💥It's Over: Hertz is Already Deal of the Year💥
Citibank/Revlon, Elon Musk Sandbags Crypto, Houlihan Lokey
👍Winners & Losers of the Week 👎
1. The Fully Vaccinated. Per the latest (wildly confusing) CDC guidance, fully vaccinated American humans are no longer required to wear masks indoors:
Fully vaccinated people can resume activities without wearing a mask or physically distancing, except where required by federal, state, local, tribal, or territorial laws, rules, and regulations, including local business and workplace guidance.
Apropos “local business and workplace guidance,” some companies were reportedly caught off-guard. While some businesses have lifted mask requirements, others are awaiting guidance from OSHA before following suit. Apparently, businesses weren’t alone. The White House was surprised too: after all, children haven’t been vaccinated yet! Americans in places like South Beach, meanwhile, were like “we were supposed to wear masks??” Many others — in New York City for instance — continue to wear masks outdoors. We’re not sure what to make of that other than that maybe people stopped paying attention to the CDC (and/or the mainstream media) a long time ago.
2. Malls (wait, what?). During the first quarter of 2021, malls saw foot traffic recover to nearly pre-pandemic levels. Tanger Factory Outlet Centers, Inc. ($SKT) reported net income of $3.9mm and Funds From Operation of $38mm for the quarter, beating street estimates. The company announced that Q121 traffic across its open-air locations reached 97% of 2019 levels. Occupancy across Tanger’s consolidated portfolio was 91.7%, down just 200bps from prior quarter. During the earnings call, management was optimistic about the macro picture, but noted that the company expects store closures related to bankruptcies and brand-wide restructurings to continue into 2021.
The results broadly align with mall traffic data reported by Placer.ai last month:
Simon Property Group ($SPG) announced revenue of $1.24b during Q121, down 8% from Q120, but an improvement over the prior sequential quarter. Portfolio-level NOI fell 8% YOY, excluding the impact of the TRG acquisition. Reported portfolio NOI was up 4%. The company reported 90.8% occupancy at the end of March, noting strong momentum in leasing across the portfolio. Observing “some level of euphoria” among shoppers, CEO David Simon noted:
The improving domestic economic environment, shopper sentiment, have increased shopper foot traffic and sales across our portfolio. As I mentioned, increased traffic for our open air and suburban centers has been very encouraging and retail sales continue to improve across the portfolio with higher sales volumes in March compared to 2019 levels.
On the flip side, states that have been more conservative in lifting restrictions are causing a drag on the company’s performance:
I mean let's take California versus Florida. I mean, Disney World has been open 9 months. And Disneyland, I think just opened, right? So California has a 9-month lag.
In addition to scooping up brands alongside Authentic Brands Group (including the recently-announced acquisition of Eddie Bauer), Simon has been betting on a recovery in brick and mortar retail sales. In addressing tenant COVID negotiations, the company has in some cases brought down its base rent rate in exchange for lower sales breakpoints.
Fiscal policy commentary aside, here’s a live look at SPG’s Houston Galleria mall:
Which gets us to retail sales. They stalled in April (while March was revised up) coming in flat versus March numbers, surprising analysts who expected stimmy checks to keep pumping up the numbers. Auto and restaurant sales drove much of the April number. Without auto growth, overall retail sales were down ~1%. Does this mean that Mr. Simon may be overly optimistic? It’s likely too early to tell but physical store sales and clothing store sales dropped 5% in April so 🤔.
3. Ransomware. After a ransomware attack targeting Colonial Pipeline Inc. caused the disruption of operations across 12,000 gas stations, the company paid the criminal hacker group approximately $5mm to regain access to its systems. This cuts both ways — Colonial is the obvious loser, along with consumers across the Southeast, who saw gasoline prices sky rocket amid region-wide shortages (compounded by panic buying where morons were literally filling plastic bags with gasoline). Bloomberg reports that the number of ransomware attacks on critical infrastructure has been growing over the resent years, even as companies continue to invest in cybersecurity. As always, Twitter chipped in with brilliant ideas:
And by “brilliant” we mean “f*cking stupid.”
1. Secondhand retailer stocks. Shares of The RealReal Inc. ($REAL), Poshmark Inc. ($POSH), and ThredUp Inc. ($TDUP) had a rather volatile week as the companies released Q121 results. RealReal reported 27% growth in Revenue and GMV, but investors are becoming increasingly concerned with sequential quarter guidance and widening losses. Poshmark reported 42% revenue growth year over year, adding that it expects second quarter revenue to be ~flat from Q1. In its first quarterly filing since the IPO, ThredUp reported 15% revenue growth over same period last year. Despite lackluster short-term guidance across the three companies, the secondhand category is expected to grow over the long term. By ThredUp’s calculations, secondhand resale market is expected to compound at a rate of 39% annually from 2019 through 2024. Among the major platforms, analysts expect ThredUp’s partnerships with brands to provide the company an advantage over its peers. The fact that ThredUp also publishes a much ballyhooed report on resale every year touting the (growth) opportunity also provides it with an advantage over its peers.
