Citi and Revlon Are in Murky Waters

Let’s see:

• In 2016, Revlon Inc. borrowed $1.8 billion from some banks and hedge funds using a seven-year term loan secured by Revlon’s assets. Citibank NA advised on the loan and served as its administrative agent.
• In 2019 and 2020, Revlon took some of the collateral for the 2016 term loan and snuck it out, away from the lenders: It put much of its intellectual property, including brands like American Crew, Elizabeth Arden, Almay and Mitchum, into new subsidiaries (generally called “BrandCo”) that did not secure the 2016 loan. It borrowed some new money secured by those brands, and rolled some of the old term lenders into the new facility in order to get them to vote to approve it. There were various shenanigans involved, including doing a new revolving loan under the 2016 credit agreement in order to get just enough votes to approve the new deal. We have discussed the basic form of this before: If you are a company in trouble, you pay off 51% of your lenders to get them to approve hosing the other 49%. That’s what happened here: Revlon gave some of its lenders a new loan with better security (those brands), making the security for the other lenders worse. (This is explained in more detail
• The 2016 lenders who didn’t participate in the new BrandCo deal were annoyed: Their collateral had disappeared, and now they were effectively junior to the 2020 lenders. They Revlon, Citibank and various other people, claiming that the BrandCo deal violated the 2016 credit agreement and was invalid. If they won … I dunno, it would be a mess if they won, but generally speaking if they won then they would get those brands back as collateral for their loans.
• The day before they filed that lawsuit, Citi paid them off by accident. Oops! This was very funny and we have talked about it a lot, but the gist is that Citi, as administrative agent for the loan, was supposed to pass along a small interest payment from Revlon and accidentally paid off the whole loan with its own money.
• Citi politely asked the 2016 lenders for the money back, but the lenders were really mad at Citi for helping with the BrandCo transaction, so some of them — who had gotten about $500 million of Citi’s money — said no.
• Citi sued them and, somewhat shockingly,
• Citi appealed. I assume Citi will win on appeal, but then I assumed they’d win in the trial court so who knows. The appeal is still pending and could take a while.
• Meanwhile the thing everyone worried about happened, and Revlon filed for bankruptcy last week.

This raises various wild questions. For instance: Who are the creditors on the 2016 term loan, now? There are three main options:

1. Citi paid off that $500 million on Revlon’s behalf, so it presumably steps into the shoes of those creditors and has a $500 million bankruptcy claim against Revlon. (This is probably not worth $500 million: My Bloomberg screen shows the 2016 term loan trading below 30 cents on the dollar, while the 2020 BrandCo term loan looks to be in the 50s.)
2. The original lenders: Maybe Citi will win on appeal, in which case the lenders will have to give back Citi’s $500 million, in which case Revlon will still owe them the money. “Lawyers for the repaid lenders in the bankruptcy court hearing on Thursday described their clients as only ‘contingent creditors’ who since they have already been repaid will not need to participate in the bankruptcy fight unless the appeals court orders them to return the cash to Citi,” reports Sujeet Indap at the Financial Times. But since it will presumably take a while to find out, they continue to have some interest in the case.
3. Nobody: Did Citi pay that $500 million on Revlon’s behalf? Or did it pay the $500 million out of the goodness of its heart, discharging Revlon’s obligation to the term lenders but not creating any new obligation to Citi? That seems ridiculous, but on the other hand Revlon in bankruptcy so it has an incentive — an obligation, almost — to minimize its debt load.

Bloomberg’s Jeremy Hill and Eliza Ronalds-Hannon reported last week

“There isn’t a lot of law on this,” said Eric Talley, a Columbia University law professor who has studied the Citi-Revlon debacle. “Revlon would like nothing better than to wipe this debt off its books completely and have it be Citibank’s problem.”

The so-called subrogation rights that Citigroup claims it has over the $500 million loan principal are a common concept in insurance law, but are relatively untested in the world of finance, according to Talley. The limited precedent that exists probably falls in Citigroup’s favor, but Revlon’s precarious financial position likely makes even a long-shot attempt to wipe out the debt worth considering, he said. 

