(Bloomberg View) -- Programming note: Money Stuff will be off on Monday, back Tuesday.
Accounting and reality.
We talked a bit recently about how Citigroup Inc.'s $23 billion of tax expense last quarter wasn't real. Oh sure if you look at Citi's financial statements, you will see $23 billion of taxes, but it is not like Citi wrote a check to the Internal Revenue Service for $23 billion in December. Instead, most of that number came from an abstract adjustment to an abstract accounting notion: Citi lost a bunch of money in the past, and it can use those losses to offset its taxable income in the future, and it treats those future offsets as an asset (a "deferred tax asset") on its balance sheet, and when the recent Tax Cuts and Jobs Act reduced the corporate tax rate, the value of those offsets went down, and so Citi had to write down that asset. Even though Citi's future taxes will actually go down, not up. The tax bill will give Citi more money, but Citi has to account for it as a loss. It is a pure accounting oddity, a set of conventions that produce, in this particular case, a result that is at odds with economic reality.
On the other hand yesterday American Express Co. announced that it would suspend its stock buyback program because of the (similar) effects of the tax law. That's a very real thing! American Express was going to hand cash to its shareholders, and now it won't, because of ... accounting?
Well, not entirely. Most of Citi's tax expense came from the reduction in value of its deferred tax assets, but some of it came from the "deemed repatriation" of its offshore profits. With Amex the mix is reversed; from the earnings call:
To provide a bit more detail we recognized a Tax Act impact in the quarter of $2.6 billion which is primarily composed of two pieces. First, given the global nature of our business, we recognized approximately $2 billion of taxes on deemed repatriations of certain overseas earnings. And second, we recognized a roughly $600 million charge related to the remeasurement of our U.S. net deferred tax assets to the lower rate of 21%.
Deemed repatriation is significantly less fictional than remeasurement of deferred tax assets. Under the old tax system, U.S. companies were taxed on all of the income they earned everywhere, but only when they brought it back to the U.S.; they could defer taxes on foreign income by keeping it offshore. The new tax system is mostly territorial -- U.S. companies pay U.S. taxes on U.S. income and foreign taxes on foreign income -- but there is a one-time "toll tax" on foreign income previously earned abroad. That tax is at a much lower rate than the old (or new) corporate tax rate -- 8 or 15.5 percent instead of 35 (or 21) percent -- but it has to be paid over the next eight years, whether or not the money is actually brought back onshore. So for companies that were planning to keep their foreign profits offshore forever, this is an actual new cost. (For companies like Apple Inc. that had already accounted for the cost of bringing the money back at 35 percent, though, it creates an accounting profit.) American Express really will have to pay that $2 billion of taxes over the next eight years. Perhaps it would have ended up paying more than that anyway under the old regime, if it had brought the money back, but it will definitely pay that much under the new regime. So it needs to find $2 billion, and that is money that it cannot pay out to shareholders.
Remeasurement of deferred tax assets, on the other hand, is just an accounting convention, for Amex as for Citi. But that doesn't mean it can't limit Amex's buyback capacity, because Amex's buyback capacity is not (only) determined by the amount of cash it has actually lying around in the bank. Amex is a regulated bank holding company, and it can buy back stock only if it passes the Federal Reserve's capital-return stress tests and persuades its regulators that it has a surplus of capital to return to shareholders. And bank regulatory capital has its own accounting regime, with its own set of odd notions, related to but distinct from the notions of U.S. generally accepted accounting principles. One notion that GAAP has is the thing about deferred tax assets; one notion that regulatory capital has is: yes, sure, deferred tax assets, but not too many of them. (Bank capital is roughly speaking assets minus liabilities, and deferred tax assets are assets, to compute bank regulatory capital you take your GAAP deferred tax assets and run them through some calculations that limit how much of them you can count toward your capital requirements.)
And so part of the capital strength that Amex and Citigroup could rely on, back in September of 2017, in thinking about how much cash they could return to shareholders, was that their past losses would allow them to take tax deductions against future income. And now the value of that particular source of capital strength -- which was a weird one to begin with -- is diminished. Even though their taxes on future income will be lower. And so their capital ratios are lower. (Amex's Common Equity Tier 1 capital ratio went from 11.9 percent in the third quarter to 9 percent in the fourth; Citi's went from 12.98 percent to 12.3 percent.) And so even though Amex expects to make more money from the tax cuts, it needs to pay less of it out to shareholders. (For a little while. "We plan to suspend our share buyback program for the first half of 2018 in order to rebuild our capital," says Amex.)
Citigroup, meanwhile, with its much larger tax loss, will not be cutting back on its capital return plans. And neither will a lot of other banks in similar situations:
Despite a lot of one-off hits from tax and a pretty miserable trading environment on Wall Street, the banks all said they would look to step up payouts to shareholders through higher dividends and bigger buyback programmes (with the blessing of the regulator.)
