Money Stuff: Main Street Doesn’t Want Weird Loans

Money Stuff
Bloomberg

Would you borrow from the Fed?

We talked yesterday about the Federal Reserve's Primary Market Corporate Credit Facility, a program that the Fed launched on Monday to lend money to big investment-grade U.S. companies. I was skeptical that it will actually do much lending. "What, companies are going to fill out forms just to borrow a few tens of millions of dollars?" was the gist of my argument. The PMCCF requires a bunch of certifications; it asks issuers to include unusual provisions in their bond indentures or loan agreements with other investors, and to get those investors' permission to give the Fed special treatment; it comes with various legal and administrative headaches. Also the investment-grade U.S. corporate bond market is absolutely white-hot right now, so companies can easily raise lots of cheap money the regular way instead of messing around with the Fed.

Today the Financial Times has a story about how the Fed's Main Street Lending Program, which launched a few weeks ago and is intended to lend money to medium-sized U.S. companies, is not doing much lending:

Senior executives at some of the biggest US lenders told the Financial Times they had more people working on the Main Street Lending Program than they had borrowers interested in taking money from it.

The banks have typically seen fewer than 200 serious expressions of interest each since the programme — which is 95 per cent funded by the Federal Reserve — was launched a fortnight ago.

And the gist of the problem seems to be, again, "What, companies are going to fill out forms just to borrow a few hundred thousand dollars?"

Bankers say the MSLP is overly complicated. Drawing up loan documents can costs tens of thousands of dollars, they say, and borrowers have also been deterred by the administrative burden. Although the Fed twice reduced the minimum borrowings from an initial $1m to attract more small and medium-sized businesses, demand for smaller loans has been particularly low.

"What banks are telling us is that once borrowers have a better sense of the details and the complexity of the programme — the legal documentation, the fact that it is a participation structure, the requirement that the borrower has to do quarterly reporting — they may lose interest," said Lauren Anderson of the Banking Policy Institute.

And here too, the Fed's program interacts awkwardly with other lenders:

In addition to the costs involved in tailoring documents for every borrower, banks making loans to large customers have to seek agreement from all that businesses' existing lenders. Banks are further constrained because they are blocked from reducing existing loans for some businesses that benefit from the MSLP.

A senior executive at another large bank said it takes a "village of people" at the bank to meet the requirements for a programme that is right for a "pretty narrow set of borrowers".

Here is the term sheet for the Main Street New Loan Facility, one of the MSLP's programs, under which the Fed will buy 95% of new medium-sized business loans from banks, but only if, among other things, the borrower agrees not to voluntarily repay any other debt before the maturity of the Fed's loans, the borrower promises to try "to maintain its payroll and retain its employees" for that full five-year term, and the bank agrees not to cancel any lines of credit. It's a lot for everyone to commit to.

Arguably, at least in the case of the PMCCF, this is all not a bug but a feature. The point of the PMCCF was really to support the normal functioning of the investment-grade credit market. The Fed's general announcement that it would backstop corporate credit, by lending money to companies and buying their bonds, had exactly the intended effect: It reopened the corporate bond market for huge issuance volumes at low rates. The Fed could have just stopped there, but it didn't, it actually launched the program, presumably for some combination of institutional-inertia and well-we've-already-told-the-lawyers-to-draft-it-so-they-might-as-well reasons. But also because the program is a backstop, an insurance policy; the Fed is supposed to be ready to step in if the bond market freezes again. Having a program that is genuinely available to lend lots of money to companies at competitive, normal rates is good because it puts a floor under the market; having the documentation for that program be annoying is good because it means no one will actually use it unless they get desperate. The market can function normally, with the Fed appropriately in the background.

With the Main Street program that is all also sort of true, except that the market for lending to small and medium-sized businesses is not as big or liquid or hot as the investment-grade bond market, and those companies are a lot more likely to be desperate. "A senior executive at a large US bank said that if a client was a good credit 'the odds are you make the loan outside the Main Street programme rather than within it,'" reports the FT, which is kind of how you want a backstop program to work. The problem is that, if the client is a less great credit, (1) the Fed might want to get some money in its hands anyway but (2) the administrative complexities of the program might make that hard.