In its latest quarterly report, Revlon said it hasn’t taken a stance on Citigroup’s rights as creditor. It went a step further this week, saying that if Citigroup ultimately loses its battle to reclaim the money, Revlon “reserve all rights and defenses with respect to any claim Citibank may assert against” the company. 

A successful challenge of Citigroup’s claim could erase almost 15% of Revlon’s $3.4 billion debt load in an instant, easing the company’s path out of bankruptcy. But the scorched-earth tactic is far from a sure thing, and risks souring the company’s relationship with Citigroup, said Bloomberg Intelligence analyst Phil Brendel, who believes the odds are against Revlon.

I can’t imagine Revlon winning that argument, but I can easily imagine them trying.

But there is another wild question, which is: What about that lawsuit to set aside the BrandCo deal? If the 2016 term loan lenders win that argument, then their loan will get a higher recovery (they will have a claim on the BrandCo assets) and the 2020 lenders will get a lower recovery (they will have to share the BrandCo assets). But if they win their Citi appeal, this doesn’t affect them at all: They already got paid 100 cents on the dollar (by Citi), so they don’t care. They are “only ‘contingent creditors.’” Still, they contingent creditors — they might lose on appeal — so they have an interest in arguing in bankruptcy court that the 2020 BrandCo transaction was invalid and they should get the BrandCo collateral. (Also, to be fair, some of the objecting 2016 lenders gave Citi its money back voluntarily, and remain Revlon creditors, so they have a more direct interest.)

You know who else has that interest? Citi. If Citi loses on appeal, then it (probably?!) steps into the shoes of the 2016 term-loan creditors, with a $500 million bankruptcy claim against Revlon. 1  It will want that claim to be more valuable rather than less, which means that — if Citi is in fact a Revlon creditor — then it will want the court to set aside the BrandCo transaction. The BrandCo transaction that Citi helped arrange. Here are Hill and Ronalds-Hannon again, citing Bloomberg Intelligence analyst Phil Brendel: 

“Recall that Citi was a fantastic financing partner for Revlon in 2020 when it arranged a new revolver just to gerrymander a lender vote to strip assets from the 2016 term lenders,” Brendel said, referencing a controversial maneuver that benefited a group of senior creditors now key to the company’s restructuring. 

“Now, through a series of unfortunate mistakes and luck, Citi finds itself potentially the owner of those loans,” Brendel said. “Do Revlon and its likely new owners now add insult to injury? I don’t think the answer is obvious.” 

Yes but the 2016 term lenders are suing Revlon and Citi for that gerrymandering and asset stripping. And also Citi now the biggest 2016 term lender. If Citi loses its appeal against the other term lenders, it will want those term lenders to win their case against Revlon (and Citi), because that will make the 2016 term loan that it now owns more valuable. Which means that Citi should be … suing itself … to invalidate the transaction that it did? Not really? But a little bit?

Crypto leverage

We have a few recently about how people borrow money to do leveraged trading in decentralized finance, and how it differs from leveraged trading in traditional finance. One key difference is:

1. In traditional finance, if you have borrowed money to buy some stocks, and the stocks have gone down, your broker will call you up and say “hey could you post more collateral.” Ideally you post the collateral and everything is fine. Sometimes you don’t, and your broker sells the stocks at hopefully a high enough price to pay off your loan. But sometimes you say “sorry, I can’t post any more collateral today, but I can try tomorrow,” and your broker gives you another day.
2. In decentralized finance, if you have borrowed money (stablecoins) to buy some crypto, and the crypto has gone down, a robot sells your crypto at hopefully a high enough price to pay off your loan, automatically and without bothering to call you.

