Apr 9, 2020

Axios Capital

By Felix Salmon
Felix Salmon

Situational awareness: Just when you thought the Fed might be out of ammunition, out it comes with another $2.3 trillion from its "super bazooka." Even more than the European Central Bank's Mario Draghi, Fed Chair Jay Powell is proving himself to be the ultimate "whatever it takes" central banker.

  • In this week's newsletter: Debt standstills, corporate cash-grabs, WeWork's redesign, and all the reasons why stocks are going up right now. All in 2,186 words, an 8-minute read.
1 big thing: A pause button for debts

Illustration: Aïda Amer/Axios

Governments have forcibly put much of the U.S. and the global economy on pause in recent weeks, for very good reason. Factories, offices, sporting arenas, restaurants, airports and myriad other institutions have closed down. But one thing hasn't been paused: monthly debt-service obligations.

The big picture: The less movement and activity there is in an economy, the more the coronavirus curve is flattened. But the obligations in bond and loan contracts can't be paused. That's worrying CEOs who fear a wave of business failures if economic activity doesn't pick up next month.

Why it matters: Millions of American businesses and individuals need some relief from debt payments. Nearly a third of American apartment renters didn't pay rent in April; that number will likely rise even further in May. The number of mortgage loans in forbearance is soaring, causing major troubles for mortgage servicers. Commercial mortgages are already in serious trouble. Moody's estimates that 16% of high-yield bonds and loans will default.

  • Be smart: Default, on its own, is relatively harmless. It creates arrears, and arrears can be restructured over time. A landlord won't want to evict an otherwise profitable retailer over back rent — not if the tenant is able to pay market rate going forward in an environment where replacing that tenant with another tenant would be difficult.
  • Default causes business failures only when creditors force companies into bankruptcy or liquidation.
  • The more aggressively creditors chase after what they're owed, the worse off everybody — including those creditors — is going to end up. But aggression is built into debt contracts. Preventing it is a collective-action problem with no obvious solution.
  • The problem: The American system is not set up to allow arrears to quietly sit in a cryogenic deep-freeze pending the restart of the economy. That's why the Fed is advancing as much money as it can to companies, including via the new "Main Street" lending program, so that they can keep current on their debts.

What they're saying: In a Brookings call this morning, Fed Chair Jay Powell directly addressed the plight of individuals who are seeing unpaid debts accumulate due to the shutdown. “People are making these sacrifices for the common good," he said. "We need to make them whole." That's spending, however, not loans — which means that only Congress could enact such a scheme.

The bottom line: The Fed notwithstanding, we're becoming an arrears economy. Dealing with those arrears is inevitably going to prove either incredibly painful or almost inconceivably expensive.

Bonus: The solution for Africa
Data: IIF; Chart: Danielle Alberti/Axios

A debt standstill looks unworkable in the U.S., but it might yet be possible in Africa.

Driving the news: The biggest names in African finance are urging the International Monetary Fund and the World Bank to announce a "standstill" on the continent's external debt obligations .

  • If all African countries stopped making principal and interest payments on their bonds for the rest of this year, that would save the continent some $44 billion, Brookings senior fellow Brahima Coulibaly tells Axios. That money could then be used to directly address the costs associated with the health crisis.
  • How it works: By encouraging all African countries to default on their bonds (as well as on bilateral debt), the IMF would minimize the cost of default for any individual nation. Meanwhile, rich-country governments could try to pressure bondholders to avoid a rush to New York and London courts in the midst of a global pandemic.

Between the lines: Such a standstill only works for sovereign debt, says Coulibaly. African corporations also need debt-service relief — the liquidity required to pay the principal and interest on their bonds —  but Coulibaly says they should turn first to their governments, rather than their faceless capital-markets creditors.

2. Big Business beefs up

Illustration: Aïda Amer/Axios

All companies want to be cash-rich — and as big as possible — heading into an era of extreme uncertainty.

  • Companies raised an astonishing $287 billion through bond issuance between March 17 and April 3 alone. That's more than they raised in the entire second quarter of last year.

Slack didn't raise any money when it went public in a novel direct listing. But being a public company certainly helped Slack this week, when it easily raised $750 million in a convertible bond deal that could end up being as big as $862 million.