Oh Elon

A problem for directors at Tesla Inc. is that they have a mad genius chief executive officer, Elon Musk, who does erratic things that might get Tesla sued. If you are a director of a public company, you do not want to be sued personally for your CEO's erratic behavior, so you want Tesla to buy a good large directors-and-officers insurance policy to defend against lawsuits and pay out any settlements. But if you are a D&O insurer, you don't want to pay out a lot of money for Musk's tweets either, so you will charge Tesla a lot for that policy.

Tesla thought it had found a solution to this conundrum: It would buy its D&O insurance from Musk. Musk is rich, so he has a lot of money to pay out D&O claims. He (presumably) has a better opinion of his own Twitter account, and of his own behavior generally, than the average D&O insurer does, so he'll charge less for idiosyncratic Musk risk than a third-party insurer would. And if he is on the hook financially for the directors' legal risk, maybe that will give him an incentive to behave better: If he just quiets down and doesn't get Tesla in trouble, then he can pocket the insurance premiums and not pay out any claims.

Well, that's what I said when Tesla announced this plan back in April. I thought it was pretty good. Nobody agreed with me, oh well:

Proxy adviser Glass Lewis criticized the arrangement earlier this month when it recommended that shareholders vote against re-electing Robyn Denholm, Tesla's board chair, as a director.

"It is the duty of independent directors to oversee management in the best interests of shareholders," Glass Lewis said in its report. "We are concerned that this D&O arrangement gives the company's independent directors a direct, personal financial dependency upon the CEO they are tasked with overseeing."

The directors have some bad wrong-way risk, in that, if Musk does something egregious, (1) they will be exposed to legal liability and (2) his own wealth (which is largely in Tesla stock) will go down, making it harder for him to indemnify them. On the one hand, the directors' financial dependence on the CEO for insurance, and this wrong-way risk, should focus their minds: If he does a really bad thing, they'll be sued and he may not be able to indemnify them, so they should try very hard not to let him do bad things. On the other hand it might give them perverse incentives around disclosure: If they discover that Musk has already done a bad thing that could expose them to liability and reduce his wealth, they might want to cover it up because of that unhedged personal risk.[1]

I don't think this trade-off is particularly bad, but everyone else does, and there is something vaguely and miscellaneously shady about buying your D&O insurance from your CEO. And so now the deal is mostly off and Tesla will go find regular D&O insurance. This will take some time, though, and in the meantime Musk is giving the directors bridge D&O insurance. Here's Tesla's disclosure. Musk will provide $100 million of coverage for 90 days, for a premium of half the rate that a regular D&O insurer would charge for 90 days (but at least $972,361).

I thought the original plan was fine and gave Musk and the board good incentives; everyone else thought it was bad. Now we have a little test! If Musk insuring the directors is bad and makes it hard for them to oversee him, then you should expect him to do a lot of especially bad nonsense in the next 90 days (and then quiet down once they have outside insurance). If I'm right and Musk's indemnity gives him incentives to calm down, then you should expect him to keep fairly quiet for 90 days (and then go nuts once they have outside insurance). And if Elon Musk is utterly unswayed by financial incentives and just does whatever amuses him at all times, then you should expect him to be equally silly now and later. I guess that's the bet I'd make.

Beauty secrets

I don't know what to make of this but it's fascinating:

Seed Beauty, the company that helped launch cosmetics lines for Kylie Jenner and Kim Kardashian West, is suing Coty Inc. for allegedly stealing trade secrets while investing in the famous family's businesses.

