History Is Not A Straight Line Forward: Cannabis, Bitcoin, 3D Printing

History is not a straight line forward.

Setbacks are usual on the road. Plus, it takes time for new ideas to evolve into a better version of itself. As long as it represents a future that’s needed, it will come back from “disillusion”.

Instead of chasing the very new idea, investors looks back and brings past “bubbles” back to life – when they can show some real progress/changes.

Cannabis, Bitcoin and 3D printing are just three examples. It’s interesting to see the cycles forming, although 2-3 years might not be long enough to be called “big cycles”. That’s how the future arrives.

Future ways of living, of production and of how to organize the society are always the areas to invest – but be careful with bumps on the road.


1/ Cannabis

Cannabis stocks had a great performance in the second half of 2018 before they crashed. In the past few month, they are back to life with some 100-200%+ returns.

What has changed? People are expecting the US market to open up as legalization on the federal & states levels is under way. Price stabilizes, oversupply concerns are going away, more consolidation in the industry, and companies post strong growth and healthier gross margin in Q3.

Jan 1, 2017 – Jan 8, 2021 | ~2 years from the previous peak

 

2/ Bitcoin 

Bitcoin was called a “bubble” and is still called a “bubble” today. Bitcoin price hit $20k 3 years ago. Now it’s doubling the previous high to $40k.

What has changed? More people are seeing it as a hedge against USD depreciation as bitcoin’s supply is limited – it’s younger generation’s gold.

Jan 1, 2017 – Jan 8, 2021 | ~3 years from the previous peak

 

3/ 3D printing

3D printing was in a “hype” mode back in 2014 and quickly lost most of its “market cap” afterwards – just like cannabis and bitcoin.

What has changed? During COVID-19, when global supply chain was disrupted, people realized the value of flexibility of 3D printing, especially in medial equipment solutions. The 3D printing companies are also developing more “recurring” business model. With auto and other manufacturing sectors are expected to recover in 2021 and beyond, people are betting on a more “agile” future of the industrial world, with more customization and more flexible capex.

Jan 1, 2012 – Jan 8, 2021 | ~7 years from the previous peak


Charts are created by author, soured from WSJ

Airbnb’s IPO Plan & Capital Allocation

Airbnb did well in the past quarters before 2020 and doesn’t have much concerns for cash. It was one of the most financially healthy startup.

Actually, its full year earnings turned positive as early as 2017, when it generated earnings of about $100m while bookings grew around 150%. It became profitable in the second half of 2016.

In 2018, it made $93 million in profit on $2.6 billion in revenue.

More recently, it took in more than $1 billion in revenue in 2019Q2.

However, Airbnb racked up a $322 million net loss for the nine months through September, down from a $200 million profit a year earlier.

In 2019Q3 alone, Airbnb increased its revenue to $1.65 billion in the third quarter, up almost $400 million from a year earlier, one of the people said. But costs rose faster. Net profit for the quarter was $266 million – less than the $337 million profit for the same period in 2018

All sorts of reports said Airbnb is preparing to go IPO in 2020… until coronavirus hit.

When WSJ reported in Feb, it says Airbnb’s business in China is currently down about 80% compared with last year.

Now as travel industry worldwide is hit, Aribnb total revenue could decline 70-90% and might have cash flow problem.

It now has raised debt and cancelled summer internships.

In early April, Airbnb raised $1 billion in debt and equity from private equity firms Silver Lake and Sixth Street Partners.

Last week, Airbnb raised another $1 billion in debt. Fidelity, T Rowe Price and Blackrock are participating along with Apollo and Oaktree.

While Airbnb should be fine and solvent, how its revenue gonna recover & how to show its growth rate will be an IPO headache.

Occidental Petroleum (4): Agreement With Carl Icahn, Oil Price Plunge

According to the 13F-HR, Icahn held 33,244,429, 26,332,388 and 22,571,854 shares of Occidental as of June 30, September 30 and December 31, 2019.

Icahn’s fifth message on February 12, 2020.

Things evolved fast in 2020.