2. Chamath Palihapitiya. This is just a savage graphic ⬇️
On the other hand, he seems to be “doing just fine.” We cannot shake the feeling that one day there will be books written about this time in the cycle and we’ll all look back with incredulity about how far afield things got. We’d comment on this more but we have some Pokemon cards to go find.
3. Cosi Inc.? This is a strange one. Unable to access critical PPP funds because it was already in bankruptcy, the restaurant chain asked the US Bankruptcy Court in Delaware to dismiss its chapter 11 (22, actually) bankruptcy filing so that it could tap into much-needed federal funds and fend off liquidation — a hail mary that company acknowledged was a “tremendous risk.” On May 11, the bankruptcy court obliged. And then on May 12, Crain’s New York reported:
The federal Restaurant Revitalization Fund is all but out of cash.
Restaurants in the priority group requested $29 billion in relief funds, more than the $28.6 billion in the total grant allotment, according to the Small Business Administration.
The priority group was defined in the American Rescue Plan Act, which created the relief measure. It includes restaurants owned by women, veterans or “socially and economically disadvantaged business owners.” Although any restaurateur who lost money last year could apply for funds, the SBA reserved the first 21 days to review and fund applicants in the priority tier.
There may still be funds available from various pots in the federal relief bill but it is far from clear. The Cosi debtors must be sh*tting bricks larger than a piece of flatbread.
⚡️Update: Hertz Global Holdings Inc., LOL.⚡️
It all comes back to Hertz Global Holdings Inc. ($HTZGQ), the unofficial poster child for COVID-19 era markets.
Let’s recap the bona fides:
The company filed for bankruptcy in May 2020 after the pandemic sparked governments around the world to shut down air travel. No business trips and vacations quickly destroyed the rental car market as revenue fell off a cliff. The precipitous decline in sales triggered a margin call on debt backing the Hertz Debtors’ car fleet — a margin call that they could not satisfy. In other words, the chapter 11 bankruptcy filing was in no way tied to near-term structural business reasons that merely got uber-accelerated (word choice purposeful) by the pandemic (like many other bankruptcy filings at the time); it was as pure a COVID-19 filing as they came at the time.
The entire capital structure capitulated but a month later the stock mysteriously rose to over $6/share. The markets were incredulous and lots of really smart people using decades of historical precedent cast shade on Robinhood bros and memers for being dumb enough to buy shares in a bankrupt company with loans trading at levels (30 cents) that reflected significant impairment higher up in the capital structure. In other words, Hertz became sort of like an analog meme stock before more-digitally oriented meme stocks (e.g., GameStop Inc.) became a thing.
Needing additional funding, the Hertz Debtors sought to capitalize on the good fortune conferred upon them by WallStreetBets and partake in an at-the-market equity offering, a strategy viewed by most as a cynical maneuver to take advantage of willing fools. This sent the Twittersphere into a tizzy but ultimately (and predictably) got approved by the Delaware Bankruptcy Court. Shortly thereafter, however, the SEC put the kibosh on this plan which probably had something to do with the Hertz Debtors acknowledging that they were knowingly and intentionally feeding pigs what they reasonably thought to be sh*t. The Hertz Debtors did squeak out a small allocation of shares, though (at just over $2/share).
Hertz then flooded the market with used cars as it sought to raise cash in a depressed travel environment; from June 1, 2020 through December 31, 2020, Hertz disposed of more than 199,000 vehicles.
During that time, there was a torrent of car purchases as people were wary of air travel. Meanwhile, auto OEMs had to curtail production — first because of COVID-19 and then due to semiconductor shortages (PETITION Note: production cuts of new cars now total a reported 1.2mm vehicles). Large customers like Hertz also ceased volume orders. Used car prices quickly recovered. As just one way of illustrating the “torrent” point, take a look at Carvana Co’s ($CVNA) revenue:
Fast forward to a miraculous economic recovery (Jay POW-ell!) and as borne out by Avis Budget Group Inc. ($CAR), car rentals came back. Consequently, the Hertz Debtors decided to put the pedal to the metal and get the hell out of bankruptcy. Who knew whether this would all last? Better to take advantage of this momentum now, the thinking went.