Coty, which owns brands such as CoverGirl and Sally Hansen, gained unlawful access to Seed's proprietary strategies for developing and growing cosmetics lines through its recent $600 million deal to take a majority stake in Jenner's company, according to the suit filed Tuesday in Los Angeles. The action comes after Seed Beauty won an injunction this month preventing Kardashian West from sharing trade secrets in a separate deal with Coty. …

Seed Beauty, which partners with celebrities to develop and distribute cosmetics brands, said in the filing that Coty's investment in Jenner's brand "was a subterfuge to learn Seed's confidential business methodologies." The Oxnard, California-based company also named King Kylie LLC and HFC Prestige Products Inc. in the suit.

With a name like "Seed Beauty," and a business model like partnering with celebrities to develop cosmetics brands, you might think that Seed is in the, you know, seeding business. Help celebrities launch their brands, take a stake, and profit when those brands get big and sell out to companies like Coty, that sort of thing. You might think that this would be a success.

But, nope! Seed's complaint is a little vague, and heavily redacted, but the point of it seems to be that the Kardashians are the public faces of their beauty businesses, while Seed develops, manufactures and distributes the actual products:

Seed Beauty has a unique business model which allows it to incubate new brands and products and swiftly bring them to market. For example, Seed Beauty's unique business model enabled it to create, develop, manufacture, store, sell, and distribute products for multiple direct-to-consumer brands all under one roof and bring products to market in record speed based entirely on consumer demand and through its e-commerce strategy. This business model, combined with the affordable, safe, and high-quality nature of Seed Beauty's products, has skyrocketed young start-up brands to beauty and cosmetics sensations over a period of only a few years. …

Significantly, Seed is the sole developer, manufacturer and supplier of King Kylie and KKW color cosmetics products ...

Seed Beauty's business model, and the contracts related to its various product lines, are maintained as trade secrets by Seed Beauty. Most importantly, the exclusive deals between Seed Beauty and its partners are carefully maintained as trade secrets and are not shared with competitors. The structure of those partnerships, as well as the economic terms, are key differentiators under Seed Beauty's business model and are important to Seed Beauty's success. In fact, Seed Beauty's success depends in part on the protection of its trade secrets and other confidential information.

All the actual secrets are then blacked out, and it is not obvious to me why Coty would pay hundreds of millions of dollars to learn the details of Seed's exclusive business deals. But it seems like the basic issue here is that Seed had deals with Kylie Jenner and Kim Kardashian West in which Jenner and Kardashian West provided the brand names and Seed provided the products, and now Jenner and Kardashian West are moving their brand power over to Coty, and that brand power is extremely valuable and Seed is sad to lose it. Which seems reasonable! If you're going to be a "beauty brand incubator" you really should be taking equity in the brands, you know? When startups get acquired, their venture capitalists don't sue the acquirers for stealing trade secrets. If you are betting on Kylie Jenner's cosmetics line at the start of her career, you want to structure it so you will be rich and happy if she succeeds.

Who controls a company?

We talked last week about a corporate governance dispute at Arm Ltd.'s Chinese joint venture. The big shareholders of the venture—Arm and Hopu Investment Management Co.—voted to remove its chief executive officer, Allen Wu; under conventional theories of corporate governance, the shareholders get to do that. But Wu refused to go, and he had some powerful corporate governance theory on his side too. Specifically, in China, the legal representative of a company (Wu) controls the company seal, which is required to endorse corporate documents like, you know, the ones firing him. So as long as he hangs on to the seal they can't get rid of him.  

This is a common issue in Chinese corporate governance, and the Financial Times has a broader look at the power of the "chop," as these seals are called:

Chops, or traditional company seals, are the sole means of authorising official documents in China. Inked signatures used in western countries hold little weight.

The system, used for thousands of years in China, grants whoever holds the chop the power to pay the company's employees, fire executives, open bank accounts and make acquisitions — essentially conduct any official business.

The Arm dispute is not the first time that this has happened:

TPG, the US private equity group, began sparring with local management after buying a majority stake in Japanese leasing company Nissin Leasing (China) in 2008. This led to an attempt to remove the chief executive and replace her with a TPG partner.

When the chief executive refused to step aside or surrender the chop, a top TPG executive appeared at the Shanghai office with seven security guards and a handful of staff in search of the item. But the TPG executive was forced to flee the country when local management called the police, sparking a months-long court battle. TPG sold its stake in the business in 2013.