Oil prices plunged in March as COVID-19 developed and a price war started.

Line chart of Brent crude ($/barrel) showing Oil price crashes 30% after Saudi Arabia launches price war

Oil plunges 24% for worst day since 1991 after OPEC deal failure ...

Occidental’s stock price closed at $12.51 on March 9, dropping 53.4% from March 6 and 60.3% from March 5. The ex-div date was March 9, with $0.79 dividend per share announced in February.

The following day (March 10), Occidental reduced to quarterly dividend to $0.11 from 0.79, effective July 2020.

It also reduces 2020 capital spending to between $3.5 billion and $3.7 billion from $5.2 billion to $5.4 billion and will implement additional operating and corporate cost reductions.

Meanwhile, Icahn boosted its ownership close to 10% of Occidental.

On March 25, both parties reached agreement. Occidental will add three new Icahn designated directors to Occidental’s Board.

The Icahn Group has withdrawn its slate of director nominees and stockholder proposals at the 2020 Annual Meeting and agreed to vote in favor of the Board’s director nominees and amendments to Occidental’s restated certificate of incorporation that enhance Occidental’s corporate governance.

Under the agreement, the Icahn Group will petition the Delaware Supreme Court to withdraw its pending appeal before the Court relating to the Icahn Group’s books and records request under Section 220 of the Delaware General Corporation Law.

At the same time, Occidental further cut the capital spending to between $2.7 billion and $2.9 billion from its original 2020 guidance of $5.2 billion to $5.4 billion. The Company also announced it will reduce 2020 operating and corporate costs by at least $600 million compared to the original 2020 plan, including significant salary reductions for executive leadership. Operating cost reductions are expected to lower 2020 domestic operating costs to approximately $7.00 per BOE.

To further reserve cash, on April 15, Occidental elected to pay a quarterly $200 million payment it owes Warren Buffett’s Berkshire Hathaway Inc. in common shares, at a 10% discount. Occidental could choose to pay Berkshire differently in future quarters.

Occidental 2019 full year financial result | Earnings call transcript

Occidental Petroleum (3): Sweetened Bid, Carl Icahn

The Sweetened Winning Bid

On May 5, 2019, as part of the financing plan, Occidental entered into an agreement with Total to sell Anadarko’s African assets for for $8.8 billion , contingent on successfully completing the acquisition of Anadarko.

The assets to be sold to Total represent approximately 6% of the expected net production and approximately 7% of the cash flow after capital expenditures of Occidental in 2020 pro forma for the acquisition of Anadarko.

At the same time, Occidental increased the cash portion of its $76-per-share offer to a level that would allow it to make a bid that does not require the approval of its shareholders. Under the new terms, the offer comprises $59 in cash and 0.2934 shares of Occidental common stock per share of Anadarko. (78% Cash and 22% Stock)

This modification (of not requiring a shareholder vote) would become one of the major arguments brought by Carl Icahn later on.

Vicki Hollub, CEO of Occidental, also explains in her letter to Anadarko’s Board,

Our revised proposal does not require an Occidental shareholder vote, which has been repeatedly cited as the explanation for why you previously chose Chevron’s $65 offer over our $76 offer

Plus, the $1 billion breakup fee would be borne by Occidental after the acquisition.

The bidding war didn’t escalate.

On May 9, 2019, Occidental won the battle for Anadarko as Chevron exited bidding.

“Costs and capital discipline always matter,” Mr. Wirth said. “An increased offer would have eroded value to our shareholders.” Shares in Chevron rose 3.1% on Thursday. Occidental’s stock fell 6.4%, while Anadarko’s shares declined 3.2%.

Shareholders’ Discontent & Carl Icahn Coming

Along the bidding process, on the day (April 30) that Occidental secured Berkshire’s money, T. Rowe Price Group, one of the largest shareholders of Occidental Petroleum, says it opposes the energy company’s proposed merger with Anadarko Petroleum.

We think there is significant execution risk with the Anadarko deal and it would increase Occidental’s financial leverage significantly as well.