I have mostly emphasized that the traditional approach can be more generous to you, the borrower: Sometimes you don’t pay back your loan, but your broker gives you more time. Why would the broker do this? Well, you might be a good customer, and the broker won’t want to make you mad. Or you might be a big fund, and the broker will think “sure this position is undercollateralized but all in all they’re good for it.” Or you might be so big that the broker will think “if I liquidate this position it is going to crash the market and cause a systemic crisis, whereas if I just give them another day to pay maybe everything will be fine.” 2  

Or you might say “sorry, can’t make a margin call right now, I’m on vacation with limited cell service” and your broker might say “ah we’ve all been there” and give you another week. (True story: Once, when I was a banker, I sent a Brazilian client a large margin call. They said “it’s Carnival, sorry, try us next week.” I gulped and waited. It worked out fine!) 

The crypto robots don’t do any of this sort of thinking. They just look at the collateral, look at the position, and if the collateral is too low they liquidate. The crypto system is often stricter, which is good (less buildup of systemic risk) and bad (harder to sleep).

On the other hand, the traditional approach can also be stricter. Sometimes your stocks haven’t gone down, and your broker calls you up and says “hey we are changing our margining requirements and would like you to post more collateral.” And if you say no, the broker will (eventually) liquidate your position.

Why would the broker do this? Well, there might be a new risk manager at your broker, and she might want more collateral. Or volatility might have gone up and your broker’s model now demands more collateral. Or your stocks might have gone , and your broker might say “this position is so big that we need to manage the risk more strictly.” Or your broker might have heard a rumor that you are in financial trouble. Or your broker might have heard a rumor that a bunch of other investors are in trouble, so it is tightening up collateral across the board. Or something else.

your broker do this? Does your contract with your broker allow them to just call you up for more collateral? The short answer is, sure, probably; brokers are good at protecting themselves. The longer answer is that you are all embedded in a fuzzy system of repeat players and you cannot ignore your broker’s demands forever, even if your current contract favors you. If your broker asks you for more collateral then, in the long run, your choices are (1) post more collateral or (2) find another broker; either of those approaches accomplishes the broker’s essential goal of reducing its risk exposure. 

This is actually an element of the Archegos Capital Management story: When Credit Suisse Group AG called Archegos for more collateral, it was because Archegos’s stocks had gone down; they had gone , and Credit Suisse took a closer look at its margin provisions and realized they were not great, so it called up Archegos and asked to change those provisions. Archegos said “we’ll get back to you” and then imploded, oops. But the basic story is that Credit Suisse tried to adjust its margin provisions on the fly to address newly salient risks, and Archegos was at least in theory willing to work with Credit Suisse on that.

Meanwhile in decentralized finance, if you wake up one morning to realize that a whale has built up a huge position in an increasingly volatile market, and that your margin provisions are not adequate to protect you if you need to close the position, what do you do? I mean … kind of the same sorts of ad hoc things that you’d do in traditional finance, but you get a lot more grief for it.

Solend is a DeFi lending platform on the Solana blockchain. It … discovered? … that it has one “whale” client who has borrowed a huge amount of stablecoins from Solend to fund a position in Solana’s native SOL token. If the price of SOL falls too far, the Solend smart contract will automatically start liquidating the whale’s position in a way that will apparently overwhelm market liquidity, crater the price of SOL and cause huge losses for Solend and its own depositors (the people who put up the stablecoins that Solend is lending to the whale). CoinDesk reports

The anonymous wallet at the heart of the crisis had deposited 95% of Solend’s entire SOL pool and represented 88% of USDC borrowing. But Solend’s single-largest user came dangerously close to a massive margin call with SOL’s cratering price. If SOL hit $22.30, the protocol would automatically liquidate up to 20% of the whale’s collateral.

To avoid this, Solend decided to amend the smart contract to let Solend’s team take over the whale’s position and start liquidating it in over-the-counter transactions it hits the margin trigger. To do this, it put the proposal to a vote of its decentralized autonomous organization; from Solend’s blog post

Any action we take (including inaction) has a set of trade offs to consider. There is no perfect solution. With that in mind, the action we believe would result in the best outcome is as follows:

Enact special margin requirements for large whales that represent over 20% of borrows. If a user’s borrows amount to over 20% of all borrows for the Main Pool, a special liquidation threshold of 35% is required. This policy will go into effect upon approval of the proposal.

