[echelon]

Companies were over-leveraged and didn't have cash stockpiles. They're trying to get liquid cash so they don't have to divest of assets in a market that isn't buying or go into chapter 11.

All the same, people are willing to extend loans because they are long on the economy, recovery, and return to normalcy. The engines are starting again.

The biggest issue was that companies were over-leveraged with debt. Maybe we'll learn a lesson from this, although I suspect opportunity cost will prevent many from being more prudent.

[alexpetralia]

To play devil's advocate, how are companies over-leveraged during an environment of such low interest rates? Companies will optimize their capital structure for the lowest cost of capital, and if the cost of debt decreases, companies should rationally leverage accordingly.

That's why we see Apple issuing $8B of debt (at ~135bps over 30 year Treasury bonds!) despite having over $200B of cash on hand. If your hurdle rate is 2.5%, surely your profitable business can return more to shareholders than that, so you should binge on this capital source? (Or even, as Apple claims it will do, distribute this directly to shareholders via buybacks & dividends.)

Also, I would qualify your statement that people are not necessarily long the economy in the short-term, which is where credit markets have miraculously thawed; they're long the fact that they will undoubtedly be able to get credit from yet someone else (namely, the lender of last resort).

[code4tee]

Apple’s move is more about tax optimization. Yes they have all this cash but it’s sitting in accounts all around the globe. They’d have to pay hefty taxes to repatriate it and then pay it out as dividends. It’s “cheaper” for them and better for shareholders to take out a loan (bond) in the US and then take that cash and give it to shareholders than it is to bring the money from around the world into the US and pay it to shareholders.

This is why Apple keeps asking for a “tax holiday” to bring all this money back home to the US.

[gwd]

GP said "leveraged and didn't have cash stockpiles". Your example of Apple may fit the first criteria, but not the second.

And this is exactly why you should have a cash stockpile, either as a company or an individual: You can never tell when a random event will completely wipe out your earnings for 6 months.

I'm no corporate financier, but I've certainly heard arguments in favor of borrowing money during times of low interest rates in order to have a cash stockpile. But borrowing to do stock bybacks when you don't have a stockpile is just skating further out onto thinner and thinner ice.

[cat199]

> But borrowing to do stock bybacks when you don't have a stockpile is just skating further out onto thinner and thinner ice.

this also partly depends on your expectation on the availability to resell the stocks later on if desired

[SilasX]

If you're creating the cash buffer as a way to stay afloat during hard times, that's a bad strategy, since the market for shares (including yours) will be weak precisely when you need the cash.

[alexpetralia]

Yes, I agree with you. I am sure shareholders saw piles of cash and demanded: "better in our pocket than yours." (Carl Icahn famously tried this with Apple.)

[Traster]

Don't these yields suggest that people actually aren't willing to extend the loans which is why the yields are spiking. Double digit yields in a deflationary economy should indicate that these loans are being made with a high expectation of default.

[johnrgrace]

It's loan to own! I did high yield Oil & Gas investment banking in the late 90's and a lot of investors had the thinking - Heads I get 12%, Tails I wind up owning a good chunk of the equity and the firm has limited debit.

[C1sc0cat]

I am surprised the Avis has to goto the junk bond market - the cruise line I can sort of get

[pm90]

The rental car market is strongly tied to the travel (both business and leisure) which has crashed. Why would it be surprising if a rental car company is in financial trouble?

[MR4D]

Hertz is on the verge of bankruptcy so it only follows that the risk premium for Avis is high.

Just think - if nobody is flying, who is renting all those cars?

[TheAdamist]

No one, they dont even have enough parking for them to all be idle simultaneously. The airport rental agencies near me have been renting out all the stadium parking nearby to use as overflow storage.

[koolba]

On the capital side, one of the biggest assets for rental companies are their fleets. The sell them as used cars. With nobody buying cars at all and the glut of unsold new cars packing lots, those fleets are being revalued at much lower prices. It’s a double whammy.

[mrep]

Yeah, I saw on reddit last month a possible insurance scam in which 3500 rental cars caught fire in an overflow parking lot in florida because they are all sitting around unused [0].

