Monday, 24 February 2020

The Iconic Macy’s Downgraded to “Junk” Status

Quite often here in Financial Regulation Matters, we have looked at the experience being faced by British retailers against the onslaught of online commerce but, of course, the experience is shared with American ‘bricks-and-mortar’ retailers. In this short post we will review the fortunes of one of America’s most iconic department stores – Macy’s.

Macy’s, founded in 1951 by Rowland Hussey Macy, is one of the most iconic American department stores. To provide some context for the marketplace, Bloomingdale’s is another iconic store but it operates under the Macy’s Inc. holding company, which used to be known as the ‘Federated Department Stores’ holding company before it purchased Macy’s in 1994 and re-branded. Macy’s Inc., in the last full financial year, recorded revenues of nearly $25 billion. However, earlier this month the company announced a set of plans to revive what are quickly becoming ailing fortunes. As part of what the company has labelled ‘Operation Polaris’, the plan is to shore up profitability by way of closing 125 stores over the next three years and targeting 2000 corporate job cuts, as well as shutting corporate offices. This marks a shift for the company, who will be moving its central headquarters to New York and, in the process, closing its Cincinnati base (as well as large offices in San Francisco and Ohio). The company’s CEO, Jeff Gennette, recently stated that the company had ‘significant work to do to improve the bottom-line’, and that the company hoped that the cuts would generate about $600 million of savings this year alone. Yet, for investors and onlookers, there is little to be excited by. A number of comments have been reported in The Financial Times, including ‘kind of the same thing – and it hasn’t worked’, to ‘nothing new [and it fails to] solve the major problems that plague Macy’s’.

Now though, it is the turn of the credit rating agencies to have their say, with S&P taking the lead. Both Moody’s and Fitch have the company at one grade above ‘junk’ status but for S&P, the time has come for the company to be placed in its non-investment grade category. S&P stated that the chain’s ‘competitive advantage has diminished more than we expected’ and that the downgrade ‘reflects our view that Macy’s improvement trajectory is weaker than our prior expectations and execution risks are elevated as the company pursues its Polaris strategic plan against an ongoing difficult industry backdrop’. A large proportion of S&P’s rating is based upon the understanding that not only are shoppers’ attitudes and preferences changing, but that the company has a large number of stores that it has acquired over the years that now leave it ‘saddled’ – the shares in Macy’s dropped nearly 5% on the announcement of the downgrade. Experts in the field doubt whether Macy’s has the managerial competency to save itself, with it being noted that its revival plans are well behind rivals such as Target, Costco, and Walmart who are facing similar pressures in the marketplace; a Marketing Professor at Columbia University recently remarked that ‘I know this sounds awfully critical, but Macy’s is a rudderless mess. Current and past management is truly clueless as to what to do to successfully position the company for the future’. Interestingly, rather than blame the online retail space for its woes, some experts have agreed that this is not necessarily the issue for Macy’s (who are doing quite well online), but that the issue is that they are failing to bring people into the stores by updating them and customising the experience for customers who do shop in stores; this is what they mean by poor management.

With the pressure building on the company, it will be interesting to see how they develop. It seems incredible that their only response to falling customer interest will be to cut jobs, stores, and offices but then not work to upgrade what they already have. The company is planning to invest in its online offerings and will build a new hub in Atlanta to service this offering, but it surely must seek to lead in the marketplace rather than react to the fear that the online marketplace will take over and dominate. People still shop in-store. However, if they are overlooked or have their experience essentially limited because the company are concentrating on other matters then, of course, they will stop coming. Macy’s seems to be at an important cross-roads in its development and its identity, and particularly how it perceives its own identity, will likely be the key to its future success.