You know about the back-and-forth by this point. First there were one group of plan sponsors (Knighthead Capital Management LLC and Certares Opportunities LLC) and then there was a “pivot” (a group consisting of Centerbridge Partners L.P., Warburg Pincus LLC, Dundon Capital Partners LLC and an ad hoc group of the Hertz Debtors’ unsecured noteholders) and then another “pivot” and then another “pivot” and then a 36-hour auction and, ultimately, the initial sponsors, supported by reinforcements (Apollo Management Group), ended up back on top. Each time the outlook for general unsecured creditors and, more importantly, shareholders improved. Some noteholders absolutely crushed it.
Now — NOW! — shareholders are the big winners too! The mainstream media tripped all over itself to declare the memers the victors and the shadecasters as pessimistic boomers who didn’t understand the recovery potential (though some also pointed out the luck involved). And there’s probably some truth to the latter though we highly doubt that 99% of the former were running complex recovery analyses enough to know whether the equity had value.
But some well-known public market money managers were! And they combined with Knighthead and Certares to push through with the winning bid. The media celebrated $8 a share.
But is it really $8 a share? Or even “near $8/shr?” Bloomberg’s Matt Levine pays this point short shrift though at least, to his credit, he does note that there’s more there there:
“That $8 number isn’t quite real — you have to decide how much you value the warrants and reorganized equity — but certainly the equity is getting something. And if you believe, or partly believe, the $8 post-bankruptcy valuation, then $6.25 a year ago was a bargain. If you bought Hertz stock at $6.25 last June, that was a reasonable bet. Not necessarily a great bet — you’re down about 20% over the last year, and of course you’d have been better off buying Dogecoin — but a reasonable one, and if a few more things break your way you’ll have a nice little profit. And if you paid under $3 for Hertz — which is where it traded for most of last June — you did great.”
But that’s the thing. The entry point matters. And the details matter. Shareholders will get (a) $239mm in cash, (b) common stock representing 3% of the shares of the reorganized Company (subject to dilution from warrants and equity issued under a new management incentive plan); and (c) 30-year warrants for 18% of the common stock of the reorganized Company (subject to dilution by a new management incentive plan) with a strike price based on a total equity value of $6.5 billion, or the opportunity, for eligible shareholders, to subscribe for shares of common stock in the $1.635 billion rights offering at Plan equity value. As if that doesn’t sound complicated enough, shareholders could also elect to participate in the rights offering but, kinda sorta not. Instead, they could sell their rights pursuant to an auction and receive their pro rata share of proceeds of the rights sale instead of warrants. Thoughts and prayers to the retail investor trying to figure what the bloody hell that actually means for them.
So what does it mean? It means — NOT INVESTMENT ADVICE, DO YOUR OWN WORK! — $1.53 in cash per share. It means, with the 3% piece, another $1 per share. So, ~$2.53 is a guaranteed recovery. Beyond that, it depends upon what the shareholder opts to do and how they might value the warrants. And on that point we say, “good luck with that.” Why are we so flippant? Because this entire analysis depends on how you run your — 😳gulp 😳— Black-Scholes model (lol), which, among other inputs, requires an assessment of volatility (LOL). This volatility assessment could get you anywhere between $2/share to $5.50/share (LOL!!) and so going shorthand with $8/share isn’t exactly telling the whole story (despite making a good story). The Hertz Debtors note a volatility range of 50-65%. At its midpoint, the warrant value comes to ~$769mm or $4.92/share. Applying additional inputs might get you to $5.47/share. You could be forgiven for thinking that some Managing Director was spinning around in his chair ordering an analyst to somehow “land around $8/share” and then some excel monkey made some magic happen (adding an extra penny at the end to make things look more optically kosher). The bottom line is that along with entry points and details, the inputs matter too. And so there must be a whole lot of people running some B/S models this week (LOL!!!):
Of course, that’s a whole bunch of nuance that today’s equity market doesn’t exactly have time for. But 🤷♀️.
On Wednesday, Consumer Price Index data pushed the market into a swoon with CNBC coming about an inch away from this:
Headline year-over-year inflation came in around 4.2%, a somewhat misleading number since it factored in oil prices that, on a relative basis, were over $100/barrel higher than the year before.
Drilling down further into core CPI (excludes volatile food and energy) and the clear outlier is used car prices. Per the U.S. Bureau of Labor Statistics:
The index for used cars and trucks rose 10.0 percent in April. This was the largest 1-month increase since the series began in 1953, and it accounted for over a third of the seasonally adjusted all items increase.
In other words, while other indices also increased, used cars/trucks were the largest contributor to the CPI number that freaked everyone the hell out.
Which brings us back to Hertz. The company is out in the market trying to stock back up on cars pushing prices up in a supply-constrained auto environment. It would be the greatest irony of all time if inflation fears decimated the personal trading accounts of all of the new retail entrants into the market on the same day that they experienced a win on their Hertz stock. The Lord giveth and the Lord taketh away.