Grant emergency power to Solend Labs to temporarily take over the whale’s account so the liquidation can be executed OTC and avoid pushing Solana to its limits. This would be done via a smart contract upgrade. Emergency powers will be revoked once the whale’s account reaches a safe level.

The proposal passed, but in a hasty way that led to lots of objections, so they walked it back: Solend introduced another proposal to rescind the first one, and then a third to create new position limits to mitigate this risk in a more mechanical way. 

I suppose you could conclude something along the lines of:

1. In traditional finance, this stuff is managed through a combination of contractual remedies, background legal and equitable principles, and fuzzy relationships and reputations.
2. In decentralized finance, people like to say that “code is law”: Everything is supposed to be transparent and deterministic; smart contracts specify exactly what happens in every case.
3. Code is not law. Sometimes the smart contracts do not cover the cases you end up caring about, or they do, but not in the way anyone wants.
4. Nothing else is law either, so you make things up from scratch.

Elsewhere in crypto leverage … uh, I dunno, there’s a lot of it?

• Babel Finance, the distressed crypto lender which froze withdrawals on Friday, said it won a reprieve on debt repayments as it battles to survive a tumultuous slump in cryptocurrency markets.”
• Celsius Network Ltd.need more time to stabilize its liquidity and operations, the embattled crypto lending platform said in a blog post after it froze deposits last week.”
• “Cryptocurrency-focused hedge fund Three Arrows Capital Ltd. has hired legal and financial advisers to help work out a solution for its investors and lenders, after suffering heavy losses from a broad market selloff in digital assets, the firm’s founders said on Friday.”
• “Crypto lending platform announced that it has secured a $250 million revolving credit facility from FTX, BlockFi CEO Zac Prince said in a tweet on Tuesday, and the company subsequently announced in a press release.”

Also here is a sentence that I love: “Due to hostile market conditions, Bancor’s Impermanent Loss Protection is temporarily paused.” I don’t know why I find it so funny. It’s, like, doubly temporary. In the long run everything is fine! In the short run, things are troubling, but only temporarily and also impermanently.

“Impermanent loss” basically means that if you act as a market maker in crypto, and the market moves away from you, you lose money. (There is nothing particularly impermanent about this; the name is just a hilarious bit of branding.) Bancor runs an automated market maker system that uses customers’ crypto deposits to make markets, and when its customers have “impermanent loss,” Bancor prints more of its own BNT tokens and gives them to the customers to make them whole. That is a system that works great as long as crypto is generally going up: Bancor can keep printing tokens, which keep getting more valuable, which means it can pay everyone who loses money on a trade. When the token goes down it stops working. From Bancor’s blog post

BNT rewards effectively have a double-cost:

They depreciate the BNT value, resulting in impermanent loss on the network.

This IL is compensated with additional BNT emissions, causing further value depreciation.

The intuition is that if the price of BNT goes down, Bancor will print more BNT to make the BNT holders whole for the loss. But printing more BNT to give to BNT holders makes the price go down more, etc. This is not the same mechanic as what happened to TerraUSD, but it has a family resemblance. (Actually it has a family resemblance to a lot of crypto mechanics, in which people are often incentivized to hold some token by printing more of that token, and new money flowing into the system counteracts the inflationary effects of that printing — until the new money stops flowing.) And so now Bancor’s impermanent loss protection is temporarily paused. 

