Month: April 2020

Just days Whiting Petroleum it became the first shale casualty of the current oil price crash, when it filed for prepackaged Chapter 11 bankruptcy on Wednesday morning after the plunge in oil prices left it unable to pay its debts, the company’s board – supposedly with the approval of the company’s creditors – approved $14.6 million in cash bonuses for top executives.

As part of this KERP, or Key Employee Retention Plan, CEO Brad Holly would collect $6.4 million of the total, which will be “paid immediately,” the company said in a filing Wednesday according to Bloomberg. Four other executives including Chief Financial Officer Correne Loeffler will get the rest.

The board said employees eligible for variable compensation can receive payouts that amount to no more than their target levels. The payouts will be made quarterly. As part of the deal, the senior executives agreed to forfeit equity awards they were in line to receive this year.

The bonus plan which was signed off by the board on March 26, or 5 days before the Chapter 11 filing, is “part of an overhaul of the company’s variable compensation program” with the filing noting that the coronavirus pandemic, coupled with a price war between Russia and Saudi Arabia, has dealt a crushing blow to the oil and gas industry, making it “virtually impossible” to set short-term performance goals.

To be sure, the board knew just how bad the optics of this deal would be, so why do it? The stated reason: the program “is intended to ensure the stability and continuity of the company’s workforce and eliminate any potential misalignment of interests that would likely arise if existing performance metrics were retained.”

CEO Holly, who was executive vice president at Anadarko before he was named Whiting CEO in 2017, has collected $4 million in salary and bonuses since then; he’s also received payouts of stock that have plunged in value. CFO Loeffler, who joined the company just eight months ago, will receive $2.2 million from the bonus plan.

In other words, only the people who pushed Whiting into Chapter 11 can deliver it from bankruptcy, or so the thinking goes.

Authored by Jonathan Turley,

There are many surreal aspects to this pandemic but Eduardo Moreno is still something of a stand out. The California engineer attempted to ram his locomotive into the USNS Mercy because he was suspicious of its real purpose in Los Angeles.

His effort took the train off the rails and across a remarkable distance before stopping short of the ship. The family has started a GoFundMe page that cryptically says “Eddie is not hurt physically but isn’t with us at this time.”

The case has resulted in a relatively rare federal charge of training wrecking. By handing Moreno over to the federal prosecutors, state authorities minimized his defense options and maximized the potential sentencing.

Moreno was operating a Pacific Harbor Line train on March 31st when he decided to try to reach the ship at high speed. According to the U.S. Attorney, “Moreno ran the train off the end of tracks, and crashed through a series of barriers before coming to rest more than 250 yards from the Mercy.”

KTLA.com reports that Moreno said he wanted to “wake people up” and hoped the derailment would get media attention so “people could see for themselves,” according to prosecutors.

Firefighters responded around 12:30 p.m. Tuesday to the port, where the train came to rest about 250 yards from the Mercy after crashing through a series of barriers. No injuries were reported, but it did trigger a fuel spill that prompted a hazardous materials cleanup.

Moreno tried to flee the scene but was detained by a California Highway Patrol officer who witnessed the incident, officials said. The officer reported seeing the train smash through a concrete barrier, steel barrier and chain-link fence before sliding across a parking lot and lot filled with gravel, coming to rest against another chain-link fence.

The officer told investigators that when he spoke with Moreno, the suspect said things like, “You only get this chance once. The whole world is watching. I had to. People don’t know what’s going on here. Now they will.”

It is still not clear to me how the train could have possibly reached the ship despite traveling over an impressive distance after derailing.

That fact could be used to contest allegations of an intended collision as opposed to the current current charge of train wrecking. Nevertheless, the charge still brings a potential 20 year sentence.

