever do a trade like this because it involves a lot of effort and paperwork and complexity, and it's a headache to explain to your other investors ("wait one investor gets a put right why?"), and no one who is eligible for the program actually needs the Fed's money because, again, the investment-grade bond market is as hot as it has ever been. (That could change, sure, but the facility will stop buying bonds on Sept. 30, so it would have to change fast.)

That seems like the most likely outcome to me, but then ... why do it? Why spend all the time writing all of these rules for the program, and drafting all the forms, and playing out all these mechanics, if the program is unlikely to ever make any loans or buy any bonds? Perhaps I am missing something, and the Fed will actually be a hugely attractive source of financing and will make a lot of loans. Perhaps this is all a complex but necessary backstop: The Fed doesn't really plan to make any loans in the expected case, but if conditions change (by Sept. 30) it needs to be ready to swoop in at a moment's notice to make complicated legally compliant loans. Or perhaps it is just a sort of institutional inertia: The Fed announced that it would set up a primary credit facility back when conditions were bad, and now, when conditions are good (because of the Fed's announcement), it's going to go ahead and set up that facility even if it no longer makes any sense.

Elsewhere in the Fed:

The Federal Reserve became one of the top holders in some of the world's largest credit ETFs less than two months after stepping into the market.

The central bank owns more than 13 million shares of the $54 billion iShares iBoxx $ Investment Grade Corporate Bond exchange-traded fund (LQD) as of June 16, making it the third-largest holder, according to data compiled by Bloomberg. … The Fed is also the second- and fifth-largest holder of the $29 billion Vanguard Short-Term Corporate Bond ETF (VCSH) and the $36 billion Vanguard Intermediate-Term Corporate Bond ETF (VCIT), respectively.

That seems fine to me? It's just buying giant broad index credit ETFs in the secondary market like any other (huge) investor. Part of the Fed's mandate, now, is keeping down the cost of corporate credit; that's just a kind of monetary policy now. The Fed is a really big owner of Treasury and agency bonds too; if investment-grade bonds are a tool of monetary-ish policy, then the Fed is going to be a big owner of bond indexes.


One thing that happened over the last few years is that companies figured out a viable way to raise money to build products by pre-selling those products. The way was called an "initial coin offering": You plan to put the product on the blockchain, and then you sell tokens on that blockchain. People buy the tokens, you get the money, you build the product, and once it's built the tokens can be exchanged for the product. This is an oversimplification—often what was being sold was not exactly a product but more a right to participate in a network, etc.—but not too much of one.

One very popular opinion, early on in the world of ICOs, was that ICO tokens were not "securities" under U.S. securities law. The tokens were "utility tokens," the theory went; people bought them not to speculate on a common enterprise but as a way to, eventually, get the product. Tokens were entitlements issued by companies, sure, but so are airline miles and gift cards, and gift cards obviously aren't securities. (I have suggested that an ICO is "like if the Wright Brothers sold air miles to finance inventing the airplane.") If you issue ICO tokens, the theory went, you don't need to register them with the SEC or provide financial statements or anything like that; they are a way to raise money for a business without complying with securities laws.

The U.S. Securities and Exchange Commission rejected that opinion as forcefully as any regulator has ever rejected anything. No, said the SEC, ICOs are securities offerings, pretty much always. They have to comply with securities laws, and if they don't, the SEC will come after them hard. Just last week, the SEC fined Telegram Group Inc. $18.5 million and made it return $1.2 billion to investors in its ICO. Telegram, a lot of people would say, actually did a good job of trying in good faith to comply with the securities laws. The SEC wasn't having it. 

An even weirder case was TurnKey Jet Inc., a charter jet company that sold tokens for charter-jet flying time. The SEC said that that was not a securities offering, and let TurnKey go ahead with it. But it was a grudging acceptance. SEC Commissioner Hester Peirce criticized the SEC's approach in a speech:

The company intended to effectively tokenize gift cards. Customer members could purchase tokens that would be redeemable, dollar for dollar, for charter jet services. The tokens could be sold only to other members. This transaction is so clearly not an offer of securities that I worry the staff's issuance of a digital token no-action letter—the first and so far only such letter—may in fact have the effect of broadening the perceived reach of our securities laws. If these tokens were securities, it would be hard to distinguish them from any medium of stored value. Is a Starbucks card a security? If we are going that far, I can only imagine what name the barista will write on my coffee cup.