Obviously you can find people who object to this, because at any level of bank capital you can find people who object to the banks returning that capital. That's fine. If you thought in September that banks were not well capitalized, then you should object to them returning capital to shareholders now. But if you thought in September that those buybacks were fine, the new tax law -- and the fact that banks' capital levels now are lower because of it -- should not change your mind. Sure the new tax law has reduced banks' regulatory capital, but it has also improved their economic prospects. (You can tell because their stocks are up. Also because their tax rate is down.) If you're worried about whether banks will run into financial trouble, their actual economic strength is probably the thing to focus on.
What are IPOs like?
You know, I was an equity capital markets banker for four years, but a weird sort of equity capital markets banker, and I never got to traipse around on a little plane doing an IPO roadshow. I cannot say I regret missing out on the experience? But I enjoyed reading this loving description of IPO roadshow life from Glenn Kelman, the chief executive officer of Redfin Corp., which went public last July in an IPO led by Goldman Sachs Group Inc. (Where, yes, I used to work.) For one thing, Kelman -- perhaps because he runs a real estate brokerage -- writes sympathetically about his underwriters' fees:
Once I realized how much money was being made on the buy-side, I almost started to feel bad for the bankers on the sell-side. The bankers worked around the clock for months; the junior analysts and mid-level associates on the team all talked about how happy they were to have a humane lead banker who insisted they take one day off every seven. For all this, they earned the bank a few million dollars, a princely sum but not compared to the amount a single fund got flipping our stock within 30 minutes of our IPO.
This is a reasonable insight for a corporate CEO to have. The bankers really do work for him, and he pays them for providing a service, and the service had better be worth it if they want to keep getting paid. The hedge funds, on the other hand, do not work for him. He works for them. They are capital and he, in the grand scheme of things, is labor. Of course their profits look unearned to him. Also:
And while it’s popular to grouse about the banks and their fees, their service was a thing of beauty. After our pitch to the sales force, Chris and I ate sandwiches in a Goldman conference room to give the sales people time to book the day. Forty-five minutes later, we were in a car headed uptown for the first of 56 meetings, which continued, without a single gap except for travel and sleep, for the next nine days.
We had two SUVs, one carrying two bankers and three or four Redfin folks, one driving behind us empty. I asked our bankers if the empty SUV was carrying spare human organs in case of a medical emergency; they laughed.
Redfin paid its banks about $9.7 million for running the IPO, of which Goldman got about $4 million. For $4 million, you can rent two cars. A basic rule of providing high-dollar financial services is that you don't blink at throwing in a few free non-financial services. The customer has little experience by which to evaluate your investor targeting or IPO pricing analysis, but he can tell whether the car you put him in is comfortable. "When I got a sore throat, the youngest member of the banking team stopped off at a pharmacy to get me some lozenges and a card with a kitten on it, which I still have," writes Kelman. For $4 million you get lozenges!
People are worried about Bitcoin liquidity.
"SEC Pours Cold Water on Prospect of Bitcoin ETFs" is the Wall Street Journal's headline about this letter from the Securities and Exchange Commission's Division of Investment Management to the Investment Company Institute and the Securities Industry and Financial Markets Association, two industry groups with some interest in getting cryptocurrency-backed exchange-traded funds approved for trading in the U.S. some day. It is true that the letter is bracing, but I am not sure that it is a hard no. The SEC is really just asking questions. Questions like:
What steps would funds investing in cryptocurrencies or cryptocurrency-related products take to assure that they would have sufficiently liquid assets to meet redemptions daily?
How would funds classify the liquidity of cryptocurrency and cryptocurrency-related products for purposes of the new fund liquidity rule, rule 22e-4? For example, would any of these products be classified as other than illiquid under the rule? If so, why? How would funds take into account the trading history, price volatility and trading volume of cryptocurrency futures contracts, and would funds be able to conduct a meaningful market depth analysis in light of these factors? Similarly, given the fragmentation and volatility in the cryptocurrency markets, would funds need to assume an unusually sizable potential daily redemption amount in light of the potential for steep market declines in the value of underlying assets?
Those questions may be familiar from back when we used to talk every day about bond market liquidity. One strain of bond market liquidity worries is that bond market mutual funds offered a "liquidity illusion": The funds let investors withdraw their money daily, but the funds may not be able to sell the underlying bonds on one day's notice. Some people, for reasons that I don't quite understand, worry more about this problem for ETFs than for regular mutual funds. Other people, though, argue that ETFS actually help solve the liquidity problem in bonds: If bond trading is illiquid and ETFs are liquid, you can get most of the benefits of bond trading through a liquid ETF instead. If I want to buy bonds and you want to sell them, the bond market may be an inefficient place for us to transact -- but we can achieve almost the same thing if I buy a bond ETF from you.
One could pretty easily imagine the same argument with Bitcoin: If people want to trade Bitcoin with each other, and if Bitcoin markets are a horrible mess, why not let them trade Bitcoin in regulated exchange-traded fund form? The ETF could be liquid, and if you want a bit of Bitcoin you could buy the ETF and not have to worry about whatever horrors are going on in the underlying market.