We are never address a train wrecking charge before on this blog. Since we are unlikely to have another occasion soon, here is the provision:

§1992. Wrecking trains

(a) Whoever willfully derails, disables, or wrecks any train, engine, motor unit, or car used, operated, or employed in interstate or foreign commerce by any railroad; or

Whoever willfully sets fire to, or places any explosive substance on or near, or undermines any tunnel, bridge, viaduct, trestle, track, signal, station, depot, warehouse, terminal, or any other way, structure, property, or appurtenance used in the operation of any such railroad in interstate or foreign commerce, or otherwise makes any such tunnel, bridge, viaduct, trestle, track, signal, station, depot, warehouse, terminal, or any other way, structure, property, or appurtenance unworkable or unusable or hazardous to work or use, with the intent to derail, disable, or wreck a train, engine, motor unit, or car used, operated, or employed in interstate or foreign commerce; or

Whoever willfully attempts to do any of the aforesaid acts or things-

Shall be fined under this title or imprisoned not more than twenty years, or both.

(b) Whoever is convicted of a violation of subsection (a) that has resulted in the death of any person, shall be subject also to the death penalty or to imprisonment for life.

As indicated by the family’s statement, the only defense is not to contest these elements but Moreno’s mental state. It seems rather that Moreno, 44, has a questionable mental state to put it mildly. He could not explain the basis of his suspicions or why he thought a hospital ship had some nefarious purpose. Prosecutors simply recounted that Moreno confessed (after he tried to flee the scene) and said that he “was suspicious of the Mercy and believing it had an alternate purpose related to COVID-19 or a government takeover.” He also later said that he wanted to “wake people up.”

That brings us back to the federal standard for insanity. Here is the code provision at 18 U.S. Code §17:

(a)Affirmative Defense.—It is an affirmative defense to a prosecution under any Federal statute that, at the time of the commission of the acts constituting the offense, the defendant, as a result of a severe mental disease or defect, was unable to appreciate the nature and quality or the wrongfulness of his acts. Mental disease or defect does not otherwise constitute a defense.

(b)Burden of Proof.—The defendant has the burden of proving the defense of insanity by clear and convincing evidence.

After the assassination attempt of President Ronald Reagan, Congress passed the Insanity Defense Reform Act of 1984. Like many in the criminal defense field, I am a critic of the law in making it far more difficult to bring an insanity defense. Those changes are likely to impact Moreno in a particularly profound way. It put the burden on the defense to establish insanity by clear and convincing evidence while (more importantly) eliminating diminished capacity defenses.

Moreno’s effort to flee and his operation of the locomotive could present a problem for the defense. It is better suited for diminished capacity or irresistible impulse defenses which are no longer allowed. Many doctors have rightfully objected to the elimination as ignoring available science on the scope and variation of mental illness. I believe that the Alabama Supreme Court had it right in 1887 in Parsons v. State when it held that it is not enough to simply conclude that a defendant could tell right from wrong. I discussed that standard in a prior column in relation to the Andrea Yates case. Rather there is also the question whether, through “the duress of such mental disease [that] he had … lost the power to choose between right and wrong.” Thus, “his free agency was at the time destroyed” and “the alleged crime was so connected with such mental disease, in the relation of cause and effect, as to have been the product of it solely.”

Moreno strikes me as the prototypical example of a diminished capacity or an irresistible impulse defense. There is no indication that he failed to understand that his actions were wrong (including his attempted flight) or that his actions would put the ship (and areas around the ship) into danger.

The interesting element in this case is that Moreno was initially in state control but then turned over to the federal prosecutors for charges. California follows a similar type of M’Naghten (or McNaughten) rule that allows insanity as a defense when the defendant did not understand the nature of his criminal act or did not understand that it was morally wrong.

However, California may have been a better jurisdiction for Moreno due to its application not of diminished capacity but “diminished actuality” tests. Like the federal government, a single case resulted in a fundamental change in its insanity standards for criminal cases. It was not the Reagan assassination but the murder of San Francisco Supervisor Harvey Milk by Dan White. White offered the infamous “Twinkie defense” that he had a temporary chemical imbalance of the brain resulting in diminished capacity.

The public was outraged by the defense after White was convicted of voluntary manslaughter. Thus, in 1982, the voters eliminated the diminished capacity defense. Instead, a new law was passed allowing for “Diminished Actuality”. Under California Penal Code Section 28(a), the defense may present evidence that a defendant suffers from a mental disease, mental defect, or mental disorder “solely on the issue whether or not the accused actually formed a required specific intent, premeditated, deliberated, or harbored malice aforethought, when a specific intent crime is charged.”