And yet, the staff's letter did not stop at merely stating that the token offering would not qualify as a securities offering, but highlighted specific but non-dispositive factors. In other words, the letter effectively imposed conditions on a non-security. For example, the staff's response prohibits the company from repurchasing the tokens unless it does so at a discount. Further, as I mentioned earlier, the incoming letter precluded a secondary market that includes non-members. Does that mean that a company that chooses to offer to repurchase gift cards at a premium or that allows gift card purchasers to sell or give them to third parties needs to call its securities lawyer to start the registration process?

What if you took Peirce's concerns seriously? What if you divorced them from the now rather dated context of "ICOs" and "tokens" and "blockchains," and just focused on the substance of the transaction, which is pre-selling a company's product to future users. Is that a security? Conventionally, no, but you could imagine an argument that it should be. The buyers, after all, are taking credit risk; they are to some extent speculating on the company's success. (If it goes bankrupt before they get the product, they won't get their product, or their money back.) They are also perhaps speculating that the product will be desirable; if there's resale value, they're speculating on that too. Shouldn't they have the information—financial statements and risk factors and so forth—that securities purchasers get? Shouldn't they have the protection of securities laws?

No, again, is the answer, but my (and Peirce's) point here is that the SEC's extremely aggressive ICO regulation kind of opened the door for the SEC to think about crowdfunding and product pre-sales generally. If ICO tokens are securities then maybe any pre-sold product is too.

Or not, I don't know, but here's a story about Nikola Corp., the bizarro-world Tesla of trucks:

Even in the innovative world of electric vehicles, it's an unusual proposition: Plunk down as much as $5,000 now to reserve the right in a few years to buy a battery-powered truck, before seeing a prototype or manufacturing plan to assure it'll ever be built.

That's what Nikola Corp., the Phoenix-based company whose sudden stock surge has captured the attention of investors, is asking customers to do starting Monday. The reservations, which are refundable, take a page from Tesla Inc.'s playbook, but they require would-be vehicle buyers to take an even bigger leap of faith than Elon Musk ever did.

Nikola founder Trevor Milton has said he hopes the truck, called the Badger, will one day rival Ford Motor Co.'s F-150, which for 43 years has been America's best-selling pickup. ... In a March filing, the company said it didn't expect to draw up plans for the Badger pickup unless an established manufacturer agreed to make it.

I suppose if the reservations are refundable at par and there's no secondary trading, it's hard to make the case that they're securities. Also Nikola is already a public company, so you can look at its financials and risk factors. (It lost $32 million, on $58,000 of revenue, last quarter, okay.) Still maybe you would like more disclosure? Maybe the prototype is somehow a matter of securities law now?

Who controls a company?

At Bloomberg Businessweek, Kit Chellel and Liam Vaughan have the insane story of Quinn Industrial Holdings, "an offshoot of a vast manufacturing and insurance conglomerate" founded by Northern Irish businessman Sean Quinn. Quinn's company was seized by the nationalized Anglo Irish Bank in 2011, after Quinn lost billions of dollars betting on contracts for differences in the 2008 crisis. Quinn was not happy about this, and he had a lot of supporters at the company; "minor acts of sabotage occurred on an almost weekly basis," and selling assets was complicated:

Some assets were successfully sold, but just as often, when they were closing in on a deal, the interested party was threatened and ended up walking away. When rival cement producer Lagan Group entered talks about a potential merger, its chairman got a rifle bullet in the mail, with a ransom-style message pasted together out of newspaper cuttings: "[IS] [THIS] [WHAT] [U] [WANT]."

(Meanwhile Quinn was shuffling assets and at one point went to prison for contempt of court.)