– John Linehan, manager at T Rowe Price Equity Income fund

On May 3, Bloomberg reported that Carl Icahn had built a small stake in Occidental Petroleum Corp.

Some investors expressed their intention to vote against approving Occidental’s Board.

At Occidental’s annual meeting in Houston on Friday (May 10), a proposal cutting the percentage of shareholders required to call a special meeting (from 25% to 15%) was backed by investors speaking for 60% of the shares voted, in defiance of opposition from Occidental’s board.

On May 30, Carl Icahn sued Occidenta over its acquisition of Anadarko, calling its $38 billion deal to buy Anadarko Petroleum Corp. “fundamentally misguided”.

Icahn argus that the Purchase is a Levered Bet on the Price of Oil, as Occidental’s debt (and debt-like preferred stock) increases from approximately $10 billion to over $45 billion.

The Icahn parties estimate that if the price of oil declines to approximately $45 per barrel or below for an extended period of time, Occidental might be forced to cut the common dividend. The warrants given to Berkshire alone were worth approximately $1.2 billion on the day the preferred deal was announced. And the singular focus to win the Anadarko bid at any cost prevented Occidental from
maximizing value in its sale of Anadarko’s African assets. [Court Document]

However, the complaint was to seek certain books and records relating to the Anadarko acquisition, etc. And eventually, in September 2019, the court ruled in favor of Occidental.

On June 26, in a preliminary copy, Icahn called for a special shareholder meeting where he plans to oust and replace four Occidental directors and change the company’s charter through a stockholder consent solicitation to prevent it from ever engineering a similar takeover again. [Icahn Solicitation Statement – Preliminary] [Icahn Solicitation Statement – Definitive]

On July 22, Icahn published an open letter to Occidental shareholders, four days after the definitive proxy statement was filed.

On August 8, Occidental announced that it has completed the acquisition of Anadarko.

[Icahn’s second and third open letters on August 13 and August 28]

In the third letter, Icahn opposed the two new board members (not in Icahn’s slate) proposed by Occidental.

On November 8, in his fourth open letter,

Earlier this year we owned over 33 million shares of OXY, but recently we reduced the size of our investment.  I still own almost 23 million shares, valued at almost $900 million, but this has become a very risky investment and without changing the incumbent Board and potentially the CEO, and in the absence of accountability for the OxyDarko Disaster, I am very concerned.

We fully intend to run a proxy fight, and if elected, work to right this teetering ship.

Occidental Petroleum (2): Topping Chevron’s Bid For Anadarko, Buffett’s Preferred Investment

Occidental Bids Anadarko Petroleum (APC)

Having grown into the No.1 operator in Permian in 2018Q4, Occidental definitely don’t want give that title back to Chevron.

While acquiring Anadarko is an add-on for Chevron, it’s much more financially challenging for Occidental.

Source: Chevron

Occidental produces at a similar scale as Anadarko. So it’s presumably an acquisition that would double its size.

But Occidental moved decisively. It offered $76.00 per share for Anadarko on April 24, 12 days after Chevron’s announcement, with ~17% premium over the $65 per share agreement. Taking into account the stock price movement, Occidental’s deal presents a ~20% premium.

Occidental’s offer also has more cash component (50/50) – $38.00 in cash and 0.6094 shares of Occidental common stock per Anadarko share, valuing Anadarko at $57 billion.

Occidental also argues a $3.5 billion free cash flow improvements through synergies and capital reduction, compared with Chevron’s $2 billion / year synergies.

Occidental actually tried to acquire Anadarko earlier in April, according to the press release later on.

It is unfortunate that Anadarko agreed to pay a break up fee of $1 billion, representing approximately $2 per share, without even picking up the phone to speak to us after we made two proposals during the week of April 8 that were at a significantly higher value to the transaction you were apparently negotiating with Chevron.

We noted to you on April 8 that our due diligence is complete. As you are aware, our financial advisors are BofA Merrill Lynch and Citi, and our legal advisors are Cravath, Swaine & Moore LLP, and we and they are available to discuss any aspect of our proposal. We and our advisors have reviewed your merger agreement with Chevron. We are separately sending to you and your legal advisors a form of merger agreement on that basis which we would be prepared to enter into, subject to our agreeing to the disclosure schedules to be attached, together with a copy of our financing commitment letter.