Keywords – Macy’s, Retail, business, cuts, @finregmatters

Wednesday, 19 February 2020

Trump’s Politics and White-Collar Criminals: Michael Milken Pardoned

President Trump’s time in office is undoubtedly one of the more unique periods in American political history, and recently he has turned his attention to righting what he sees as wrongs within the financial sector. That attention, in the past few days, has been directed to providing clemency for convicted criminals – often referred to as ‘white collar criminals’. There are few of particular note and, probably chief amongst them all, is the so-called ‘Junk Bond King’ of the 1980s Michael Milken, the former head of the high-yield department at Drexel Burnham Lambert. In this post we will get to know these figures a little more and look at President Trump’s almost-revisionist agenda.

Michael Milken’s story is truly fascinating and there are a number of accounts of this story in the literature. One such book is The Predator’s Ball that attempts to provide an account of the incredible world oh high-yield high-risk finance that took hold in the late 1980s. The ‘Predator’s Ball’ was the name associated with Drexel’s annual High Yield Bond Conference and it attracted many high-profile financial figures, like Ivan Boesky the renowned arbitrageur and Carl Icahn, the legendary corporate raider. However, at the core of the story is a financial pioneer that is still revered by a proportion of the modern financial field even to this day.

Born in 1946, Milken read for degrees at the University of California, Berkeley and then the University of Pennsylvania at its renowned Wharton Business School. It has been noted that, whilst at Berkeley, Milken was influenced by the works of W. Braddock Hickman, a former director of the Corporate Bond Research Project at the National Bureau of Economic Research, and in particular his work entitled Corporate Bond Quality and Investor Experience. Essentially, Milken’s genius was to realise that investors could make much more money, investing on a risk-adjusted basis, by investing in bonds issued by ‘non-investment grade’ or ‘junk-status’ companies than they could investing in ‘investment-grade’ companies, as determined by the largest credit rating agencies. However, the issue was that these non-investment grade were not issuing much debt because, quite frankly, there was not a large enough market that had the appetite to make it viable to do so. It is within this space that Milken, with Drexel supporting him, would so successfully operate. Drexel began to create a new supply of these so-called ‘junk bonds’ by underwriting the bond issuances, which then created the market for this method of financing. In addition, Milken began to engineer pioneering financial products that would allow financial heavyweights like Icahn to purchase companies and the like. The development of the now widely understood Collateral Debt Obligation (CDO) financial product is attributed to Milken – the idea is that the CDO is issued by SPE (Special Purpose Entity [or Vehicle]) and this then purchases the junk bonds from a client’s balance sheet, thereby cleaning up the client’s balance sheet for all sorts of purposes. The CDO was not operational when Milken was arrested and convicted, but was ready to go and has become a piece of the financial furniture since. What this process did was being financing to the masses, in theory. Yet, the real beneficiaries were corporate raiders. Corporate raiders, technically, use financing streams to purchase shares in companies that are deemed to be undervalued. Then, the purchasing of shares that give them a majority position allows them to implement decisions that will see the value of those shares rise, and then often the shares are sold at a premium – the company may be repositioned to be included in a merger, for example. However, this practice proved to be exceptionally controversial, with the corporate raiders being known also as asset strippers; ‘Reagan’s laissez-faire economic policies meant that once these asset strippers had a toehold in corporate America, there was nothing to stop them becoming dominant. Revlon, Disney, Gulf, Phillips… one by one, the giants were “downsized” – that is, disembowelled – from the inside out’. Yet, this field of finance has become incredibly important to the modern marketplace, and is said to be worth over $2 trillion with nearly $250 billion of new high-yield securities being issued each year in the US. Despite Milken’s criminality – he was charged with insider trading, manipulation of stock prices, inaccurate record keeping, fraud, and racketeering and was eventually convicted on six counts of securities and tax violations (which he pled guilty to in a plea bargain) ranging from aiding and abetting another’s failure to file accurate statements, selling stocks without disclosure, and failing to notify that commissions would be included in transactions – he is still revered by portions of the financial community.