And so a compromise was brokered. Quinn's top three former lieutenants, Liam McCaffrey, Dara O'Reilly and Kevin Lunney, teamed up to buy back the business. "Quinn himself would return to the top of the business, everyone involved in the bid agreed, once his legal problems were resolved." Well, not quite everyone:

By now the company's fate resided in the hands of three American hedge funds—Brigade Capital Management, Silver Point Capital, and Contrarian Capital—which had bought up Quinn Group debt on the cheap. When they learned that former Quinn executives were interested in buying back parts of the business, they offered to team up and bankroll the acquisition. Under the terms of the proposed deal, Lunney and the others would get a generous salary and a minority stake in the new enterprise. But there was one condition: Sean Quinn couldn't be involved.

The U.S. investors, who among them managed a total of $15 billion, had no desire to get into business with Quinn, in their eyes a former convict who was still officially bankrupt. After some persuasion from the QBRC team, they agreed to employ Quinn as a consultant at €500,000 ($600,000) a year, but he was barred from owning shares. With little choice, Quinn reluctantly agreed.

This did not go well, pretty much from the beginning:

Quinn still saw himself as the boss, and it quickly became clear that he was unwilling to play any other role. He made his disdain for the QIH deal plain at the first meeting, in January 2015, when he sat down, scowling, in his familiar seat at the head of the boardroom table. Things were going to go back to the way they were, Quinn announced, with him in charge. Lunney, McCaffrey, and the rest were being paid too much, he said, and he didn't approve of them owning shares when he didn't. "You're a shower of grabbers," he fumed, according to several people present.

A few weeks later, after the owners agreed to sell the flagship glass business to a Spanish conglomerate, Quinn raged in the QIH boardroom, in front of the buyer's chairman. "Youse are all f---ing gangsters," he said.

One lesson here is that if you've got a company founded by and owned by and named after one person, and that founder is forced out and then brought back as a consultant, it is going to be hard to confine him to the consultant role. He is just going to think he's still the owner, you know? If you let him in the boardroom, he's going to sit at the head of the table. And a lot of employees are going to think that he, rather than some distressed-debt hedge funds, is the real owner:

Asked about the violence and intimidation that had been directed at his rivals, Quinn walked across the kitchen, picked out a toothpick from a packet, and sat back down. "Let's put it this way: In order to run a business, you need some fundamentals. And the fundamentals would be respect," he said. "And if the staff and the community knows that they have knifed Sean Quinn in the back and taken his business, are they going to support them?"

I mean, that is partly about employee loyalty, but it is also partly about violence and intimidation. There are some specifically Irish-borderlands lessons to the story; Lunney was kidnapped and tortured last year, and this happened:

Before they could let Lunney go, they explained, they needed to mark him. The leader slashed his face with the knife then took the blade to his chest. "Just so you remember why you are here," he said, as he carved three letters into Lunney's flesh: Q I H.

I sometimes say that whoever has the keys to the front door has some effective control over a company, regardless of what the law and the shareholder ledger say, but you can sort of extend that logic to other forms of physical control. Being willing and able to kidnap and mutilate one's rivals for corporate control can also, in some circumstances, be a pretty effective way to get control.

Things happen

Uber Makes Offer to Buy Postmates Delivery Service. Coffee's for Closers: How a Short Seller's Warning Helped Take Down Luckin Coffee. New China security law could stifle research in HK, say analysts. 'Flying Blind Into a Credit Storm': Widespread Deferrals Mean Banks Can't Tell Who's Creditworthy. The hedge fund manager behind a long-shot coronavirus pill. PPP Loan Window Is Closing, With $134 Billion Still on Offer. Panicked Investors Inundate Brokers as Zimbabwe Shuts Bourse. Las Vegas Workers Sue Casinos Over Covid-19 Safety. Kim Kardashian West's Beauty Brand Valued at $1 Billion in Deal With Coty. The Perfect Art Heist: Hack the Money, Leave the Painting. Suitcases of Cash Halted by Virus in EU Money-Laundering Hotspot. "If you are going to audit a brewery, you don't just count the barrels of beer. You should wiggle them to see if they are full."

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