A tax trade

Here is a schematic tax trade. In US federal income taxation, long-term capital gains — net gains on assets held for more than a year — are taxed at low rates, while short-term capital gains — less than a year — are taxed at high rates. The trade is:

1. All year, generate a lot of short-term capital gains, for instance by operating a market-making business that turns over an inventory of stocks and options many times each day.
2. On Jan. 1, buy 100 stocks, and short 100 different but correlated stocks.
3. On Dec. 30, close out the losing position from Step 2: If the stocks are up, buy back the ones you shorted; if they’re down, sell the ones you bought. Now you have short-term capital losses that offset your short-term capital gains.
4. The next Jan. 2, close out the winning position from Step 2: If stocks are up, sell the ones you bought; if they’re down, buy back the ones you shorted. Now you have long-term capital gains that offset your short-term capital losses.
5. The net result is that your trades from Steps 2 through 4 offset each other: Nothing has happened, economically, between Step 2 and Step 4, and you are just left with your trading gains from Step 1. 
6. The net post-tax result is that you have transformed the short-term capital gains from Step 1 into the long-term capital gains in Step 4, saving yourself a lot of taxes.

This is a schematic simple version, and in the real world various nuances and complications are required. Of course, you could imagine an even simpler version: In Step 2, instead of buying some stocks and shorting some other stocks, you could just buy a ton of one stock and short a ton of the same stock. But this is frowned upon: It is called a “straddle” in tax law, and you can’t use losses on a straddle to offset other income. 3  You basically want to do a trade that is correlated enough to — to generate roughly offsetting gains and losses without too much risk of the losses totally swamping the gains — but uncorrelated enough to get by the tax authorities. 

Here is a fun ProPublica story about Jeffrey Yass and the other partners of Susquehanna International Group, which allegedly does this sort of stuff:

Since 2011, IRS records show, a partnership called Susquehanna Fundamental Investments has been the source of the majority of long-term gains for Yass and his partners. Every year, it channeled hundreds of millions in long-term gains to them, while also providing hundreds of millions in short-term losses.

Year after year, the gains and losses rose and fell roughly in tandem, as if one were a near reflection of the other. In 2015, for example, Susquehanna Fundamental produced $774 million in long-term gains and $787 million in short-term losses for Yass. In 2017 it was $940 million in long-term gains and $902 million in short-term losses. …

Susquehanna Fundamental held billions of dollars of individual stocks such as Google, Wells Fargo and, as it happens, Coca-Cola. These stocks were among the largest companies in the S&P 500 index.

Meanwhile, the fund also held a large bet against the S&P 500. In essence, it held a bet against many of those exact same stocks.

On its face, the fund actually lost money for Yass: Over eight years, it registered $5.4 billion in losses against $5 billion in gains — a net loss before taxes. But by transforming the tax rate on so much income, it delivered $1.1 billion in tax savings, and Yass came out way ahead.

This is not quite as lovely as the Renaissance Technologies approach of putting all the short-term trades into a basket “owned” by an investment bank and then buying an “option” on that basket, but I guess it does the job.

Musk Stuff

Bloomberg News Editor-in-Chief John Micklethwait interviewed Elon Musk, and of course they touched on his deal to buy Twitter Inc.:

 So with respect to the Twitter transaction, there’s a limit to what I can say publicly given that it is somewhat of a sensitive matter. So I like to be measured in my responses here, such as not to generate incremental lawsuits.

Micklethwait: That seems to be a risk you sometimes manage to overcome.

 Yes, deposition minimization, I think, is important.

Micklethwait: Has Twitter given you enough information?

 Well, there are still a few unresolved matters. You’ve probably read about the question as to whether the number of fake and spam users on the system is less than 5% as Twitter claims, which I think is probably not most people’s experience when using Twitter. So we’re still awaiting resolution on that matter, and that is a very significant matter. So we’re awaiting resolution on that. And then of course, there is the question of, will the debt portion of the round come together? And then will the shareholders vote in favor? So I think those are the three things that need to be resolved before the transaction can complete.

Nope! The bot thingcompletely fake, and “resolving” it is not in any way a condition to the closing of the transaction. The shareholder vote certainly is, but Twitter closed on Friday at $37.78 and Musk’s deal is for $54.20 per share in cash, so shareholders are definitely going to approve it. “The debt portion of the round” is committed financing from Musk’s banks; they have no market out, and there is no financing condition to Musk’s obligations, so it is not exactly true that anything about the debt would “need to be resolved before the transaction can complete.” 4  I am not saying that Musk won’t find a way out of the deal; I am just saying that none of his excuses make any sense. 