This has resulted in a slightly more favorable standard for defendants as opposed to the federal system. Thus, by handing Moreno over to the federal prosecutors, state authorities put him into a more restrictive system with historically harsher sentencing on such crimes.

It is worth noting however that intentional train wrecking does have a pronounced interstate and federal element, particularly when the target was a federal ship. Even without the differences in state and federal laws, the federal prosecutors would have made a strong case that Moreno should be tried in federal court since he was trying to attack a U.S. military vessel responding to a national pandemic emergency.

When Boeing requested a $60 billion bailout from the US government a few weeks ago, the implicit assumption was that the company may get some of this funding as long as the chronic buyer back of its own stock did not engage in layoffs. That, however, did not stop the brilliant financial engineers at the aerospace giant who for the past 7 years learned how to turn debt lead into buyback gold, and instead of issuing a record amount of pink slips, Boeing instead offered voluntary buyouts to its entire staff of 161,000, in a bid to shed costs and adapt the massive manufacturer to a coronavirus crisis that could depress the aircraft market for years.

“When the world emerges from the pandemic, the size of the commercial market and the types of products and services our customers want and need will likely be different,” Chief Executive Officer David Calhoun said in a message to employees Thursday. “It’s important we start adjusting to our new reality now.”

According to Bloomberg which first reported about the offer, the buyout is being present companywide to all eligible employees of the Chicago-based company. Boeing will provide information on the terms within four weeks.

“This move aims to reduce the need for other workforce actions,” Calhoun said.

The move from the company which hopes to receive tens of billions whether or not it still employes workers or not, should preserve much-needed cash at Boeing, which is facing a sharp contraction in demand along with its European nemesis Airbus. About 44% of aircraft across the globe are in storage due to the coronavirus lockdown according to an estimate by Cirium, and with virus cases approaching 1 million worldwide, there’s no telling when carriers will return to normal schedules, no less buying planes.

“As painful as it is going to be, Boeing needs to reduce workers,” said Nick Cunningham, an analyst at Agency Partners based in London, adding that salaries make up the biggest portion of the company’s fixed costs. “If you don’t, you’ll destroy the company.”

This, of course, makes sense. The question then is whether Boeing’s bailout should be prorated by the number of employees it still has at the end of this fiasco.

Boeing was already reeling from a prolonged grounding of its 737 Max when the coronavirus pandemic hit, with revenue and cash flow depleted. The disease has slowed work on recertifying the single-aisle workhorse, while clouding the outlook for sales once it returns.

The company is also facing a falloff in demand for twin-aisle aircraft like its 787 Dreamliner and the coming 777X, as long-distance travel has been hit harder than shorter hops. Wide-body jetliner production could tumble by 60% over the next three years, Jefferies analyst Sheila Kahyaoglu predicted in a March 31 report.

As noted above, the need to downsize has created a dilemma for CEO Calhoun: while forced layoffs would give Boeing more control over where and how it cuts costs they would stir up a backlash that could complicate any effort by the manufacturer to access government aid.

While Boeing previously told Congress that the industry needs some $60 billion, Calhoun has blanched at the strings that would potentially be attached, telling Fox News that the company has “other options” should the government seek an equity stake in Boeing.

Of course, voluntary buyouts keep the government-bailout option viable, should Calhoun ultimately choose to pursue it. Boeing is analyzing the funding options available, people familiar with its review said last week.

Yet even if it is successful in letting 160,000 workers go without actually firing them, another challenge emerges: as it pares back its staff, Boeing will have trouble maintaining essential skills that will be needed when the market bounces back, Cunningham said. “But you have to actually survive as a company in order to come back again.”

Submitted by Peter Garnry, Head of Equity Strategy at Saxo Bank

Summary: With all the major central banks expected to be effectively zero bound in 2020, the scope for returns in bonds will be low for years to come.