Taking this a step farther, it would be amazing if the Fed felt compelled by inflation or perceived inflation to tighten monetary policy (read: raise rates) in part because Hertz vomited nearly 200,000 cars into the market and then, months later, had to go back to that market and buy its sh*t back. (PETITION Note: the inflation argument sure didn’t spook markets for long as momentum swung back fast and furious to the upside on Thursday and Friday. Markets today are fickle AF.).
Regardless of what happens with the Fed and inflation later, Hertz has already established itself as a founding member of a lot of special clubs all at the same time:
✅the pandemic-induced bankruptcy club;
✅the meme stock club; and
✅the inflation club.
Which makes us wonder: what’s next for Hertz? Is it going to NFT something? Or will it announce that it plans to carry Bitcoin on balance sheet? How long until it issues new debt into the market for the sole purpose of paying Knighthead and Certares a big fat dividend?
Nothing would surprise us at this point.
💄Revlon: Lipstick on a Pig? Part XVII (Appeal to Common Sense)💄
We’ll be honest: from a content perspective the Revlon Inc. ($REV) + Citigroup Inc. ($C) fiasco is the gift that keeps on giving.
By now you’re well familiar with the story: we’ve covered it in SIXTEEN(!) prior parts (last three here, here and here) so if you feel like revisiting this debacle from various perspectives you’re more than welcome to. From the vantage point of the Citi bankers, this is a horror show. From the perspective of the hedge funders who were fighting with REV and benefitted from Citi’s inadvertent payment of $500mm in term loan principle not due for three years (and largely thought to be a guaranteed below par recovery), this is a feel good story. For REV this is 🤷♀️. For us, this is the best comedy of the past two years!
Citi is definitely not laughing at any of this. Thanks to some first class lawyering and an excellent poker face, Revlon’s creditors managed to convinced District Court Judge Jesse Furman that they were entitled to keep the money Citi fat fingered into their accounts. Because if you look at things just right 🤣you can sort of maybe kind of see how they were supposed to receive hundreds of millions ahead of time (what’s a few years acceleration of payment amongst friends anyways).
Repeat: Citi isn’t amused. And so Citi appealed the ruling. The crux of the appeal? The sound legal basis of:
As Citi put it: a “reasonable person would have been suspicious that something was wrong.” But we aren’t dealing with reasonable persons: these are hedge fund managers! From Citi’s appellate brief:
Last August, Citibank wired over $500 million of its own money by mistake. Ordinarily, the recipient of such a mistaken transfer must return the money. Yet the District Court held that, in this case, Citibank is not entitled to restitution because another entity—Revlon Consumer Products Corporation—was supposed to pay the recipients the same sum of money three years later—in 2023. That extraordinary result is as wrong as it sounds. (emphasis added)
Over the next 60 pages, Citi lays out how the “discharge-for-value” defense invoked by the defendants does not hold here.
New York law holds that if a party transfers money in error, they are generally entitled to get their money back. “Discharge-for-value” is one exception to this common sense holding.
The discharge-for-value defense is a narrow exception to this general rule. It
excuses a party from its restitution obligations when it “receives money to which it
is entitled,” “in the ordinary course of business and for a valuable consideration,”
and “in good faith.” (emphasis added)
Citi unsurprisingly claims that none of the three bolded provisions ⬆️ applies in this case. Citi politely pointed out how it thinks the District Court ruled in error:
First, the District Court held that a creditor may rely on the [discharge-for-value] defense even when the creditor is not entitled to the funds when it receives them. That expansive application is at odds with how New York courts and others have articulated the exception for over a century and bears no relationship to the rule’s purposes.
Second, the District Court held that the discharge-for-value defense applies before a creditor has given value for the payment, including by crediting the debtor’s account. That expansion is inconsistent with the rule’s equitable origins and places the District Court at odds with every other court to have confronted the issue.
Third, the District Court held that the defense applies in the face of highly suspicious circumstances that would have led a reasonably prudent person to investigate: Revlon — a company Defendants believed was insolvent — supposedly paid nearly $1 billion, three years before the debt was due. Meanwhile, Citibank’s calculation statement never mentioned a principal payment, nor did the lenders receive prompt notice of prepayment, as required by the credit agreement. Nevertheless, the District Court held that a reasonable person could hypothesize how Revlon pulled a billion-dollar rabbit out of its hat and why the calculation statements failed to match the sudden payment. But a prudent investigation must be one designed to answer the questions raised, which requires a reasonable person to seek out answers, not speculate.
Each of the District Court’s errors thus carried the defense into uncharted waters, and each independently warrants reversal.
