Finance – Page 23

Lending Loop – Why even bother?

Lending Loop is one of those peer-to-peer financing companies where you can allow yourself to be the recipient of future defaulted loans in the name of some business cause or another spending it without any real accountability. When you sign up, on top it states “Start investing today and earn a projected return of 5-8% per year*”

The “*” leads to a link with a model that uses words like “projected”, “estimated”, and other such mumbo-jumbo that is nearly as good as a COVID-19 mortality prediction.

Why the heck would anybody want to lend some random small business money at 5% when you can pick a brain-dead debenture (e.g. Rogers Sugar RSI.DB.F, 6.25% YTM) of a publicly traded company that has a billion more layers of accountability, and actual consequences (i.e. owners lose equity) if there is a default?

Finally, during this COVID-19 crisis, we have the following:

We have implemented a temporary hardship program for borrowers that are currently distressed as a result of impacts of COVID-19. This program will allow Lending Loop clients that meet certain criteria to make interest-only payments on their loans for a period of 3 months to accommodate this unexpected event.

I am guessing they are not doing this with the consent of the lenders. If the terms and conditions of the loans are so malleable, why would anybody ever bother putting their money in Lending Loop or other peer-to-peer lending services? This never made sense to me.

This is also why companies like Alaris (TSX: AD) never made sense to me. Companies have to be pretty desperate to lend money at double-digit coupons, and if you’re willing to sell royalties on revenues, you’re likely to destroy the margins that are required to keep your business competitive. It might make sense in specific scenarios (e.g. gold mining streams can make economic sense at times, e.g. “some percent of something versus 100% of nothing”) but gold miners are not like widget manufacturing where you have to squeeze out 200 basis points of margin in order to make a living. (Very abstractly, the less competitive the industry is, the more possibility that royalty selling makes sense).

And finally, if you want your double digit yields on questionable debt of corporations, there’s always gems like Bombardier unsecured, which when I last checked would net you 20% YTM if you feel brave. Less riskier than most stuff on Lending Loop and higher potential return, in addition with the likely possibility of getting a few morsels of recovery if they defaulted!

The blowup in oil – and what’s next

I posted about it the oil situation earlier, and here are some ramifications: Interactive Brokers took a $88 million hit on client margin accounts on oil futures:

Several Interactive Brokers LLC (“IBLLC”) customers held long positions in these CME and ICE Europe contracts, and as a result they incurred losses in excess of the equity in their accounts. IBLLC has fulfilled the firm’s required variation margin settlements with the respective clearinghouses on behalf of its customers. As a result, the Company has recognized an aggregate provisionary loss of approximately $88 million.

Other financial institutions and/or funds were probably cleaned out on this transaction as well.

Anybody investing in the USO ETF (US Oil) is actually investing in a combination of the two front month futures contracts (retail is crazy to use this ETF as an oil instrument – if they really feel like ‘safely’ speculating on oil, better to put some money in XOM, COP, or if they insist on Canada, SU or CNQ). At the time of the May 2020 contract calamity, USO had zero exposure (they already rolled over to June), but today there was visibly obvious trading action on the charts that are classic liquidation trade signs:

Whenever you see “V” type charts, especially sharp ones that you see here, this is most likely due to a function of margin trading and customers getting cleared out en-masse – a cascade of market sell orders in the accounts with insufficient equity. Conversely if you’re bright enough to put some layered orders on the buy side (and have sufficient fortitude to not catch the absolute bottom since you have no idea when the forced selling will end) you can make huge profits in a very short period of time.

Needless to say the negative oil prices on the May 2020 contract (coupled with some rumours of Supreme Leader Kim) has increased the perception of market volatility and risk, and I have been nimble enough to reduce risk and get out of the way of any potential blowups of this magnitude. The net result of this is that a whole bunch of oil producers are going to go belly up and this will drastically reduce the supply going forward, probably at a higher rate than the decrease in demand exhibited to date.

Now my next question is: Are banks the next to drop? They are ultimately backstopped by central banks, but I deeply suspect they are in more trouble than it may seem. People looking for “safe dividends” in Canadian financial banks should be very, very cautious right now. It’s very difficult to predict how much of their lending will go belly up.