This is proven by the recent clemency that has been granted to Milken by President Trump (amongst others). A number of high-profile financial heavyweights have come out in support of Trump’s decision, including: Sheldon Adelson (Casino owner and Republican donor); Elaine Chao (US Transport Secretary and Wife of Mitch McConnell); David Rubenstein (chairman of the Carlyle Group); Sean Parker (major Facebook Investor); Rudy Giuliani (the President’s personal attorney who was the US Attorney for the Southern District of New York who had investigated Milken during his downfall), and Rupert Murdoch (the media mogul who Milken had helped consolidate his News Corp. empire). Additionally, even though Milken was barred from ever working in the financial industry again upon conviction, he has become a mentor and guide to a number of high-profile financial players, including Josh Harris of Apollo and Josh Freidman of Canyon Capital, and also David Solomon, CEO of Goldman Sachs. These people, and many more besides, have supported the decision to pardon Milken, with the White House itself adding that Milken is ‘one of America’s greatest financiers’ and that he had ‘democratised finance’. Further still, the White House declared that ‘Mr Milken was charged in an indictment alleging that some of his innovative financing mechanisms were in fact criminal schemes’ and that ‘these charges filed against Mr Milken were truly novel’. Interestingly, the statement does not cover the massive damage that was caused to Drexel and its non-superstar employees who lost employment and pension pots as a result, and also every entity connected to Drexel that suffered as a result. One element that is given a lot of credence by his supporters is his decision, post-conviction, to apply himself to philanthropic endeavours. His world-renowned Milken Institute is widely regarded for having provided genuine good, and his personal battles with cancer have caused him to invest incredible amounts in the fight against the disease. Milken is perhaps identified as somebody slightly different in the financial world, in that money was perhaps not the overriding objective for his efforts; at the height of his powers, Milken lived in a modest house in California and drove a humble Oldsmobile – it has been noted that ‘there seemed to be no personal use for the fortune Milken had built’. For Milken, the suggestion was that he always just wanted to be regarded as better than his peers. Even though Milken is today tremendously wealthy, this still seems to be the case when we consider his philanthropic endeavours. Yet, the question remains as to whether this should be the basis of a Presidential pardon.

President Trump has not just pardoned Milken. Alongside him people such as former Illinois Governor Rod Blagojevich (who served 8 years of a 14 years sentence for attempting to sell a US Senate seat), former New York Police Commissioner Bernie Kerik (convicted for tax fraud and lying to officials), and Eddie DeBartolo Jr. (the former owner of the San Francisco 49ers NFL team who pleaded guilty to failing to report a felony in a bribery case in 1998). The thought within the media that this granting of clemency to a number of high-profile convicted criminals is a direct response to the President’s acquittal in his recent impeachment case in the Senate; CNN report that his reduction of Blagojevich’s sentence was even unpopular amongst his own aides and Republican supporters, but that he did it anyway. Yet, in the case of Milken, Trump is almost guaranteed a victory. He has given a number of Wall Street heavyweights what they have wanted (when Presidents Clinton and Bush Jr refused to) just as the re-election campaign gets going. Perhaps he may not need their support with the way he structures his campaigns, but it certainly will not hurt and will certainly not be rejected. The granting of clemency to Milken also feeds into a revisionist agenda that President Trump is determined to see through in an image that he sees America – the ‘Make America Great Again’ moniker is based upon championing the genius of somebody like Milken, but also based upon revising the actual truth about his excesses and abuse of his position, driven by the need to be powerful, or at least considered to be – this granting of clemency is a very good microcosm of the Trump agenda. Yet, it has been suggested today that the SEC will not be influenced by this decision with regards to lifting his lifetime ban on entering the financial industry, and a spokesperson for Milken confirmed that, for now, returning to finance was the ‘farthest thing from his mind’. How the future unfolds for Milken will be interesting to watch, but recent events are simply just another mile-marker in what is the fascinating life-story of Michael Milken.