Would you buy that stake? What would you pay more for, TPG's shares of the business, or the chop? Now, of course, there are ways around this system, besides just hiring burly men to grab the chop. But they too rely on physical possession of something:

Another option is to attempt to re-register the business through China's State Administration of Market Regulation, a process that could take months. If successful, new chops can be issued, rendering the old ones useless.

Arm has gone to the Shenzhen police to apply for a new chop. But for approval, it must produce the company business licence, which Mr Wu also controls.

Good heist

In Bloomberg Businessweek's heist issue, Zeke Faux, our great poet of crime, has a story about a Lynn, Massachusetts, cat burglar who stole a bunch of New York Giants Super Bowl rings as revenge for the Giants beating the Patriots on the "helmet catch." That summary is, like, the ninth-most-interesting thing about the story, which is wall-to-wall amazing even for Zeke Faux. For instance the cat burglar, Sean Murphy, previously wrote a book about cat burgling (in prison) titled "Master Thief: How to Be a Professional Burgler." Prosecutors understandably used this fact against him at his trial, where he represented himself and had this incredible exchange with his accomplice and weed dealer Rob Doucette, who testified against him:

Murphy: Why don't you just admit to the jury that you took Murphy's professional burglary course?

Doucette: I've only hung out with you, and we smoked weed. And you told me, because you like to run your mouth, about how everything is.

Probably some of Socrates's students would have said much the same thing. Anyway, sorry, that quote is actually from Murphy's other trial: While police were investigating the Super Bowl ring theft, he and his crew went and robbed an armored car depot but accidentally set the money on fire. That led to this scene of, I am sorry, money laundering:

Murphy and his crew had stolen more than $1 million in cash. But the bills smelled terrible, and many were damaged. Doucette sprayed Febreze on them to try to cut the smell, but that didn't do much. They tried putting some of the bills through a laundry machine, which only crumpled them into balls.

As a longtime advocate for "don't put it in email," I suppose this is where I should say "if you are a successful professional cat burglar, don't write and publish a book about it," but honestly, no, you're fine, go ahead, who could resist, plus you're in prison already anyway. (Maybe after you publish the book don't go back to cat burgling? I don't know.) Honestly more fun criminals should write tell-all books; I would read them all. "Master Libor Manipulator." "Master Bitcoin Thief." Surely the audience is bigger than just me?

Things happen

Taiwan Courts Hong Kong Bankers Spooked by China's Security Law. Wirecard Raided by Prosecutors Over Missing $2.1 Billion. Wirecard's real business relied on small number of customers. Stocks' Huge Rally Is Pushing Investors Back Into Hedge Funds. Specialty Lenders Face Funding Challenge as Covid-19 Boosts Defaults. Eileen Murray Is Named to Lead Finra, Wall Street's Self-Regulatory Arm. Labor Department Proposes Fiduciary Exemption for Retirement Plans. Pizza Hut and Wendy's Operator NPC Files for Bankruptcy. Big Hotel Owners Stand to Gain From a Government-Orchestrated Debt Relief. How "Books and Records" Rewrote the Rulebook. Happy Bobby Bonilla Day!

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[1] Though this is also true for directors who don't *have* D&O insurance, which is not legally required or anything. When we last talked about this, I wrote that "every company buys directors' and officers' insurance to defend and indemnify its directors against liability," and that "no one would serve on a board without D&O insurance." But that's not quite true! There's one famous exception."We do not provide them directors and officers liability insurance, a given at almost every other large public company," Warren Buffett once wrote about Berkshire Hathaway Inc.'sdirectors. "If they mess up with your money, they will lose their money as well." Well, fine, Warren Buffett can get away with it, presumably because of Berkshire'sgeneral halo of respectability (and because being on the Berkshire board is extremely prestigious). Still I suppose that if Berkshire directors discovered that Buffett was cooking the books, they'd have serious incentives to keep it quiet!

 

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