[0]: https://www.cnn.com/2020/04/05/us/airport-fires-cars-trnd/in...

[johnrgrace]

It wasn't an insurance scam because they don't have insurance, they are going to eat the cost of all of those vehicles.

[lmm]

I'd assume most of their business is renting to people who've just flown somewhere, and right now hardly anyone is doing that.

[C1sc0cat]

Ah true - though I wonder if their balance sheet wasn't that good to start with.

[pepy]

why would you be more prudent when your failures will become a social cost while your successes will become a private profit?

moral hazard through the roof

[bluGill]

That depends, more prudent companies will have cash on hand (and good credit to borrow more) to buy the less prudent companies at fire sale prices.

A bailout rewards the less prudent companies at the expense of the more prudent ones who cannot take advantage of their junk competition.

[listenallyall]

>> The engines are starting again.

The engines are always on, when prices/yields are allowed to appropriately reflect risk, without interference or intervention. One of the most important functions of an unobstructed free market is price discovery.

[remarkEon]

>I suspect opportunity cost will prevent many from being more prudent.

I suspect people will not evolve to be more prudent unless there are some regulatory changes.

[marvin]

Bankruptcies or stock offerings at crisis prices would help too. For instance, the airline Norwegian just accepted 95% dilution of existing shareholders in order to qualify for a government emergency loan. If they'd refused this, they would have gone bankrupt.

Some shareholders were expecting a government bailout, and got a real beating. They're going to think twice about expecting a government bailout the next time.

[remarkEon]

I don't know that I see 95% dilution as totally reasonable terms for a bailout (though I know absolutely nothing about the details of that example), but making it clear that bailouts come with a cost seems like a good development ... so good on the Norwegian government for doing that.

[marvin]

Why do you consider that unreasonable, when the free-market option is bankruptcy? They got to keep 5%, rather than 0!

The terms of the emergency loan was a certain debt:equity ratio, so in order to qualify, their very high debt load had to be reduced.

This could be accomplished in any way the company desired, and it turned out that the only viable pathway was to allow bondholders to convert their loans to new shares at a favorable price. This led to a 95% dilution for existing shareholders.

If they hadn’t done this, proper bankruptcy would have been the next step.

[zdkl]

I wonder why this mechanism (converting potentially derelict bonds into equity) isn't more widespread. In cases where the underlying company reasonably could be expected to continue operating were its debt ratio lowered, apart from legitimate resistance of bondholders expecting debt+interest payments why wouldn't this outcome be preferred to bankruptcy?

[marvin]

Perfectly agree that this is preferable to bankruptcy. I might have worded myself ambiguously -- the emergency government loan might be a sort of bailout, but it wasn't a gift to the shareholders. When I hear bailout, I normally expect the latter.

The government is expecting the loan to be repaid, and to make that expectation likely, they're requiring the company to use market mechanisms to strengthen its balance sheet. The result in this case is that existing shareholders are practically wiped out.

In the case of Norwegian, this is pretty clear-cut. They've been on the verge of bankruptcy before, and their losses now are mostly due to foreign routes shutting down. Even if you accept the somewhat dubious rhetoric that compensation is mandated when losses are partly due to government involvement, it doesn't apply to this case. There was no way they could service their debt during the Covid crisis.

Some sharehoders were expecting the government to give an unconditional loan to be defaulted on later, or participate in a stock offering at prices high enough to preserve their ownership percentage.

This is an unequivocal message to shareholders not to expect that sort of rescue operation in the future. Run your company with a debt ratio that will let you survive unexpected hardships, or accept the risk of facing such hardships on your own.

[kgwgk]

This is actually one of the possible outcomes of bankruptcy. The business may be liquidated but it's not the only option. There may be a restructuring and creditors may become the new shareholders after the orginal shareholders are (in most cases) wiped out.

[PeterisP]

IF "the underlying company reasonably could be expected to continue operating were its debt ratio lowered". That's always debatable, and even moreso in the current economic circumstances - I would not be certain that some airline will be able to return to profitability any time soon.