Keywords – Michael Milken, clemency, white-collar crime, Trump, @finregmatters

Tuesday, 18 February 2020

Kraft-Heinz Continues to Fall

In May 2017 we looked at the proposed merger between Kraft-Heinz and Unilever, where we discussed the differing approaches to business taken by the two entities. Then, in May 2019, we looked at Kraft-Heinz again as it was under investigation by the SEC because of its accounting situation. More recently however, the company has continued to struggle and now it is the turn of the credit rating agencies to weigh-in and affect the situation for the struggling firm.

It was reported last week that, on the basis of Kraft-Heinz’s decision to maintain its dividend payouts to its shareholders despite an ever-growing debt burden, both S&P and Fitch would be downgrading the company to junk status i.e. non-investment grade. S&P cited the ‘unwillingness’ to change course on the dividend decision as a key factor in the downgrade decision, although the company has countered by declaring that ‘we believe it’s important to shareholders to maintain our dividend during this time of transformation’. Nevertheless, this ‘unwillingness’ as S&P see it, when combined with what S&P have declared has been ‘significant mismanagement’ over recent years, all adds up to a downgrade that could be massively impactful for a firm that needs to borrow, but who will now be barred from the investment-grade indices. For Fitch, it warned that the company may need to raise $9 billion from disposals to reduce its levels of leverage. Interestingly, Moody’s chose not to downgrade the company, instead placing it on a negative watch for a downgrade – I say interesting because Kraft-Heinz’s largest shareholder is also Moody’s’ largest shareholder; Warren Buffett’s Berkshire Hathaway.

If we look closer at Kraft-Heinz we can see that this turn of events should hardly be surprising and, in hindsight, why Unilever were so reluctant to get involved. Kraft-Heinz and its management has come in for plenty of criticism in recent years, and one of the main reasons is the approach taken by one of its constituent components – 3G Capital. 3G Capital, a Brazilian-based outfit, are renowned for creating profits via extensive and relentless cost-cutting strategies; the Kraft-Heinz deal was said to be based upon the fact that, at Heinz, there was very little else to cut and there was a need to bring in another high-cost business in order to keep the strategy going. This cost-cutting is continuing with Kraft-Heinz, but it is also being done with a challenging market place. Its products are increasingly falling out of favour with consumers, who are turning to fresher products than that offered by Kraft-Heinz. In response, Kraft-Heinz are embarking upon a strategy of reducing their selection of new products and also revitalising their current product base, in line with increased investment in its marketing campaigns for its increasingly outdated products. Yet, there is very little to suggest that the company will be on the mend anytime soon. The downgrades will have an effect and, if Moody’s decides to downgrade too, the situation will only get worse. Adding to the fact that it appears the company’s traditional position in the marketplace has been taken for granted whilst the market has moved on significantly, one can only imagine that it will take something special from the company’s management to arrest this slide – and if S&P’s declaration of mismanagement is true, then that seems to be a long-shot.

Keywords – Kraft-Heinz, junk, downgrade, credit ratings, @finregmatters

Tuesday, 11 February 2020

Protecting Against Credit Rating Agency Transgression in the CLO Market

In today’s post we will look at recent calls for more action in the field of credit rating reform, and also some solutions that have been advanced by commentators from the field – our friends at the Expect[ed] Loss blog in particular. Recent calls from the Senate have reignited the discussion and debate regarding credit rating reform, but there are potentially much more deep-rooted questions that need to be asked.

