Solid First Shot But More Bazookas Needed
To Our Clients and Colleagues:
A little over two weeks ago, we wrote to you that the epicenter of the massive turmoil in the economy is the endless range of businesses that employ a large portion of the work force. Our focus was, and is, to help working people maintain their jobs throughout this hopefully contained period of isolation and demand collapse by supporting and maintaining previously strong and viable enterprises that employ good hardworking people. Very simply, in our view, not much less than an economy-wide buyout of the economic damage from the Coronavirus will allow a reasonable and healthy recovery to ensue. Remember, this was not the fault of any company, employee or investor, so the normally correct fears of enabling moral hazard are not present in this remarkably unique circumstance.
Fortunately, over these two weeks, as we had hoped and suggested, trillions of dollars have been committed and hopefully are starting to flow to people who have lost their jobs and many of the companies that employed them. Additionally, as we anticipated, enormous resources have been unleashed by the Fed to enhance liquidity in the higher quality sectors of the trading markets by broadening and facilitating repo capabilities and reinforcing the concept of “whatever it takes.” As we stated, this will significantly add to our budget deficit, but borrowing rates are close to zero and, realistically, there is no other choice. It appears that the falling knife that had us near the abyss two weeks ago has been slowed, but given the acknowledgement of the increasing severity of Coronavirus and the potential extension of the current massive shutdown to maximize the mitigation, we believe there is much more that needs to be done for people, the economy and the markets, and time is of the essence. The markets have drifted downward the last few days in a sign of concern for the severity of the pandemic, but also out of concern that the economic remedy is not sufficiently large enough nor sufficiently committed.
Right now, the world needs comfort that we have a fighting chance to restore to the greatest extent possible the demand for goods and services that was extant only six weeks ago. To do this, government must rapidly communicate a cohesive commitment to a truly economy-wide set of support mechanisms. The more this lingers, the more people that are forced to file for unemployment support and the more the overall appetite for risk and consumption is dissipated, the harder this recovery will be. We implore all those in power to come together for the good of the citizenry and commit immediately to a wide-ranging set of fiscal remedies.
We had no pride of authorship as we sought to distribute restorative capital to all companies through one consistent structure so that employers could serve as the conduit to deliver cash to their people based on tax records and existing payroll systems. We believed this would be the simplest and fastest way to implement and it would go to all companies. We acknowledge that no plan of this magnitude, including ours, is simple, and the devil is always in the details. The good news is that the U.S. government’s plans so far seem to address a good portion of the needs of companies with 500 employees or fewer, the large investment grade companies who can take advantage of the stimulus and benefit indirectly from the unfreezing of the higher quality credit markets, and a select few of our strategic industries such as airlines and airline/defense manufacturing. We applaud all of these efforts and as long as the money flows quickly and the taxpayer is treated fairly, this represents an excellent start. We believe that even these smaller companies will need more than 2.5 times their monthly payroll. Perhaps the tab will be four times their monthly payroll plus fix costs, but time will tell us this. Also, we believe there will be more demand from these companies, and we have no doubt that the government will rightfully expand this targeted stimulus significantly. The real issue for these smaller companies is timing. The money needs to flow easily and quickly.
The next big hole we believe the government should address is the companies with more than 500 employees and that are below investment grade. This is a massive portion of the economy, and these companies represent an enormous number of jobs and are the lynchpin of some of the structures that finance economic growth — securitized instruments. We are not seeking to bail out CLOs, private equity firms or LBOs, but rather to return previously high quality companies employing millions of people to the same position they were in before we were at war with the Coronavirus. We suggest one way to do this is to create a program whereby sophisticated private investors invest equity of $100 to $500 million and the government provides leverage of perhaps ten times this amount (or some other appropriate ratio) and thereby creates pools of capital that would either invest directly in these companies or perhaps in a portfolio of these companies selected by the sophisticated manager(s) who have equity as the first loss in the vehicle. The interest rates would be low but still a positive spread to the lower cost at which the government can finance itself, and with a maturity of two to five years. The debt would be repayable by the companies at par at any time. The proper safeguards can easily be demanded of any company taking the capital, such as no dividends, buybacks or layoffs. While some (but far from all) of these companies are owned by private equity, it must be recognized that the investors in private equity funds are primarily pension funds, endowments and other entities who represent beneficiaries who are people we should want to protect, such as teachers, firefighters, unions and much of the working population. If there are political issues regarding the managers of private equity receiving fees on any of their companies asking for and receiving this government aid, an adjustment can be made to their fees so that the companies and jobs can be secured and no “undue” profit is made at the government’s expense. This is a matter of details. The goal here is the same one we presented in our last note: support businesses and thereby all their employees so that together we can all ride out this storm and the economy can be put back on stable footing once this incredible lightning bolt is dealt with. Employees would rather see their employer standing healthy after this horrific period, rather than search far and wide for a new healthy company to join or have to fight through the morass of an overwhelmed unemployment system that was never designed to deal with the consequences of a pandemic.
We could talk further about the fact that there is need for much more support than already earmarked for hospitals, municipalities, institutions of higher learning, mortgage servicers and originators, and many others. Again, there is no choice but to do “whatever it takes.” There are a lot of smart people working on these solutions and it is clear that they “get it” and progress is being made. We also believe it is even more important than ever to support and acknowledge the work from incredible people working on therapies, vaccines and the best way to administer all of these ultimate solutions. Finally, we would be remiss if we didn’t highlight the incredible dedication, perseverance, braveness and humanity of the large group of professionals working day and night to help our sick have the best chances of surviving. The doctors, nurses, hospital staff, government workers, ambulance drivers and all the rest of these incredible people are heroes and they too will need to be taken care of in the manner they deserve.