  • Slack, which lost $588 million last year and expects to lose money this year too, is paying just 0.5% on the bonds. Investors can also make money if the share price rises above $31 per share.
  • The stock is currently trading just below $25, after rallying from a low point of $15 last month.
  • Airbnb similarly raised $1 billion this week, but because of its industry and its private status, it had to accept much worse terms.

What to watch: Private companies are trying to get big enough to survive through M&A. Often the transactions are mostly or entirely in stock, to help conserve precious cash.

  • See for instance: SoFi buying banking platform Galileo, or Foursquare merging with location-based marketing company Factual. Both deals took place largely using illiquid private stock as currency.
3. Small businesses struggle to get cash

Illustration: Sarah Grillo/Axios

The Federal Reserve is pouring trillions of dollars into programs making it easy for big companies to access liquidity on capital markets, and the Fed's new Main Street Lending Program is designed to target medium-sized businesses that need between $1 million and $150 million in marginal new debt. But the state of affairs for small businesses is still bad.

  • Driving the news: The government has pledged $350 billion, and probably will commit another $250 billion on top of that, for small businesses to keep their employees on payroll. But the program got off to a very rocky start, and it's still extremely rare to find businesses that have actually received any funds.

Why it matters: Small businesses are the most fragile part of the economy — and the hardest to rebuild. They don't have the wherewithal to be able to service extra debt, so they need loans like these that are designed to be forgiven. The scheme to help them keep their employees on payroll is however proving to be extremely complex, with a lot of moving parts that are prone to breaking.

  • How it works: Small businesses need to apply to banks (as non-bank lenders generally cannot participate). Banks, in turn, are overwhelmed and barely capable of serving their existing small business clients. They generally have no bandwidth to go through the laborious process of onboarding new clients. So businesses first need to be lucky in terms of which bank they have a relationship with.
  • The banks will then ask the businesses for a huge amount of documentation, which may not be easily available to owners who are stuck at home. The banks' websites for uploading that documentation have been crashing a lot, since the banks had almost no time to build and debug them.
  • The documentation then needs to be uploaded by the banks to the Small Business Administration, through an outdated system called E-Tran that is also creaking under the strain.
  • Then the SBA needs to approve the loan. No one really knows how long that's likely to take, on average, since the SBA has never dealt with anything like this magnitude of applications.
  • Once the loan is approved, the bank will contact the borrower to finalize the paperwork, which again takes time.

Context: In New Zealand, a similar scheme is getting money into applicants' accounts within a day or two, and with almost no hassle. In Switzerland, small businesses can find themselves funded in as little as 30 minutes.

  • Private-sector actors like Appian have built products that automate much of the process for banks, and Appian CEO Matt Calkins tells Axios that at least one major international bank is using his product to do exactly that. But that doesn't solve problems at the SBA end.

The bottom line: The Paycheck Protection Plan application process is "like an Easter Egg hunt with the most sinister possible Bunny who hid the eggs," tweeted venture capitalist Alex Rampell. Nearly all American small businesses are theoretically eligible for this scheme. But it seems probable that many of them will end up empty-handed, through no fault of their own.

4. The great stock market rebound
Expand chart
Data: FactSet; Chart: Axios Visuals

It's one of the biggest and fastest stock market rallies in living memory. In the 12 trading sessions since its low point on March 23, the S&P 500 has rallied by 25%, with its component companies increasing in value by more than $4.4 trillion.

  • The tech-heavy Nasdaq index is now higher than it was a mere 6 months ago: If you bought it at the beginning of October, you'd be sitting on a profit right now.