As reported last week by Cezary Podkul of The Wall Street Journal, a number of Congressmen have taken the option of pressing the SEC on why more has not been done regarding the inherent conflicts of interests that plague the credit rating marketplace. This is not the first time that this request has been made of the SEC, with a number of academics and former practitioners urging the SEC in November 2019 to ‘finally end the industry’s “issuer pays” business model’. The panel, however, did not promote an alternative model, and industry-insiders have been staunch defenders of the model. Nevertheless, the letter sent by Senators Wicker, Whitehouse, Grassley, and Kennedy on the 3rd February is rather clear. In the letter the Senators cite recent Wall Street Journal articles that confirm that the six largest rating agencies altered their rating criteria ‘in ways that were followed by big jumps in market shares in some sectors – particularly in sub-segments of commercial mortgage backed-securities and collateralised loan obligations’. The senators take aim at the SEC’s approach in the aftermath of the Crisis, which was to focus on the development of unsolicited ratings as one major cure for the inherent conflicts of interests, and how associated pressures are applied, within the credit rating arena – the senators note that the SEC themselves found that, as a result of their focus on unsolicited ratings, ‘competition has not increased, as unsolicited ratings remain uneconomical… there is limited willingness to pay for them’. The senators do appreciate that the SEC has at least attempted to raise the issue of the remuneration model, but that ultimately ‘the failure of other mechanisms to curb conflicts of interests, like the issuance of unsolicited credit ratings, indicates that another path forward should be considered’. Furthermore other legislators, like Rep. Brad Sherman, have confirmed they will now be turning their attention to the actual business model of the agencies. In terms of mitigating this particular issue, our friends at Expect[ed] Loss recently covered this issue, particularly in relation to CLOs and their potential impact.

One of the ways in which the conflict of interest that is inherent to the issuer-pays system could be alleviated, is by allowing either rating agencies who utilise investor-pays, or indeed non-registered entities, access to the same information the issuer-pays rating agencies have. The article discusses how the SEC could mandate that all companies that borrow on the leveraged loan market must file their 10-Q and 10-K statements on the EDGAR system, which would allow independent firms access to that data. Additionally, the posting of information like loan portfolios and details of their capital structures onto a system like EDGAR would mean that they would then be regulated as public securities, not private securities – the sentiment being this would add extra protection to what may be a particularly impactful collapse of a bubble, if a bubble were to materialise. For the CLO market this seems wise, but this does remind me of a system that already exists, but which has failed miserably. In an article in 2018, I wrote about a system known as the ‘17g-5 Program’ which was developed to allow the sharing of information outside of the relationship between issuer and rating agency. The concept is that this would allow non-hired rating firms to both provide an alternative rating for the market which may, if factors conspired, become a benchmark with which to compare the predominant rating agency, and also allow that non-hired firm to gain the reputation needed to break the oligopolistic barrier. What we found was that none of this happened, because non-hired firms are simply not incentivised enough to conduct such ratings, at cost, with no recompense – the carrot of gaining reputation within a natural oligopoly is not a particularly strong one. So, extrapolating out from this, the suggestion regarding the extra monitoring, based on transparency, within the CLO marketplace is a just suggestion, but in practice it will take non-hired entities to be incentivised properly to fulfil that role. In theory the system, both with respect to the one called for in the CLO market and the 17g-5 Program, is a progressive and potentially very valuable tool in the name of reducing the negative impact of the issuer-pays model. However in reality, as if often the case in the credit rating world, it is not that simple. There needs to be quite the incentive for an outsider entity to produce work for free, and that incentive is hard to conceptualise. It was for this reason that I suggested that a number of non-profit rating agencies come together to fulfil the role and reduce the commercial aspect of the role – but, the non-profit entities like INCRA and the CRI cited in my article have found it particularly difficult to grow in the rating climate. One assumes that there will be other initiatives, and calls, to reduce or remove the issuer-pays system but, quite frankly, it is here to stay and, along with it, are the conflicts of interests that are inherently associated with it.

Keywords – credit rating, CLO, business, issuer-pays, @finregmatters

Monday, 3 February 2020

The Competition and Markets Authority (CMA) Plans for More Regulatory Action post-Brexit, But Will It Happen?

Today’s short post responds to comments made in today’s business press from the Chief Executive of the Competition and Markets Authority (CMA) in the UK, Andrea Coscelli. The sentiment behind Dr Coscelli’s vision of the post-Brexit world for the regulator is that it will be free to pursue certain regulatory actions that it was not entirely free to pursue before, and that now it fully intends on doing so. This may be fair enough, but are there more forces potentially affecting the regulatory scope of British regulators that he is potentially underestimating?