Polite right? For the future, we need to think of similar ways to gently call someone completely unmoored from facts and reality!
Citi’s argument is presented in three parts:
I. The Discharge-For-Value Defense Is Inapplicable Because Defendants Were Not Entitled To The Funds At The Time Of Transfer.
II. The Discharge-For-Value Defense Is Inapplicable because Defendants Did Not Give Value
III. Defendants Were On Notice Of Citibank’s Mistake.
In plainer terms, the creditors’ discharge-for-value defense fails because: (i) the term loan was not due until 2023(!); (ii) the creditors did not credit Revlon’s account (!!)(i.e. provide a “valuable consideration”); and (iii) “it was obvious something was amiss” (!!!).
That last point is straight from the brief - it is hard to read exchanges like these and come away thinking the defendants were acting in good faith:
For instance, an employee of one Defendant emailed another on August
14: “take the money and run.” The response: “We have not paid the money back :).”
An employee for another Defendant praised himself for reversing the return of Citibank’s money, saying he “thankfully” was able stop a colleague who “was about to return it.”
Yet another—immediately after meeting with outside counsel on August 13—emailed “WE DON’T WANT THIS PAID BACK YET.”.
(PETITION Note: Pick up the phone, guys! PETITION Counter: Yeah, well, that didn’t work out so well in the Neiman Marcus case so….?)
Citi concludes that “Any one of the District Court’s three legal errors suffices to reverse the judgment.”
The District Court’s decision has sent shockwaves through the markets and generated outcry across the financial industry. It has no grounding in precedent or equity. This Court should reverse.
We are sympathetic with Citi and most other commentators seem to be as well. But as a lawyer for the creditors stated, “all of Citi’s arguments are rehashes of arguments considered and thoughtfully rejected by the District Court.” You can almost hear the defendant hedge funders giggling.
Citi, Revlon, and its creditors aren’t the only parties interested in this case. As we pointed out a few weeks ago, agents have already added provisions to many credit facility docs to prevent this sort of situation from ever happening again (even, in true bankery bankerness, putting in ways to make money from it if an inadvertent transfer were to occur again). And last week, the Loan Syndications and Trading Association (LSTA) filed an amicus brief urging the Court to reverse the ruling, noting that:
…a decision that permits recipients to retain mistaken payments would be extremely disruptive, putting lenders in the untenable position of having to freeze whenever they potentially receive them – retain counsel, consult their investors, seek information from others – instead of doing what they have been doing from the inception of the market: return money to which they have no entitlement.
At this point it would take parties bolder than us to predict how this will all shake out. We expected the initial ruling to break Citi’s way and, well, clearly we were wrong. Color us stigmatized. It doesn’t help that Citi keeps taking a shellacking: earlier this week Judge Furman came down against Citi again, this time denying Citi’s request to (continue to) freeze the $500mm in funds while the Citi pursues its appeal. Citi had argued that unfreezing the funds would prejudice them later if, on appeal, they prevail. The hedge funders be like, “try and collect, b*tches!”
To make matters worse, Judge Furman threw shade all up in Citi’s grill, saying that Citi “faces an uphill battle on appeal.” 😬
The defendant hedge funders will submit an opposition brief in the coming months. Oral arguments should happen by August or September if everything stays on schedule.
🚀Crypto Leverage to the Mooooooon (Short Elon Musk Fanboys)🚀
At this point there’s no denying it. The equity markets, despite some blips here and there (like Wednesday’s bloodbath), have been HOT. Q1 earnings have ripped through analyst estimates. Vaccination campaigns have worked. Inflation concerns have some worried the U.S. Federal Reserve may need to hike interest rates early to prevent the economy from overheating, but for now the 10yr UST yields ~1.6%. The market’s focus is on a broad economic reopening, and so far, everything is cooperating. President Biden is calling for a ‘Wet Hot American Summer’ with a goal of 70% of adults at least partially vaccinated by July 4. Investors are swan-diving into the markets, levering their long positions. Per AdvisorPerspectives.com, margin debt is higher than it’s ever been:
But one asset class reigns supreme as the king of levered YOLO retail trades: cryptocurrencies. The WSJ covered it here:
“Bitcoin’s high coincided with the stock-market debut of Coinbase Global Inc., the biggest U.S. cryptocurrency exchange…The rally cratered…when bitcoin suddenly fell as much as 17% to $52,149—with half the decline occurring in about 20 minutes…It is unclear what triggered the selloff, which according to the data provider CoinMarketCap wiped out nearly $220 billion of value in cryptocurrencies in an hour…
Whatever sparked the initial bout of selling, traders agree that it accelerated because of the implosion of enormous amounts of leveraged bets that investors had placed on overseas, lightly regulated cryptocurrency-derivatives exchanges. In all, traders lost $10.1 billion on Sunday to liquidations by crypto exchanges, according to the data provider Bybt. More than 90% of the funds liquidated that day came from bullish bets on bitcoin or other digital currencies, Bybt data show, and nearly $5 billion of the liquidations took place on one exchange, Binance, the world’s biggest crypto exchange by trading volume. As the price of bitcoin tumbled, many of those bets were automatically liquidated, adding more downward pressure on the price and leading to a vicious cycle of further liquidations.” (emphasis added)
We dug up source data courtesy of The Block:
In summary, crypto cratered and levered-long retail got SMASHED. The WSJ indicates that many ‘HODLers’ didn’t even get time to tweet ‘diamond hands’ emojis before they were margin called:
“As the price of bitcoin tumbled, many of those bets were automatically liquidated, adding more downward pressure on the price and leading to a vicious cycle of further liquidations. Some crypto traders were wiped out with little warning.”