The intrigue: Any move of this magnitude naturally elicits the question "why?" I spoke to NYU professor (and my ex-boss) Nouriel Roubini to answer that question and came away with 6 main reasons for the rebound:

  1. Technical. At the market peak, a lot of investors had leveraged long positions. They faced huge margin calls as the market fell, which forced them to dump even their safest assets at discounted fire-sale prices. When the forced sales ended, fears of a major financial crisis receded, and prices bounced back up.
  2. Epidemiological. The rate of hospitalizations and deaths is no longer growing exponentially, and in many parts of Europe and in the U.S. seems to have plateaued or even started falling. New York's status in particular, while terrible, is not as bad as forecasted.
  3. Fiscal. Trillions of dollars of government money are flooding global economies, and investors expect some significant part of that money to find its way into the markets, or at least help to support corporate revenues.
  4. Monetary. The Fed is pumping unprecedented amounts of liquidity into the bond markets, depressing yields and causing a search for higher returns in the stock market.
  5. Tactical. Stock market indices are capitalization-weighted, with the biggest companies having the greatest weight. Those firms are also generally the companies with the strongest balance sheets — the ones best placed to weather this storm. If the crisis wipes out their competitors, very large companies could be some of the biggest winners from the crisis.
  6. Fundamental. Some investors are betting on a V-shaped recovery, with corporate earnings quickly rebounding to their pre-crisis levels.

Why it matters: The rise in stock prices does not mean that we've even reached the end of the beginning of the crisis. But if the market does shed these gains and start hitting new lows, there's a good chance it will do so slowly, rather than dramatically.

5. WeWork revamps

Illustration: Sarah Grillo/Axios

WeWork is planning permanent layout changes to its nearly 900 locations, writes Axios' Erica Pandey, who has obtained internal company documents.

Why it matters: After months of paranoia, social distancing and working from home, the millions who work from WeWorks will be wary of returning to shared kitchens, phone booths and desks.

What's happening: WeWork is removing some seats and desks at its locations and halving many conference rooms' capacities, so workers can observe 6-foot social distancing guidelines.

  • High-touch common areas like kitchens and phone nooks will be kitted out with hand-washing or sanitizing stations.

That might not be enough for many nervous workers.

  • Tenants are telling WeWork they don't expect all of their employees to return to work at once.

The bottom line: The easiest way for WeWork to move to a higher number of square feet per worker is just for fewer workers to come into the office. That seems to be exactly what's likely to happen when the lockdown is lifted.

  • What's less clear is whether the lower worker density will prove economically sustainable for WeWork.
6. A good month for some

Illustration: Aïda Amer/Axios

Universa Investments had a pretty good March. The "black swan" hedge fund, which is designed to act as a hedge against unexpected market dislocations, gained 3,612% last month.

  • The fund is advised by Nassim Nicholas Taleb, the options trader turned author. While the coronavirus pandemic isn't really a black swan — a lot of people knew such a thing would come at some point — the slump in the markets was severe enough that the fund's out-of-the-money options trades suddenly became extremely profitable.
7. Coming up: Banks' first-quarter profits

Illustration: Sarah Grillo/Axios

Axios' Courtenay Brown writes: Investors expect the earnings season that kicks off on Tuesday to be ugly.

What to watch: The banks are among the first to report. They still made a ton of money, but the results — and the companies' outlooks — will give insight into our current unprecedented halt in economic activity.

  • One example: Analysts expect a ramp-up of provisions for loan loss reserves. That's a sign the banks anticipate that borrowers won't be able to pay back loans.

By the numbers: The "big four" banks — JPMorgan Chase, Bank of America, Wells Fargo and Citibank — are estimated to collectively bring in profits of about $20 billion in Q1, roughly $6 billion less than the same time last year, according to FactSet.

The calendar: JPMorgan and Wells Fargo release results on Tuesday. Bank of America and Citi report on Wednesday. So do Morgan Stanley and Goldman Sachs.

8. Building of the week: Your Zoom background

Screenshot: Amber Finlay (featured in front of a famous movie scene)

The wealthy Park family's house is a key character in "Parasite," the Bong Joon Ho film that won Best Picture at the Oscars this year.

  • That's despite the fact that it doesn't exist: The ground-floor set was built on an empty lot, the upstairs rooms and basement were built on soundstages, and most of the exteriors were computer-generated.
  • The house's world-famous architect, Namgoong, is also fictional.

If you're getting tired of showing your co-workers the interior of your own home on Zoom calls, then feel free to change the background to something much more glamorous.

  • It's an easy and cheap way to travel to exotic locations during lockdown. They can even be places that are literally impossible to visit in real life.
Felix Salmon