Levine on Wall Street: Legal Bills and Oil Hedges

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.
Read More.
a | A

Citi is a mess.

Yesterday Citigroup announced an extra $2.7 billion in legal expenses, and an extra $800 million in restructuring charges, leaving it "marginally profitable" for the quarter. Which expression of minimal confidence by Citi chief executive Michael Corbat do you prefer? There is this:

“We’ve tried to put our best estimate on what those numbers should be like, and try and really shoot for a clean 2015,” Corbat said at an investor conference in New York.

Or there's his quote in the press release:

Also, we believe these legal charges should cover a significant portion of our outstanding legal matters based on current information.

Oh. Umm. Cool? The $2.7 billion is mostly for "foreign exchange investigations, LIBOR-related investigations and anti-money laundering and related compliance investigations," according to that press release, and you might remember that Citi has already reached settlements on Libor (in Europe, but not the U.S.) and foreign exchange (with the FCA, CFTC, etc., but not the Fed, the Justice Department, etc.). You might also remember that, in late October, Citi traveled back in time to take $600 million more in legal charges for the quarter ended in September. (Now it's fast-forwarding a bit to take that $2.7 billion in legal charges for the quarter ending later this month.) One investor said to Corbat, "I kind of feel like Lucy and the football," slightly mangling his "Peanuts" simile but you know what he means.  This is the second charge that Citi has taken during this quarter for matters that have already been resolved with some people but now will need to be resolved with other people. The legal bills are fractal and unending. It is depressing stuff.

In happier news, Citi will at least -- wait, no, it says here "Bank of America Corp. and Citigroup Inc. said trading revenue will probably fall this quarter, providing fresh evidence Wall Street is headed for its fourth annual decline in the past five years," they just can't catch a break.

You know when was a bad time to take off your oil hedges?

I don't know what to tell you about this story, it's kind of old but just lovely. Continental Resources, a big Bakken Shale oil producer, announced in November that it had sold most of its oil hedges for cash proceeds of $433 million. You can see the before and after on pages 8 and 9 of the 10-Q: As of September 30, it had 32.5 million barrels of crude oil swaps and 7.1 million barrels of collars; as of October 31, it had 366,000 barrels of collars and a bunch of written call options, since it exited its collars by selling the floors back to the dealer but keeping the (very out-of-the-money) caps. The swaps were struck in the high $90s and low $100s; the floors were in the high $80s and low to mid $90s. In late October, West Texas Intermediate crude was in the low $80s, and Continental CEO Harold Hamm said "We view the recent downdraft in oil prices as unsustainable" after he sold all the hedges. WTI reached a low of $62.25 yesterday, as I learned from this article titled "Oil Resumes Drop as Iran Sees $40 If There’s OPEC Discord." $40! The Wall Street Journal calculates that Continental's decision to go unhedged cost it "about $127 million in forgone revenue"; Continental "said it disagreed with the Journal’s figures but wouldn’t provide its own," but if anything it seems low. I think the Journal is calculating the sales price of Continental's oil versus the price that it would have gotten under hedges, which is probably the relevant accounting, but the simple fair-value math -- about 40 million barrels of linear-ish hedges, about $20 per barrel of price drop since they exited, multiply those two numbers -- suggests a loss of many hundreds of millions of dollars.

One useful cliché is that it is legal to insider trade in commodity markets, because commodity markets are all about insider trading: Oil producers and consumers can hedge and speculate based on their inside knowledge of their business. It's just that sometimes that knowledge is useless or misleading. Harold Hamm looked at oil's slide to $80, looked at what he saw of supply and demand, and decided it couldn't go any lower. Oops. 

Two $84 million bonuses are better than one.

What is the right model for this guy? Former Lehman Brothers global rates trader Jonathan Hoffman got a bonus of $76.3 million in 2008, after Lehman's bankruptcy filing. But he got it from Barclays, which took over much of Lehman's business and hired him to -- well, in Barclays's view, probably, to keep doing the same job, but in Hoffman's view, to do an entirely new job at an entirely new bank, though with the same responsibilities and co-workers and pay. So now he wants his 2008 bonus again, this time from Lehman, and is pursuing an $84 million claim against the bankruptcy estate. Is this, just, insane petulance? Is it a way to signal macho trader aggressiveness in a way that will enhance his career prospects (but he's already so rich?) and social standing? Is it: Dude's a trader, and if you give him a cheap option he's gonna take it? I guess my money's on the latter but it's a puzzle. 

Some sovereign bond news.