Equities have hit multiple speedbumps since 2008. But every time, they came back to new all-time highs fuelled by endless policy action, mostly from central banks. Through quantitative easing and lower rates, central banks have engineered a now-evidently unsustainable investment boom in energy that cannot repay it itself, large-scale buyback programmes among US companies and ever-higher valuations for growth companies. 

The US-China trade war already started disrupting supply and slowing growth over the last year. In Q1 2020 the world economy was hit by the COVID-19 virus outbreak, creating both a supply (Chinese lockdown) and demand (lockdowns in many countries) shock, in addition to an oil price war between Russia and Saudi Arabia which threatens to significantly impact the US oil industry and global investments in general. 

Not since 2008 has the world been this uncertain and out of balance. As equity prices reflect the future and growth prospects, they are the most sensitive to current crisis. Investors are desperate to get out and cash in on years of fat profits.

S&P 500 could decline to 1,600 in worst-case scenario

The last couple of months have given investors a glimpse of what’s lurking around the corner. Countries have entered lockdown, hospitals have been overstretched and demand for certain products and services has been in freefall. The three most important questions for equity investors, then, are: 

1. How much will corporate earnings decline? 

2. What will the earnings multiple be during the contraction? 

3. What will the shape of the recovery look like?

As global pandemics of this type are very rare, all GDP forecasting models can be tossed out the window. We have instead tried to create two types of GDP paths. One is a mild shock to 0% GDP growth and then a quick reversion to trend growth. The other is a 4% drop in growth in a few quarters and a slower recovery that doesn’t quite hit trend growth. Many market participants believe in the base case scenario. But with dramatic lockdowns in Europe and the potential for COVID-19 to become seasonal the impact could become deeper and longer.

Based on data since 1954, we can fit a quantile regression on quarterly changes and log EPS on a GDP growth series. Our two GDP paths produce the following EPS paths:  

Given all the unknown variables at play in the COVID-19 outbreak, we lean towards the 25% percentile as more likely than the median paths across the two scenarios. If we take the average of the two 2021-ending EPS scenarios for the S&P 500 then we end up at $108.61, which is 28% lower than current earnings. If we assume the P/E ratio declines to 15 — which is reasonable judging from the yield level and previous crisis — then the S&P 500 could hit 1,600. These calculations are not meant to be precise and should not be taken at face value as there is simply too much uncertainty across too many variables. But the exercise is meant to give investors an idea of how bad things go in a worst-case scenario.

The current drawdown in global equities has taken valuations from 0.84 standard deviation expensive to -0.35 standard deviation cheap, and that’s before the denominator (earnings, sales and cash flows) has even begun to decline. The valuation picture leaves the equity market with plenty of room for further falls. When the global equity market hits -1 standard deviation cheapness then investors should begin to increase their allocation to equities.

We are in the phase where policymakers will throw a lot of stimulus against the economy, including various lending programmes from governments and the extension of tax payments (which is essentially just swapping cash flows over time). With the Fed’s two panic cuts taking the rate to 0.25% all major central banks are now effectively zero bound. Our view is that sentiment and asset prices could be lifted here due to all the stimulus. But then, as economic activity numbers are published investors will realise more is needed and equity markets will take another leg down. Policymakers have a record of always being behind the curve. 

Eventually, however, enough stimulus will be added to the economy that equilibrium is reached. At that time, equities will have bottomed. 

Can energy stocks climb out of the darkness?

The energy sector is suffering from both a supply and demand shock and an oil price war between Russia and Saudi Arabia, which could push many US shale producers into bankruptcy. Government policies have changed under the current US administration and we cannot rule out bailouts in the US sector to protect jobs and investments in an election year. Among energy companies in North America and Europe, it is the American energy companies that have seen their implied default probabilities rise the most. 

The energy sector is structurally weak after years of trying to rebuild profitability and lower debt levels after the oil price collapse of 2014-2015, so it’s inevitable that some companies will disappear. Our view is that investors who want exposure to the energy sector should do it in the strongest energy companies and avoid the weakest (see list for inspiration).