One of these HODLers is profiled in the story. Enter Jasim, an engineer in Kuwait:
“Jasim, an engineer in Kuwait who declined to give his last name, said he was awakened by an alert on his phone at about 5 a.m. local time Sunday. He watched anxiously as Binance liquidated some of his trades, and then he closed out others with steep losses. In all, he said he lost about $9,000. It wasn’t a new experience for Jasim, whose positions have been liquidated several times since he got into crypto in 2017. “Being greedy is the problem,” he said. Jasim has resumed trading but plans to be more careful about risk management in the future.” (emphasis added)
So Jasim’s crypto trading account is being routinely liquidated, but he doesn’t seem to mind. He chides himself for his poor risk management and buys back in. The WSJ provides a basic overview on leverage in crypto:
“Exchanges such as Binance let individual investors deposit a relatively small amount of money upfront to place an outsize bet. For instance, suppose a trader buys futures that pay off if bitcoin rises against the U.S. dollar. If bitcoin climbs, the trader’s profit could be many times greater than what could have been made simply by buying bitcoin. But if bitcoin falls, the trader can be on the hook for big losses, and must quickly top off the account with fresh funds, or else the exchange will automatically liquidate the trader’s holdings.“You have potential for a series of cascading liquidations, happening back to back to back,” said Chris Zuehlke, global head of Cumberland, the crypto-trading unit of Chicago-based DRW Holdings LLC.” (emphasis added)
If this sounds eerily familiar to the Robinhood / Gamestop ($GME) ordeal, it is:
“Adding to the weekend’s chaos, some exchanges, including Binance, reported glitches in the midst of heavy trading volumes. Traders said their inability to access exchanges dried up liquidity—which was already thin over the weekend—and exacerbated price moves. A Binance spokesman said, “In instances where we may have experienced outages, we aim to learn from them to prevent further occurrence.” (emphasis added)
While retail investors getting hurt by margin calls isn’t a new phenomenon, what’s surprising is how quickly the crypto community has embraced leverage. It’s incredibly easy for a retail crypto investor to get levered-long. In several cases, the crypto institutions are even encouraging it. Enter Celsius Networks & BlockFi.
Celsius Networks is a crypto bank “built by HODLers for HODLers” building a “new economy…where financial freedom doesn’t come with a price tag.” The company provides retail customers a variety of tools to manage their cryptocurrency holdings, including interest bearing accounts and collateral backed loans. Celsius has also issued its own token which actively trades.
BlockFi is a competitor to Celsius in the crypto banking space, offering a similar set of products. The Celsius and BlockFi interest bearing accounts are beyond the scope of this article (for info there, we point you towards the deep-dive performed by Packy McCormick at Not Boring). The crypto-collateralized loans are the focus here.
Celsius offers its retail customers crypto-backed loans priced on an LTV-based grid from 0.75% - 8.95% APR, depending upon which cryptocurrency and how much of their total stake the customer puts up as collateral. The loan application is fully automated and takes “minutes” to set up with zero paperwork, zero origination fee and no credit check.
Celsius is marketing HARD with their catch phrase “Borrow Like the 1%!” Celsius even offers signing bonuses from $75 - $500 in cryptocurrency just for taking out a loan.
Interested in becoming a crypto billionaire, but not sure how to ‘lever up’? No worries, Celsius will happily educate you on the basics of lending:
Celsius competitor BlockFi markets the same schtick: “Borrow While You HODL!”
As of March 2021, Celsius and BlockFi provided some guidance over how collateral is monitored and margin calls assessed. Per Celsius:
[Customer] will have twelve hours to react to a margin call unless the market continues to drop dramatically. [Celsius] will try to provide [customer] with alerts when the market is very volatile.