Financing The Acquisition

Acquisition of this size is difficult for Occidental, especially as it offers much more cash than stocks.

In 2018, Occidental generated $7,669 million operating cash flows with $(4,975) million CapEx. It also paid $(2,374) million in cash dividend and bought back $(1,248) million stocks.

On its balance sheet as of the end of 2018, it had $3,033 million cash, and $10,317 million long-term debt.

On April 30, $10 billion financing was secured as Buffett came on board.

Berkshire Hathaway, Inc. has committed to invest a total of $10 billion in Occidental. The investment is contingent upon Occidental entering into and completing its proposed acquisition of Anadarko. Berkshire Hathaway will receive 100,000 shares of Cumulative Perpetual Preferred Stock with a liquidation value of $100,000 per share, together with a warrant to purchase up to 80.0 million shares of Occidental common stock at an exercise price of $62.50 per share.

The preferred shares also have a dividend rate of 8% per year.

As WSJ describes, the investment “is straight out of Warren Buffett’s playbook“. During and after the financial crisis, Berkshire acted as a lender of last resort for blue-chip companies including Goldman Sachs, General Electric and Bank of America.

Occidental marks Berkshire’s largest purchase of preferred shares; the 2013 Heinz deal has $8 billion preferred stocks and other securities.

Berkshire’s Preferreds | Source: WSJ

Mr. Buffett and Occidental have some shared history.

Mr. Buffett’s first stock purchase was three shares of Cities Service preferred stock when he was 11 years old. Occidental’s chief executive, Vicki Hollub, started her career at Cities Service, which was later acquired by Occidental. Cities Service is now called CITGO Petroleum Corp. and owned by Venezuela’s Petróleos de Venezuela SA.

「News of the Week」New York State Curve Flattening, Stock Market Up

On Tuesday (April 7), Gov. Andrew Cuomo projected that the state is reaching a plateau in coronavirus hospitalizations due to strict social distancing measures.

“To the extent that we see a flattening or a possible plateau, that’s because of what we’re doing and we have to keep doing it,” Mr. Cuomo said. (WSJ)

three day hospitalizations
Source: Cuomo press conference, Axios

The S&P 500 on Thursday (April 9) closed out its best four-day streak since 1974, up 11.9% (Dow up 12%). (CNBC)

CH 20200409_dow_best_weeks_close.png

Occidental Petroleum (1): Permian, Chevron Bid For Anadarko Petroleum

Occidental Petroleum (OXY) has been one of the most watched stock since 2019. Its stock lost ~80% compared with the start of 2018 and lagged behind Chevron and the industry later on.

OXY vs. XLE & CVX Jan 2018 – Apr 2020 | Source: Yahoo Finance, author

[XLE is State Street’s Energy Select Sector ETF fund; see its top holdings here]


Permian Oil Production

The Permian, the biggest shale basin in the US, has been one of the biggest drivers of a shale oil boom that helped make US the biggest oil producer in the world, ahead of Saudi Arabia and Russia.

Source: EIA

According to the March 2020 productivity report, output from the Permian basin of Texas and New Mexico, is expected to rise 38,000 bpd to a record 4.79 million barrels per day (bpd) in April 2020.

Texas continues to produce more crude oil than any other state or region of the United States, accounting for 41% of the US total in 2019.

Source: EIA
Source: EIA

As mentioned in Occidental’s 2019 annual report, Permian accounts for more than 30% of the total United States oil production; Occidental has a leading position in the Permian Basin, producing approximately 10% of the total oil in the basin.


Chevron Bids For Anadarko Petroleum (APC)

As the competition in Permian intensifies, with Occidental and Chevron two leading operators, companies are looking for M&A opportunities.