It makes all sense that a bondholder may calculate that liquidating the company and selling off the assets will allow them to recover more of that debt than having the company continue operating. If so, bankruptcy is preferrable - and if others disagree and believe that the company will be profitable, the bankruptcy process allows various ways that essentially allow the "believers" to gather funding to pay off/buy out "unbelievers".

[drumhead]

The banks or debt holders dont necessarily want to become shareholders. It the most junior type of debt, and they're reliant on the company recovering, which may not happen. They could be left holding shares for years before it makes a return.

[firebird84]

In the US creditors have liquidation preference in bankruptcy. You give that up if you convert to shares but gain some measure of control if the company is still solvent. It's a tradeoff I'm guessing. It's possible they have more to gain in bankruptcy in certain cases.

[remarkEon]

Well now that I know it was a binary choice, yes taking the 95% dilution seems like the best option without knowing anything else about that company's financials.

[appleflaxen]

bankruptcy isn't necessarily zero, but for a highly leveraged company it probably will be.

[snarf21]

Nah, the Fed will bail them out. They are already holding a lot of corporate bond indexes and more will follow. We have a system now where companies were borrowing money at 0% to do buybacks to keep executive compensation rolling. This is one change that must happen. C-suite, VPs and board members should not be allowed to receive compensation based on stock price. It creates a perverse incentive. They should be building strong companies that allow them to stay employed. Give them bonuses based on growth or profits or whatever, just not stock price.

[dforrestwilson]

Taxing interest on corporate debt should be a DNC agenda item.

[PeterisP]

If you're lending money for interest, then the interest is taxable income just as any other revenue. What do you propose should be changed?

[IgorPartola]

You are misunderstanding. The GP is not talking about you lending money, but about you borrowing it. As it stands if you borrow $1m and pay $50k in interest as you pay back the loan, that $50k is considered a business expense and reduces your tax liability.

[PeterisP]

Yes, and why shouldn't it be so?

Off the top of my head, two simple arguments why excluding interest from business expenses does not make sense, there probably are a bunch more:

1. Double taxation - if I my operating profit is $100 but I pay all $100 in interest, then that $100 gets taxed twice; when I receive it and when the lender receives it. Such double taxation is bad because it arbitrarily changes depending on where you put the "legal entity boundary" - if the "earner" and "lender" were a single entity, then they would pay much less taxes; so such a double taxation regime would result in large financial incentives towards vertical integration of conglomerates and artificially punish fragmented businesses, which is generally opposite from what we'd want to facilitate.

2. Introducing asymmetry between owning and renting assets. Rent is considered a business expense (if the proposal wants to change that as well, then it's a much bigger change with other considerations), so any current scenario where a company is borrowing money and using it to buy capital assets (buildings/cars/land/machinery/whatever) can be replaced with an equivalent deal where the "lender" is buying the assets and leasing them. If interest does not reduce taxable income but rent does, then a huge portion of commercial credit would be restructured overnight to leasing for an arbitrary artificial reason, so you would not really gain that much extra tax revenue but would introduce all kinds of bad economic incentives (it's generally better for all the business domain-specific assets such as custom machinery to be on the balance sheets of the companies where they're useful, not belonging to generic lenders, especially in various economic crisis situations) for no good reason.

If you want to tax companies more, just raise the tax rate. Adding various artificial rule differences just adds complexity and all kinds of perverse incentives to structure transactions in weird ways so that they fit the arbitrary distinctions created by these rules.

Saying "today, interest is a special kind of expense that's taxed more" is effectively a subsidy to law and accounting firms to restructure all the corporations so that they do the same business without having transactions that technically are "interest". Case in point, Islamic banking system where interest is prohibited as such - lenders still earn the same money from lending (e.g. Murabahah gets you almost the same end situation as "normal" western loans), it just has to be structured in complicated ways.

[sokoloff]

Why? In general, the US taxes income/profits and IMO debt is a valid business expenses, just like payroll, rent, and utilities.

Are you arguing we should tax all of that as well? Or just one specific type of expense?