Hi, friends, and thank you for joining for the first official installment of the newsletter in our ~new format.~
We’ll start where we started: credit-default swaps. If you’ve followed my career at all (thank u!), you know I am never too far from these beautiful financial tools tied to the debt of companies, which pay the buyer if that company defaults or undergoes some other “credit event.” Blamed for the financial crisis, maligned in the aftermath, they find themselves again relevant.
In recent years some hedge funds have been using CDS as tools in disparate situations which lawyers are lumping under the umbrella of “Net Short Debt Activism” -- when a lender has bet against the company to which it has also lent, so that they might act counter to the company’s interests.
Such maneuvers have been proliferating: between 2006 and 2016, the Commodity Futures Trading Commission noted six “manufactured credit events,” according to chairman Christopher Giancarlo. Over the last 2.5 years, the agency has observed 14 -- seven in the last six months, he said in July in a truly excellent video.
Surely you recall the Hovnanian case last year, in which hedge fund GSO Capital Partners brokered favorable financing with home builder Hovnanian in exchange for a missed interest payment which would trigger the CDS and give GSO a payout. The whole deal evaporated after a losing-side hedge fund sued, and perhaps more critically after regulators including the pope intervened with disapproval.
But then this year delivered a surprise win to hedge fund Aurelius over an old breached covenant at telecom company Windstream, and the verdict resulted in the company filing for bankruptcy.
For company management, that’s scary. It’s one thing to be at risk of GSO offering you fantastically-priced bonds. But the Windstream situation made clear that the stakes can get far higher.
So, now, some issuers are trying to find ways to protect themselves, to dig lil moats where they can. In this just-published story, I rounded up some of those attempts, and what market-watchers make of them.
And Reuters has reported that some companies are considering blocking CDS holders from owning a loan at all.
It’s a little funny that this comes as lenders fret more broadly about loose covenants.
Part of the issue here is that lending is old -- humans (corporations) have borrowed for centuries -- but CDS are relatively new; their prefrontal cortex hasn’t finished developing. They are still figuring out who they want to be. Part of it is the regulatory structure of the CDS market -- it’s fractured between two agencies, which has created sustained confusion.
The attempts to dig these moats are many, but so far untested, and don’t appear to some market watchers, like Fitch Ratings, to be sufficient.
So for now, companies remain at risk of gamesmanship by hedge funds wielding CDS, which can result in extraordinarily favorable financing, as for Hovnanian, or bankruptcy like Windstream.
If only there were some tool that could hedge such a wide disparity in potential outcome.
Other Recent Stuff I'd Love Ur Feedback On
I was on The Indicator from Planet Money!! For a new semi-regular segment called Finance Fridays with Mary. For the first installment, we talked about the dearth of lady hedge fund managers, drawing on this Barron’s story from the end of last year. What should we talk about in subsequent episodes?
A new "Sustainability Bond" got 10x the investor interest it needed: there's been a lot of skepticism about the "green" investing space and this is just one anecdote but .... maybe people actually *do* wanna buy stuff that is also good for society????
Hedge fund manager David Einhorn wrote a letter to his investors saying he’s betting against company credit. So I took the opportunity to discuss "ebitda add-backs,” the thing everyone in debt-land is talking about this year (last yr it was BBB-rated bonds). Corporations have been issuing new debt based on "generous assumptions of future corporate synergies and savings," projecting super-sunny outcomes that inflate their future earnings. But S&P Global did a review of debt issued in 2015 to finance mergers, and looked at what actually came to pass over the next two years -- two years that were unexpectedly sunny and without a downturn, enjoyed an extended economic “cycle,” giving them the easiest possible backdrop to achieve their overly-optimistic projections.
And yet: "in the subsequent two years, 75% or more of those companies missed their add-back projections by 10% or more, S&P Global data show. In 2017, 30% of its sample missed those projections by 50%." (thank u to Justin Slatky who cited these great stats on our panel at the Milken Conference)
A VC fund, except instead of getting returns/money back, investors…. get to save lives. Innovation in ROI!
On people leaving DoubleLine, including two of its founding partners.
On Owl Rock, the new-giant-kid-on-the-block private debt firm everyone in that space is literally still talking about, listing their BDC last month.
Anything else? What am I missing/what should I be writing about?
Thank you for reading, and have a great weekend.
<3
MC