Anadarko Petroleum is the 11th largest operator in Permian Basin; its Permian production (127 mboe/d) accounted for ~18% of its 2018Q4 production of 701 mboe/d. [Occidental Acquisition Proposal Presentation April 2019]

A graphic with no description

Chevron, another major player in Permian, announced its acquisition agreement with Anadarko on April 12, 2019.

Chevron was the No.1 in 2018 whole year production in Permian, but lost that seat to Occidental in 2018Q4 as shown above. Growth by acquisition seems to be the way to go for Chevron.

Occidental Wins Battle for Anadarko as Chevron Exits Bidding - WSJ
Source: WSJ

The total enterprise value of the transaction is $50 billion. Anadarko’s equity is valued at $33 billion, or $65 per share. Based on Chevron’s closing price on April 11th, 2019 and under the terms of the agreement, Anadarko shareholders will receive 0.3869 shares of Chevron and $16.25 in cash for each Anadarko share. (75% stock and 25% cash)

[Read more on Chevron’s acquisition presentation]

Jumia And Africa E-commerce (4): Citron, Net Merchandize Value

About one month after Jumia’s IPO, the famous short research Citron published a short report.

Their first major short thesis is based on a Confidential Investor Presentation for investors in October 2018, which presents a discrepancy between Jumia’s IPO filing.

    • The active customers & merchants as of 2017 are 2.1 million and 43 thousand in the Confidential Investor Presentation while in the IPO filing are 2.7 million and 53 thousand.
      • no difference in 2018 numbers
      • they might used different definition for “active”
      • another possibility is consolidation calculation – if a user used multiple Jumia services (online shopping, travel, food, etc.), they could have been double counted. In the October 2018 presentation, they might deduct the duplicated accounts

Cirton also emphasized on omitting a metric in IPO – net merchandize value (NMV).  Since GMV doesn’t take into account returns/cancellations, which is ~41% of the GMV in 2017, this could be material in evaluating the business.

Another lever is failed delivery. Taking all these into account, GMV probably is not a very good indicator at this stage of Africa’s e-commerce. This also explains the hight fulfillment expenses. As the infrastructure in Africa improves over time, it could be better.

In Jumia’s IPO documents, it only mentions “in 2018, orders accounting for 14.4% of our GMV were either failed deliveries or returned by our consumers. ”

In the 2019 20-F, it says “we have also experienced a decrease in the rate of cancellations, failed deliveries and returns as a percentage of our GMV from approximately 35% in 2018 to 32% in 2019.”

So around 20.6% of Jumia’s 2018 GMV is cancelled.

Actually, in Jumia’s 2019 Q2 call with analysts, it says “it has identified instances where orders were placed and then subsequently canceled“.

However, when NMV provides an important information about Jumia’s operation, after all its revenue and expenses won’t change.

Buffet’s Shareholder Letter In Feb 2020

While the market is volatile and uncertainty is ahead, I went back to read Buffet’s 2019 annual shareholder letter, issued in February 2020.

[More letter could be found here]


Some ket takeaways:

  • Berkshire’s earnings has 3 components (operating earnings, realized capital gains, unrealized capital gains) and indeed becomes more volatile under the new accounting rule
  • The 3 criteria for purchases/investments:
    1. First, they must earn good returns on the net tangible capital required in their operation.
    2. Second, they must be run by able and honest managers.
    3. Finally, they must be available at a sensible price.
  • Per the accounting rules, earnings from controlled companies fully flow into “operating earnings”; but for noncontrolled companies, only the dividend portion of their earnings is reflected in Berkshire’s operating earnings.
  • There is a large part of companies’ value that is embedded in their retained earnings
    • some may argue the changes in stock prices (thus the unrealized gains) capture it; but it’s a poor reflection I think.
    • “Overall, the retained earnings of our investees are certain to be of major importance in the growth of Berkshire’s value.”
  • “What we see in our holdings, rather, is an assembly of companies that we partly own and that, on a weighted basis, are earning more than 20% on the net tangible equity capital required to run their businesses. These companies, also, earn their profits without employing excessive levels of debt.”
  • “In all, I estimate that it will take 12 to 15 years for the entirety of the Berkshire shares I hold at my death to move into the market.”
  • “It would be an interesting exercise for a company to hire two “expert” acquisition advisors, one pro and one con, to deliver his or her views on a proposed deal to the board – with the winning advisor to receive, say, ten times a token sum paid to the loser. Don’t hold your breath awaiting this reform: The current system, whatever its shortcomings for shareholders, works magnificently for CEOs and the many advisors and other professionals who feast on deals. A venerable caution will forever be true when advice from Wall Street is contemplated: Don’t ask the barber whether you need a haircut.”
  • Board independence is unlikely to be real for many companies.
  • Berkshire is going to repurchase shares when price-to-value discount is meaningful and Berkshire is left with ample cash; but, value is somewhat subjective.