If after [customer’s] margin call the value continues to drop, making [customer’s] Loan-to-Value Ratio (LTV) 80% or higher, [Celsius] will sell enough of [customer] crypto to bring the value LTV to 65%% until [customer] respond[s] or the five hours expires.
At a 65% LTV, [a BlockFi retail lender or customer] would get an email notification stating that [their] loan is approaching margin territory and [that BlockFi] recommend[s] action (but not required).
At a 70% LTV, [customer] would enter a Margin Call. From there, [customer has] 72 hours to cure [the] margin. If…margin is not cured within 72 hours or…loan hits an 80% LTV, [BlockFi] will sell a portion of [customer] collateral to bring…LTV back down to a healthy level.
At an 80% LTV, [customer gets] another email notification stating [the] loan is in Default and subject to immediate liquidation…In accordance with [BlockFi’s] Loan and Security Agreement, [the] loan would enter Default and BlockFi reserves the right to initiate a sale of [customer] collateral to restore [customer] LTV to a healthy level. Default Liquidations are not something we actively wish to do and would take as many steps as possible to avoid this if possible.
As the trading prices of cryptocurrencies have soared, so has both the popularity and valuation of crypto banks. In July 2020, Celsius raised $18.8mm in a Series A, while in March 2021 BlockFi raised $350mm in a Series D funding, valuing the company at $3b. Despite some high flying valuations, crypto banks don’t appear nearly as safe as their fiat counterparts. For one, a Viktor Tachev Medium article argued that the LTV indicator doesn’t sufficiently protect crypto banks or their deposit customers in a crypto bear market:
“One of the lending companies’ key selling points is that they don’t perform credit checks, thus making crypto loans available to anyone. This means the only real risk management tool in the industry is the Loan-to-Value indicator, which estimates the value of the collateral that the borrower should deposit to be granted a loan. If, for example, the LTV is 50%, then to get a loan of $5,000, the borrower should ensure $10,000 worth of collateral. Once the LTV goes out-of-bounds, the borrower is urged to deposit additional collateral or sell a part of his cryptocurrencies to repay the loan. Failure to do so triggers an automated collateral liquidation.
To minimize the default risk, some lenders try to over-collateralize by setting LTVs as low as 20%. Even if the loans are over-collateralized, in case there is a significant drop in the crypto market, and the LTV jumps, the only outcome is collateral liquidation. However, at that point, the collateral might already be worth significantly less than the outstanding value of the loan. Moreover, a simultaneous default of several borrowers would generate an immense selling pressure at a time when there won’t be enough buyers.
The LTV is designed to mitigate losses, rather than protect from default risk. This shows that lenders and borrowers are equally vulnerable to the market’s unpredictability. (emphasis added)
We think retail is largely ignoring the risks of crypto leverage, particularly given the nature of the asset class which is i) extremely volatile and ii) highly concentrated among its largest holders. The scale of crypto concentration is actively debated within the community. With regards to bitcoin, accounts holding between 1,000 - 5,000 bitcoins are known in the industry as “whales,” while accounts with greater than 5,000 bitcoins are known as “humpbacks.” A Bloomberg article in November 2020 indicated that “2% of the anonymous ownership accounts control 95% of [all bitcoin[“ citing researcher Flipside Crypto. Glassnode Insights contested this claim, stating that whale accounts only controlled 18.4% of bitcoin and humpback accounts controlled 13.3% of supply. This puts the range of ‘highly concentrated’ bitcoin supply somewhere between ~32% - 95%. A wide range, sure, but it’s clear the whales hold A LOT of crypto. Combining the volatility of crypto with a highly concentrated holder base means that if/when whales sell, retail feels it. And if retail investors have taken out loans against the crypto they own, they are extremely exposed to negative price moves as whales puke their holdings into the open market.
Yet keeping some of that in check is the sheer resilience of the crypto investor to weather tremendous drawdowns for future gains. And even after being liquidated for huge losses, retail investors like Jasim still get back in the game. Jasim’s $9,000 loss likely still produced substantial long-term gains. But let’s walk through a hypothetical scenario to see how ugly this can get. Imagine after getting liquidated in a 30% drawdown, some of these crypto gambling muppets lick their wounds and buy back in. They’re buying at a higher cost basis, thereby risking even more capital for an equivalent level of ownership. If price continues to soar, the temptation to take out new loans against crypto collateral rises along with it. These investors may find themselves levered-long crypto again, but their risk of capital impairment is now multiples higher than it was previously. On the next price move, the retail investor is primed for losses. And if crypto does in fact implode, these retail investors become newly minted bagholders.