None of it all that cheery! Well, some of it is kind of cheery, depending on your point of view: Argentina seems happy to fund itself in local bond markets, which is good news for the Argentine government but not so good for those who were hoping that it would reach a settlement with its holdout creditors, cure its continuing default on its bonds, and return to the international bond markets. The local deal "came as a bucket of cold water to those who were expecting a deal under this administration." Further north, 150 investors and analysts showed up to a Cleary Gottlieb discussion of potential scenarios if Venezuela defaults on its debt:

Among the topics debated were whether the state oil company’s U.S. gasoline stations could be seized as collateral and whether it was legally possible for Venezuela to restructure the producer as an empty shell to avoid bondholder claims, they said.

Back in Caracas, President Nicolas Maduro blames the rating agencies, pointing out that "Venezuela has lower credit ratings 'than countries at war or with Ebola,'" though the fall in oil prices seems like a more obvious culprit for Venezuela's financial difficulties. Elsewhere in difficulties, "The International Monetary Fund has identified a $15bn shortfall in its bailout for war-torn Ukraine and warned western governments the gap will need to be filled within weeks to avoid financial collapse." And oh hey look Greece's curve has inverted and its banks' stocks are collapsing as it looks more likely that anti-bailout party Syriza might win an election.

Never go public.

You could have a model of tech-company finance that is like: A bunch of start-ups start up with venture money, and some of them fail quickly, and others grow a bit, and the ones that grow a bit go public, and then they live out their lives and build their businesses as public companies. On that model, private-company valuations would be sort of binary: Either they would grow monotonically until the initial public offering, or they would flop to zero and there'd be no IPO. But if your model of technology-company finance is that new ideas are funded, and companies grow, mostly in the private market, and then when they are stable mature cash-flowers they reward their "real" investors by going public, then it stands to reason that there'd actually be a lot of volatility in the private market, as so much of the drama of a business's rise and fall happens while it's private. Also, on that model, private investors who are funding growth might actually demand lower returns than public investors who are mostly cashing out the private investors. So all of that seems to be true. "The public market is still rational when they’re buying these IPOs, while in some cases private-market investors are irrational," says one adviser.

Financial advice.

I said yesterday that I am not really the target for financial advice, but this Chicago Booth note is a good reminder that some people are:

According to the researchers, trust between financial advisers and investors is a key variable that determines both individual and financial-sector fortunes. Trust reduces savers’ anxiety about taking investment risks, which increases the fees the adviser collects, as investors invest more money generally, and invest more in riskier instruments that have higher fees. For many savers, the peace of mind gained from this trust relationship is far more important than picking investments with the highest returns.

The research disputes the assumption by many economists that most individual savers could get at least market-matching investment returns without help. Many would-be investors hire investment advisers because they lack the knowledge and the confidence to invest on their own, even in the index funds that finance professors and economists see as so easily purchased. Without a professional adviser, the research contends, these savers would simply leave their money in the bank. Although the returns they collect after paying advisory fees are often subpar to index funds, they typically beat the near-zero returns generated by bank savings accounts.

There is a sense in which the job of a financial adviser -- or hedge fund manager, etc. -- is to make a lot of money for her clients, a job that can be measured easily on a single axis. Or you could have a more sophisticated risk-adjusted returns model, etc., but whatever your measurement, you will find a lot of failures. Prices of financial assets follow a random walk. You can do one of two things with this information: You can sneer at financial advisers and money managers as mostly overpriced and wasteful and bad for their clients, or you can re-frame the job of the financial adviser as something other than maximizing her client's (risk-adjusted) returns. I feel like either of those approaches has its pitfalls, but that Booth note suggests that the second choice -- "oh no we're about relationships, not returns" -- doesn't have to be in bad faith. Also, of course, returns relative to what baseline? 

Some Harvard Business School news.

The weird thing is that this guy teaches in the "Negotiation, Organizations & Markets unit" at HBS. And this is how he negotiates? And from the Harvard Business Review, Making Dumb Groups Smarter.

Things happen.

Some more Luxembourg tax leaks. Boutique banks are having a moment. The best colleges for hedge funds (the answer is always Wharton and Harvard). Larry Fink wants electronic bond trading. Somehow the Dix Hills Soccer Club was a Ponzi scheme. Did Radio Shack default on its debt? (It says no.) And will Caesars? Will there be a buyout of Abercrombie & Fitch? Apple Store Opening In Williamsburg Across From Whole Foods Near The J. Crew Steps From Starbucks. Judge: Bernie Madoff's Aide Is Guilty, But Too Short To Do Hard Time (misleading headline). Dutch adventurer reaches the South Pole on a Massey Ferguson tractorSweater-wearing sheep found wandering in north Omaha. Go home.

  1. He means he feels like Charlie Brown. Neither Lucy nor the football has any cause for complaint.

  2. Josh Barro correctly points out another weird thing, which is "that the 'high end Sichuan cocktail bar' trend got to Woburn before NYC."

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net