Live stream for the annual meeting on May 2nd: https://finance.yahoo.com/brklivestream

Reading Notes For Thomas J. Barrack’s Medium Posts

Two of Mr. Barrack’s recent posts:

March 22 – Preventing Covid-19 From Infecting the Commercial Mortgage Market

March 28 – Unpacking the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) to Support Small and Medium Sized Real Estate Tenants and Owners


  • Depressed revenues will increasingly depress, and when combined with hiccups in the credit markets, borrowing costs will continue to skyrocket, further compounding the inability of businesses to support jobs.
  • Without jobs, Americans will be unable to make payments on their mortgages, rent, credit cards, and automobiles; to acquire goods and services; and, to spend money at restaurants and coffee shops and in support of the gig economy
  • … loan repayment demands are likely to escalate on a systemic level, triggering a domino effect of borrower defaults that will swiftly and severely impact the broad range of stakeholders in the entire real estate market, including property and home owners, landlords, developers, hotel operators and their respective tenants and employees.
  • At a moment when liquidity is essential to avert public panic and to facilitate investments that respond to rapidly-changing and unprecedented economic conditions, the real estate financing market is in danger of inciting a liquidity freeze.
  • In particular, the banks, mortgage REITs and debt funds must agree on a collaborative solution — implemented with the reinforcement and support of federal government policy — to ensure stability moving forward.
  • Among other measures that may be taken, a key element will be averting rushed and widespread margin calls and other “mark-to-market” measures for a period of time under the real estate whole loan and commercial mortgage-backed securities (CMBS) repurchase agreements that lenders rely on to provide liquidity in the market.
  • In recent years, publicly-traded mortgage REITs and debt funds have taken on an increasing role in providing commercial real estate financing. This increase is due in part to federal regulatory measures taken in response to the 2008 financial crisis, as financial regulations taken at that time were designed to reduce exposure of banks to certain categories of commercial mortgages, such as construction or bridge loans, by making these loans more expensive from a capital perspective and imposing more stringent and burdensome underwriting standards.
  • Repurchase financing arrangements, through which banks purchase a portfolio of commercial mortgage loans from mortgage REITs or debt funds who agree to buy back the loans at a future date, have enabled banks to provide liquidity for commercial real estate borrowers while complying with the new regulations. Repurchase facilities also offer banks protection through the cross-collateralization of a diverse loan pool that spans multiple asset classes, mitigating exposure in the event of a downturn in a particular segment of the commercial real estate market.
  • Central to the fundamental credit structure of repurchase arrangements is each bank’s ability to “mark-to-market” the loans or CMBS the bank is financing and require the mortgage REIT or debt fund to satisfy any resulting “margin call” by partially paying down the advances on the affected loans
  • it is imperative that real estate lenders are not forced by their financing sources to meet their borrowers with rigidity during this time of heightened need. Under most repurchase arrangements, bank consent is required for mortgage REITs and debt funds to grant material waivers, concessions and modifications requested by their borrowers in order to adapt to the changing economic landscape, ultimately enabling a return to pre-pandemic operations.
  • From January 2008 to January 2009, hotel occupancy dropped to less than 60%. Currently, in the dawning hours of the COVID-19 crisis, hotel occupancy rates are approaching 0% and are likely to remain at those levels for the foreseeable future. Even assuming an optimistic estimate of 25% hotel room occupancy in the coming months, job losses are projected to total between 2.8 and 3.5 million — a roughly eight-fold increase compared to the 2008 financial crisis.
  • If unchecked, margin calls will take hold of the repurchase financing market and the liquidity constraints of lenders will force borrowers and their tenants to divert scarce capital resources towards loan and rent payments — a particularly grave concern in a pandemic context when capital must be allocated towards ensuring that businesses stay solvent and that health-related needs are met.
  • Faced with an unimaginable economic catastrophe, the White House, Congress, Federal Reserve, FDIC and supporting regulatory institutions can work to mitigate this crisis by bringing the banks, public REITs and private debt funds together to reach a solution that provides the liquidity necessary to sustain the commercial real estate market and broader economy.