In the meantime, every one of us can only take life and business day-by-day, protecting our people, helping those in need and moving forward. Together with our amazing human spirit combined with a fully engaged and incredibly powerful government, we will all get to the other side.
Trying to help with ideas and action,
Rich and Brian
For your reference, please find below our letter from March 18, 2020.
To Our Clients and Colleagues:
We want to continue to share our thoughts with you about the evolving economic environment and the financial markets.
Jefferies’ Investment Banking clients are primarily mid-sized public and private companies in all industries, generally worth $500 million to $10 billion. They employ many tens of millions of people and represent a true cross-section of the economy. We are on the front line and may see things through a different lens than do others. First, let us state the obvious — the gravest issue facing us today is to stop the spread of the Coronavirus and protect the health of all citizens. The second vital issue and fundamental to our economy and way of life is that too many businesses do not have customers right now because the customers, whether consumer or commercial, are rightfully staying home, are afraid to touch anything, are concerned about their livelihoods or liquidity, or otherwise withdrawing from commerce and society. We are not so slowly grinding to what could become a dead stop. As a result, real businesses, small and large, will have absolutely no choice, but to severely (perhaps more than ever in history) reduce their payroll costs, one way or another — pay cuts, terminations and furloughs. A very small handful of companies in the world can survive significant (and, in some cases, complete) reductions in revenue. The math just doesn’t work for the vast majority of businesses and the time span for survival is shorter than most people realize. If what we fear is happening in fact gains more momentum (and we are pretty far along this road), not only will unemployment skyrocket, but we will see huge numbers of businesses shut down, liquidated or file for bankruptcy. In our view, this MUST and CAN be avoided.
In 2008, we all agreed that the epicenter of the financial crisis was the large financial institutions and that by assuring their survival and ultimate health, we would assure that the wheels of commerce broadly would continue to turn. Now, the epicenter of this economic crisis is almost the entire business community where we are freezing up the same way the banks were seizing up. Healthy businesses, through absolutely no fault of their own, but rather because of the evaporation of demand caused by viral disease, have no visibility and no confidence to invest good dollars to keep their employees on board and to wait patiently for the all clear siren. What our economy needs is funding to buy time to breathe, keep paying employees, maintain capacity and capabilities, and simply get to the other side.
It may be helpful to give each person some cash directly in their pocket. However, it is much more permanently impactful to make sure each individual will have a job and livelihood once the crisis passes. This must be a top priority for the future of our world and our way of life. This is the confidence that the markets and society need to get through the economic portion of this crisis.
We don’t have all the answers and understand what we are about to describe isn’t easily actionable, but it is a straightforward method of keeping businesses alive and people employed, with the cost ultimately borne by the private sector, but financed for a time by government. Government could set up a program that would refinance first lien and, if necessary, some second lien loans and bonds, plus provide incremental credit to support employment. The employment loan would be equal to up to 50% of the compensation deduction that the company took on its 2018 tax return. That way we know what the real payrolls for the companies were historically. Eligibility for this loan and program would be conditioned on the company keeping all its employees and paying out compensation in the next six months at least equal to the amount of the incremental loan, thereby assuring a version of full employment for the next six months for all companies and their people. By using the companies to distribute the payroll to their employees, this can be accomplished quickly and efficiently. The government has all the tax records and can make clear that using any funds used improperly would be a punishable crime. The money goes to the workers, and the company is merely the conduit which allows the money to get quickly distributed and ultimately the guarantor of its repayment. Governments borrow at super low rates today, so the size of this job protection package, while potentially enormous ($Trillions+), should be relatively easy to implement and service. The loans that the government will be injecting into the companies will replace the most senior part of the capitalizations (safest) plus add the amount of the six month employee protection program, and carry a modest and acceptable interest rate, pay in kind for up to two years and have a maturity of 5-7 years, with no early prepayment penalty. This would be reasonable for businesses and, by virtue of the interest rate and the maturity, would provide them the breathing room to get to the other side. This program probably would cost the government nothing because effectively you are lending money at the top of the balance sheet funded by super low cost government debt. The positive spread from loans to companies that will be healthy in a matter of months should more than cover any losses (similar to the TALF program in 2008). A similar program could be undertaken by the SBA for smaller companies and perhaps with an even lower interest rate and some other more favorable terms to really spur the smaller companies.
Mass bankruptcies and massive layoffs at otherwise innocent and healthy companies makes no sense. The government will have to pay unemployment to the people and, in three months, there won’t be companies to go back to so they will stay unemployed. These initial companies feeling the first wave of pain and their people are interconnected with the healthier companies that are further away from the first line of fire and, if no aid is forthcoming, the wave of carnage will sweep through the economy. Mass bankruptcies beget more mass bankruptcies.
This is not a “bail out” of businesses. This is enabling healthy companies who did absolutely nothing wrong to continue to keep their businesses intact while the world is shut down. Their people will get paid and have the same jobs waiting for them when the virus has passed. This is merely a template and we are sure there are many wrinkles, nuances and improvements that the government and others in the private sector can suggest to improve this simple plan. We are confident that this disease will run its course and the world will rally together with proper social distancing and improved hygiene. We also believe eventually therapeutics and hopefully a vaccine will come. If we also deal with protecting our companies by helping to keep all employees safe and paid during this painful period, our economy will be ready, willing and able to return to its glory.
With hope, admiration for all around us and the beginning of a plan,
Rich and Brian