Dr Coscelli’s comments in today’s edition of The Financial Times relates to the CMA’s potential regulatory stance towards the big US tech giants once the UK formally moves away from European regulations at the end of the year (once the transitionary period has concluded). Coscelli stated that ‘the upside [of the UK leaving the EU] is that you take back control – genuinely – of the decisions’. This sentiment has been connected to the declared position of the CMA in that it wants to take a more active role in scrutinising the actions of the large US-based tech players, like Google and Apple. This apparent will to get more involved in the regulation of these societally-central companies comes after scandals such as the Facebook-Cambridge Analytica scandal and it is not just British regulators that will apparently be getting more involved – European regulators have vowed to take a tougher stance on the tech giants too. Yet, in responding to criticism from business that more regulation may stifle innovation in a given commercial sector, Coscelli confirmed that the regulator will still have a ‘reasonably pro-business approach’. However, this apparent pro-business but inquisitive and critical approach that Coscelli wants to take, irrespective of that sentiment perhaps being slightly paradoxical, potentially ignores the new post-Brexit world that is about to engulf the UK.

Despite the sentiment being displayed by British ministers already regarding diverging from European rules – deregulation is a massive worry since the UK formally left the EU, across a range of sectors – it is the concept of an American trade deal which brings forth one of the biggest issues for British regulation. It is being coming clearer by the day that there are a number of challenges facing the UK and US if they are to successfully negotiate a trade deal, with one onlooker suggesting that the US is quickly learning ‘just how European the UK really is’. British ministers have long hailed the potential impact of the deal as a ‘big prize’, but whilst the US may be learning that the UK is still very close to their European counterparts, the UK is likely about to learn that the ‘prize’ of the trade deal does not come without strings. The US has been noted as declaring that a number of elements must be in place if the deal is to go through, including the NHS paying more for its drugs from American pharmaceutical companies, and the UK accepting chlorinated Chicken into its marketplace from American farmers. But, whilst these stories are headline-grabbing, for Coscelli it is probably worth monitoring President Trump’s approach to France’s latest move. Towards the end of last year, President Macron instituted a levy on the tech giants that irked Trump and lead to threats of a $2.4 billion tariff on French goods as a result of the levy, including tariffs on champagne. Yet, despite the threat, Prime Minister Boris Johnson has supported the idea that Macron has instituted and suggested a similar ‘digital services’ tax in the UK, to take action on the amount of money earned by the tech giants in the UK, compared the amount of tax they pay on those earnings. Trump has declared that he believes such practices to be disproportionately unfair against the US-based tech giants and has vowed to protect their interest in the global marketplace. Trump has a history of carrying through such threats, and there are more in the pipeline – tariffs on Argentina and Brazil will be reimposed shortly to punish the countries for the currency policies, whilst tariffs against European nations involved with Airbus (after subsidies given to the firm were ruled illegal by the WTO) may go as high as $7.5 billion. With all this in mind, can Coscelli really go after the tech giants in the post-Brexit world?

The answer, very likely, is no. The post-Brexit world does indeed free the hands of British regulators, but in name only. In fact, it is more than likely the case that their hands, in certain sectors, become even more tied than before. Why? Because politics will trump the regulatory agendas of entities like the CMA. Coscelli’s apparent will to regulate and punish the tech giants more will not outweigh the importance of the US-UK trade deal to the UK, despite what Mr Johnson declares, and President Trump will be well aware of this; the trade deal will be on the US’ terms, not the UK’s. With that in mind, expect to see some ‘low-hanging’ regulatory fruit being picked and masqueraded as a ‘new day’ in terms of competition regulation, but with the large US companies demanding a seat at the negotiating table (as well as British businesses), the tech giants will not be affected by this new regulatory outlook.

Keywords – CMA, Competition, tech giants, trade deal, politics, @finregmatters