Completely insane – May 2020 Crude Futures

The May 2020 futures contract expires on April 21st, but nobody wants the oil!

Attached is a chart of trading today in May 2020 crude futures. Amusingly enough, Interactive Brokers doesn’t support negative price quotes, so I couldn’t chart it through TWS:

I have never seen anything like this before in my life – you buy a contract for 1,000 barrels for negative $40. The counterparty pays me $40,000 and I take delivery of 1,000 barrels of crude oil. I then go light it on fire.

What a strange, strange world we live in.

Keep shorting volatility

Perhaps the biggest no-brainer trade of this COVID-19 economic crisis (which is going to come to an end pretty soon) is shorting volatility on spikes. Today was the first real spike up since April 7th (which wasn’t much of one). I’ve attached the spike – and note just before Easter it was at around 33-34%:

Long-time readers of the site knows that I’m generally into fundamental analysis but once in awhile, there are trades out there that are so seemingly skewed to risk/reward that I just have to take them. The even better news is that unlike scammy marijuana companies, in the futures market your only price of admission is the initial margin and you don’t have to worry about borrowing, or carrying costs or anything like that, only a US$2.38 commission to get short a contract of US$1,000 times the index of notional value (i.e. every point the VIX goes up or down, your equity goes up or down US$1k per contract).

Of course, there are always risks. Who knows, Supreme Leader Kim might decide to launch the nuclear missiles, or there might be a 9.0 Richter scale earthquake in San Fran or some other catastrophic event, so this is why you never, ever go all-in on a trade (VIX would skyrocket). However, on the skewed balance of probabilities, by the time May comes rolling around, I’m pretty sure VIX is lower. Every quant fund out there on this planet that didn’t get wiped out on March 23rd is now applying the same rubric in our ultra-loose monetary policy situation and is making coin with volatility suppression – the S&P 500 doesn’t even have to rise to make this trade work. In fact, if it meanders, the trade works even better.

One of the biggest winners of all of this volatility has been the HFT firms, including Virtu (VIRT), but I would not invest in their stock. It is interesting to note, however, that they averaged about US$9.5 million in net trading income a day in Q1-2020! Holy moly!

Quick market commentary

The month of March (up until the 23rd) was like pushing on a spring, where people and funds were getting cashed out on margin.

We’re still on the spring back. How high this will go is anybody’s guess, but my trading instincts suggest it’s probably a good time to take a few chips off the table, at least temporarily. There will be some ‘rebound’ news that will get injected into the the world that things aren’t as optimistic as projected, that the lockdown will have to last for longer, that secondary infections will come back from people previously confirmed without the virus (when it probably turns out that they were false positive diagnosed to begin with and just caught Covid-19 from somewhere else), etc. There is also the element of sheer greed from participants that want to make the quickest buck.

The rebound down will take the market down 3 or 4%, the people that have loaded up will get frightened and dump, a bunch of people will panic over the revenge of the Coronavirus and that’ll likely be the best time to load up, just when it looks like things are getting awful. The speed that this is all happening, however, is quite remarkable. The market action is happening three times as fast as the 2008-2009 economic crisis.

You’re not going to get anywhere close to the bargain pricing you saw in March but there’s still considerable upside coming as long as you avoid the sectors that are sensitive to the “main street” economy (e.g. I wouldn’t want to be owning a sports franchise).

Continue to pay attention to debt covenants, but note that credit is going to become easier to get as the corporate debt market normalizes (this is what happens when the central banks are buying corporate debt – they’ll clear out the investment grade, which means banks can loan to the BBB, BB and Bs of the world). As long as there aren’t significant maturities coming up in the next 12 months or so, you’ll probably be fine if the debt loads are ‘reasonable’. This crisis will also scare a lot of corporations into de-leveraging or lightening up on leverage – the better capitalized companies will likely clean up better in this environment. Entities that should be trading at low yields (e.g. Rogers Sugar, RSI.DB.E/F) are already at a YTM of 600-650bps while just a few weeks ago they were well into the double digits. Of course, the trashy companies are trading in the teens and above still, but even then the ones that generate reliable cash flows will get back to normal (looking at Chemtrade).