Universal owners

wrote on Thursday about how the interests of universal asset owners — people who own 10% (or whatever) of every public company — differ from the interests of concentrated owners of a single, say, oil company. In particular, I noted:

1. Owners of a single oil company will want it to drill more oil when prices are high, because it can sell that oil at high prices. Owners of every oil company will want them all to exercise some capital discipline, since if they drill more oil prices will go down. Universal ownership, the theory goes, is anti-competitive: Universal owners will want to keep margins high rather than increase production.
2. Owners of a single oil company will want it to drill more oil, but universal owners will be more concerned about the effects of climate change on all their other portfolio companies, and so will want to reduce drilling all around.

Several people pointed out an offsetting consideration: Universal owners should want lower oil prices right now, because in the actual world high oil prices seem to be driving inflation and economic worry. If oil prices were lower, then all the other companies that the universal owners own would be making more money now, though in the long run they’d have to worry about climate change etc.

That seems right. Which set of concerns dominates is an empirical question. We were talking about this on Thursday because the founder of Continental Resources Inc. wants to take his company private to avoid meddling public investors, and my sense is that in general US oil-company managers feel like their public investors are more interested in capital discipline and environmental, social and governance concerns than they are in drilling more oil. 

One point here is that the meaning of “environmental, social and governance” investing can change as facts in the world change. In a world where inflation is low, the economy is booming and Russia has not invaded Ukraine, drilling oil can look like a bad-for-ESG business. In a world where inflation is high, recession is looming and high oil prices fund a Russian invasion, drilling for oil can look pretty noble.

Things happen

Will Split Into Three Companies to Promote Growth. EY’s Breakup Plan Means Windfalls for Partners. JetBlue Lifts Offer for Spirit Airlines, Commits to Selling Assets. Have banks fixed their structured products problem? Europe does not face fresh sovereign debt crisis, says eurogroup chief. Germany spars with ECB over bond market risks. Long shadow of Russian money raises tricky questions for Swiss bankers. Former Goldman Sachs MD Is Publishing a Book Alleging Abuse and Attack. Empty Wall Street Offices to Be Revived as Apartments. Machine Learning Can Predict Shooting Victimization Well Enough to Help Prevent It. SpaceX Fires Employees Over Letter Critical of CEO Musk. Elon Musk's Boring Co. Is Feuding With Texas Over a Driveway. “It’s not like I have a catalog and, like, now I can release all of my other novelty rap fragments

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1. Actually maybe more: Citi paid off about $900 million of term loan by accident, but got about $400 million back. Some of that was subject to agreements that if Citi lost in court on the other $500 million, it would have to return that money too. I dunno.

2. I am saying “broker” for simplicity but in fact the issue is often not between brokers and customers but rather between clearinghouses and brokers. Another difference between decentralized finance and traditional finance is that DeFi tends to be sort of flat — all sorts of customers trade directly with exchanges, etc. — while tradfi tends to be sort of hierarchical, with customers trading through brokers who trade through clearing brokers who trade through clearinghouses, etc.

3. This is oversimplified; the statutory straddle rules are in section 1092 of the Internal Revenue Code, and the general rule is that “Any loss with respect to 1 or more positions shall be taken into account for any taxable year only to the extent that the amount of such loss exceeds the unrecognized gain (if any) with respect to 1 or more positions which were offsetting positions with respect to 1 or more positions from which the loss arose.”

4. This is a bit fuzzy: Musk cannot walk away without penalty if his financing falls through, but he *can* walk away and pay only a $1 billion breakup fee if his financing falls through. If his financing does *not* fall through, he has to close the deal, and Twitter can sue for specific performance. So in a sense there is a financing condition. But, again, the financing itself is not particularly conditional: The banks don’t have to do a bunch of due diligence to get comfortable lending to Twitter, because that already happened and they have committed to lend.

To contact the author of this story:

Matt Levine[email protected]

To contact the editor responsible for this story:

Brooke Sample[email protected]