Of course someone has to worry about those horrors, specifically the arbitrageurs who keep the ETF prices in line with the underlying prices. The SEC has questions about that too:
Have funds engaged with market makers and authorized participants to understand the feasibility of the arbitrage for ETFs investing substantially in cryptocurrency and cryptocurrency-related products? How would volatility-based trading halts on a cryptocurrency futures market impact this arbitrage mechanism? How would the shutdown of a cryptocurrency exchange affect the market price or arbitrage mechanism?
Elsewhere, Intercontinental Exchange Inc. is "joining with startup Blockstream to launch a data feed that would pull information," including order-book information, "from more than 15 cryptocurrency exchanges around the world and deliver it to financial firms."
Bitcoin party.
One popular criticism of Bitcoin, back when it only went up, was that a currency whose value keeps going up is not a very useful currency. After all, if Bitcoin will buy 20 percent more stuff tomorrow than it does today, why would you spend it today? If your Bitcoin sushi dinner ends up costing $180,000, you will stop spending Bitcoins on sushi. And so everyone will hoard Bitcoin and no one will spend it and its functionality as a medium of exchange will be limited.
Conversely! With Bitcoin crashing recently, there is no better time than the present to spend your Bitcoins getting drunk on a boat:
When 600 cryptocurrency enthusiasts set sail from Singapore on Monday night for their second annual Blockchain Cruise, the price of Bitcoin was hovering comfortably above $13,500.
By the time their 1,020-foot-long ship pulled into Thailand on Wednesday, for an afternoon of bottomless drinks and crypto-focused talks on a sun-soaked private beach, Bitcoin had cratered to $10,000.
Since December Bitcoin has experienced a touch of hyperinflation here and there, so it might make sense to spend it as fast as you can. Of course the Blockchain Cruise actually sold its tickets for dollars -- they've gotta rent the boat with real money! -- but still, presumably some cryptomillionaires sold a quarter of a Bitcoin or so to get there. Turns out they got a great deal.
Oh, RBS.
Look: If you ever get a memo whose title is "Just Hit Budget!," every sentence of that memo is going to be a nightmare. Nothing good can ever come of that. It is not going to be filled with useful information or thoughtful analysis or helpful advice or inspiring stories. "Just Hit Budget!" is not a deep insight. You don't need a memo to tell you that you should hit your budget. That memo is just going to be yelling at you and making you feel bad, and the only relief is going to be when the memo digresses from insulting you to spend some time insulting your customers.
A junior manager at Royal Bank of Scotland Group Plc had some unusual advice for colleagues involved in the bank’s troubled unit accused of mistreating small businesses that were struggling to pay back loans.
“Sometimes you need to let customers hang themselves. You have then gained their trust and they know what’s coming when they fail to deliver," the former manager wrote under a subheading labeled “Tips” in a 2009 memo. “Missed opportunities will mean missed bonuses.”
The document, provided to Parliament’s Treasury Committee and published Wednesday, is the latest embarrassment for the bank stemming from a probe of its business-lending practices. Entitled ‘Just Hit Budget!’, the memo is among documents sought by lawmakers as they fought regulators over the disclosure of the wider report.
"The document should be viewed in context," said RBS's CEO in a letter to the committee, and I shudder to imagine reading the "Just Hit Budget!" guy's entire oeuvre.
Business charts.
Zoe Piel, whom you may remember as the activist investor behind "Unlocking Braden's Potential" ("But in fact, no airplane. Spoon"), emailed me to say that she "needed a POWERFUL REALTIME COMPUTER INTERFACE for all the important business metrics, market movement, key trading information, etc.," so she built chart.business. I have had it up on my screen all morning, and frequently find myself consulting the $/¢ exchange rate, which was 1.06 last time I checked.
Things happen.
U.S. puts HNA deals on ice until it gets ownership info. Uber told to focus on US and Europe as SoftBank deal closes. CFPB Signals Shift by Dropping Payday Lender Lawsuit. HSBC agrees to $101.5m US forex settlement. Williams has Fed vice-chair job in his sights. Emmanuel Macron rejects special access for City after Brexit. "For Apple, in particular, the repatriation matters because it constitutes a first step towards retiring from its status as major lender to other corporations." ADT IPO Prices Well Below Expectations. "China is like a startup. The U.S. is like a big corporation." Venezuela’s Oil Production Is Collapsing. Fighting polio with financial engineering. The Beigies. What Your LinkedIn Profile Should Look Like in 2018. "Eventually, the people who apologised for apologising about the bad thing have to apologise for their apology about the first apology." Crawling Robot Baby Bravely Explores Carpet Gunk.
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Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
To contact the author of this story: Matt Levine at mlevine51@bloomberg.net.
To contact the editor responsible for this story: Philip Gray at philipgray@bloomberg.net.
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