  • the first week of April will be America’s first payment cycle since the implementation of our ambitious Health response and the first time the vast majority of interest, rental, and other payment obligations will be unmet by Americans and American businesses alike.
  • The Federal Reserve has many roles in the economy, but none of them is to take on credit risk.
  • Here’s how: The Federal Reserve will insist that Treasury contribute money from its new pot of $454 billion to a joint Fed-Treasury lending fund. The Treasury’s contribution you can think of as “equity” — that is, Treasury will stand in a “first loss” position on every loan made to corporate America. The Fed will contribute the “leverage” — the money that will help make loans but which is never put at actual risk. The loan fund will then make loans to businesses.
  • The overall size of the Fed-Treasury loan fund depends on how much risk-averse Fed money will be supplied for every dollar Treasury contributes.
  • Liquidity is how easily a business can convert a thing of value into cash. A liquidity problem is when that conversion process encounters friction.
  • This non-bank capital is critical to the support of consumer lending (installment, credit card, student, and auto loans), business lending, and real estate financing (i.e., commercial real estate (CRE) not guaranteed by Fannie and Freddie).
  • The lender either directly or indirectly bundles, or securitizes, the book of loans and sells different slices of the overall revenue stream from the bundled loans. These slices are called ABS — asset- backed securities — because they are securities that are backed by assets (which are the loan revenue streams).
  • Investors in these ABS are insurance companies, banks, asset managers, pension funds, and other large institutional investors. Their investments — especially investments by regulated entities like insurance companies — are in the investment grade tranches of these ABS (BBB and higher).
  • How do investors in ABS get the money to buy the ABS? Often by entering into liquidity transactions called repurchase agreements (or “repos”) with banks, who advance the cash to the investors and hold the ABS as collateral. The investor promises to repay the repo loan upon maturity (technically this is a sale-and-repurchase but it is viewed as a loan), which is usually short term (but is often rolled over into a new repo loan).
  • Imagine what happens to the value of ABS collateral (including commercial mortgage-backed securities, or CMBS) when: (i) students stop paying back loans; (ii) consumers stop paying down credit card or installment debt; (iii) mall tenants stop paying rent; (iv) nobody is paying to stay in hotels; etc. Two things happen: one, the ABS loses actual value (but on a big scale, not much value as it is only one month of payment missed); but two, and much bigger, nobody wants to buy those securities when the underlying contracts are not performing.
  • The market asks “who knows how long people will continue to not pay?” Values plummet, not because the underlying assets are not healthy (they are) but because there is a complete loss of confidence in these securities by the market.
  • Plummeting ABS values means plummeting repo collateral values, which means margin calls and repo foreclosures.
  • What is desperately needed is two actions: (i) for the Fed to step in and create a market for investment grade ABS and CMBS at pre-COVID advance rates to restore confidence and pricing in the market; and (ii) a margin call holiday or forbearance period (described below).
  • America needs the immediate cooperation and support from our banking sector from JP Morgan to Wells Fargo, who need corresponding regulatory relief, in order to successfully combat COVID-19.
  • In order for lenders to grant American businesses a “time-out” by forbearing rent payments, they need to be able to get forbearances from their lenders, the banks and other forms of credit such as commercial mortgage backed securities. Furthermore, these banks need to grant real estate lenders in the non-bank sector a “mortarium” on repo margin calls.