Being a crypto investor in today’s markets is pretty stressful - it trades 24/7 and is subject to tremendous drawdowns from a variety of risk factors that are difficult to underwrite. Even a well-placed tweet can throw the market into chaos. On the evening of May 12, Tesla Inc. ($TSLA) CEO & Technoking Elon Musk blew apart the market with this:
Per CNBC and Coinmarketcap, when Musk made the announcement, the value of the entire cryptocurrency market stood at around $2.4t. Over the next few hours, selling pressure began to snow, and market capitalization eventually collapsed below $2.1t, wiping off around $366b of value. According to Coindesk data, the price of Bitcoin fell as much as 14%, while Ethereum fell roughly 12%. We struggle to understand why Elon would willingly impair the value of the 38,200 bitcoins on Tesla’s balance sheet today. We think it’s naive to believe Elon’s really doing this “for the environment.” While energy consumption is something the crypto industry will need to address, a June 2019 CoinShares report estimated that 74% of bitcoin mining is powered by renewable energy. Matt Levine has explored the possibilities that Elon Musk is a master of game theory — we’re considering whether Elon could be using his influence to crush the price of bitcoin so Tesla can accumulate more. FinTwit’s reaction to the Musk statement indicates we’re not alone in our thinking:
Warren Buffett famously stated “You never know who's swimming naked until the tide goes out.” One thing is abundantly clear. If/when the crypto bull market ends (or is suddenly killed by influencers like Elon Musk), and the whales start to sell en masse, we’ll find out exactly which retail investors were swimming naked on margin.
💰How are the Investment Banks Doing?💰
Houlihan Lokey Inc. ($HLI) was the latest restructuring investment bank to release its quarterly results this month, reporting 32% revenue growth for the fiscal year ended March 31, 2021. Over its last fiscal quarter, the firm generated $99mm of net income on $501mm of revenue. Restructuring revenue grew 52% during FY2021, despite slowing down in FQ421. Echoing sentiment conveyed by other restructuring pros (see: here and here), management expects the restructuring business to contract in the short-term, but sees a path to another wave of activity on the horizon. Addressing the lingering effects of COVID, CEO Scott Beiser noted:
I think if you look at the damage done by the pandemic, there are going to be certain fundamental negative impacts on many businesses and industries, many of which we would have thought would have entered into a restructuring in April, May, June, July, etc. of 2020. And for a variety of reasons, a lot having to do with government interventions and stimulus, which in certain cases have postponed potentially the inevitable. In certain cases, companies probably will survive and do well. But we always look at it as does the business plan that you have will it succeed in the go forward world, and if it won't, it's just a matter of time when eventually it will hit the wall. If on the other hand, the business plan can evolve and succeed in today's new world, whether it's because of the pandemic, because of its ongoing technology disruptors and relatively amount of debt you have and interest rates, that's what feeds our restructuring business. So to your specific question, we do think there is another wave, not necessarily the same size that we saw six, nine, 12 months ago, but there is still companies out there that we believe have some trouble ahead, they've just been able to at least kick the can down the road and we'll see how long that will last. (emphasis added)
And while both, Greenhill & Co. Inc. ($GHL) and Evercore Inc. ($EVR), touted the benefits of working form the office, Beiser took it a step further. MDs were able to “get a lot more done,” the junior team on the other hand:
And then the last thing I'd say is as the last class of new hires that we had, especially with the junior level, we train them as best we could, but training them remotely is never as good as in-person. So I actually think the most junior of our team members will get much better once we're all back in the office, and once they can more easily work with their colleagues, and that probably has an improvement in productivity.
Beiser attributes MD productivity to reduced time spent on travel (read: blow), but we suspect there is another factor contributing to this. Traditionally, senior bankers spend at least some time developing the junior staff — whether explaining client dynamics over lunch, or walking across the floor to publicly shame an analyst for missing-page-numbers-in-a-worthless-pitch-deck-that-nobody-is-gonna-read-anyway-let-alone-notice-the-f*cking-page-numbers. Conceivably, such efforts take time away from revenue-generating work, and don’t lend themselves perfectly to a remote environment. Now that WFH is nearing its end, senior bankers will have to start putting some time in again. And that means pretending to give a sh*t about mentorship, a zero-sum game: each moment pretending to give a sh*t about mentorship is one less minute productively orchestrating a new deal.
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🔥Tweet of the Week🔥
Someone please log in to a bankruptcy court hearing like this. PLEEEEAAASE.
We have compiled a list of a$$-kicking resources on the topics of restructuring, tech, finance, investing, and disruption. 💥You can find it here💥. We’ve added “Amazon Unbound: Jeff Bezos and the Invention of a Global Empire” by Brad Stone, which we’re super stoked to read.