But even after the economy has recovered, the energy sector will have to transition away from fossil fuels — which was the theme in our Q1 Outlook. This means that there will continue to be an ongoing demand pressure for some end products of the oil industry. Our long-term belief is that the oil and gas industry will not deliver excess shareholder value relative to the equity market over the coming decades. The opportunities in the energy sector will be more tactical and more short-term as the economy goes through the business cycle.

What comes after 60/40 portfolios and risk parity?

The dramatic volatility and declines observed in the first two weeks of March severely impacted 60/40, and risk-parity portfolios will change their asset allocation in the future. With all the major central banks expected to be effectively zero bound in 2020, the scope for returns in bonds will be low for years to come. 

As the oil price war and COVID-19 shocks turn into a liquidity and credit crisis — alongside a breakdown of some parts of the ETF market — asset allocators will be forced to consider tail-risks in their approach. But even more importantly, long-volatility components (benefitting when volatility increases) will most likely enter portfolios as these strategies are the only ones that can really protect in these types of crises. 

There are many ways to express long volatility, but one is to be long on VIX futures and roll those positions over time. As the VIX forward curve is in contango (upward sloping) there is a negative roll yield to be permanently long this position. 

The S&P 500 VIX Futures Enhanced Roll Index shows the P/L of such a position since late 2006. From market bottom in early March 2009 until the week before COVID-19 volatility began, annualised return was -34%. Allocating just 2% of a portfolio to this type of long volatility strategy would create a 0.68% drawdown on annualised return during non-crisis years. In 2008 and during the first weeks of COVID-19 turmoil the 2% exposure would have added 4.7% and 3.1% respectively. 

As drawdowns have a disproportionate impact on long-term performance, it does make sense in asset allocation to add a negative expected return stream because of its negative correlation during crises.

President Trump and House Speaker Nancy Pelosi are looking at rolling back some of the more controversial pieces of the 2017 tax overhaul, as the White House and Congress hammer out the next round of economic stimulus.

Under discussion are lifting the cap on state and local deductions, as well as restoring the break for entertaining business clients, according to Bloomberg.

According to the report, Pelosi says the next round should suspend the $10,000 cap on deducitons for state and local taxes, while President Trump said in a Wednesday tweet that tax breaks for corporate client outings, dinners, sporting games, cruises and concerts should be restored. The 2017 tax law eliminated writeoffs for entertainment expenses, while leaving a 50% deduction for client means untouched. 

“This will bring restaurants, and everything related, back – and stronger than ever. Move quickly, they will all be saved,” wrote Trump.

Congress must pass the old, and very strongly proven, deductibility by businesses on restaurants and entertainment. This will bring restaurants, and everything related, back – and stronger than ever. Move quickly, they will all be saved!

— Donald J. Trump (@realDonaldTrump) April 1, 2020

“I think it will open up the restaurant business,” Trump said during a Wednesday evening White House briefing.

According to the report, the changes may be easier said than done.

The deduction cap for state and local taxes was a large cost-saving measure in the $1.5 trillion tax-cut plan enacted in 2017, and reversing that would benefit people largely in states run by Democrats. Republicans have already called the idea a “non-starter” and accuse Democrats of using the virus crisis to repeal the most politically contested portion of the tax law. –Bloomberg

According to Veena Murthy, an executive at accounting firm Crowe LLP, Congress would have to roll back decades of tax-code adjustments to make meals and entertainment costs fully deductable – telling Bloomberg “I don’t think that’s going to happen.”

SALT(y)

The 2017 law’s limit on deductions for state and local taxes largely affect Democratic-controlled regions with high taxes, such as New York, California and New Jersey. As such, Republicans aren’t excited about the idea of rolling back the rules.

“I’m not going to allow this to be an opportunity for the Democrats to achieve unrelated policy items they wouldn’t otherwise be able to pass,” said Senate Majority Leader Mitch McConnell in a Tuesday interview with Hugh Hewitt.

Discussion of a new round of economic stimulus is in the early stages, and Pelosi said Wednesday the House might take up a bill soon after its scheduled return to Washington April 20.

The SALT limit and other cost-saving measures were necessary to keep the massive 2017 corporate and individual income tax cut below a $1.5 trillion price cap — a condition of the budgetary process Republicans used to pass it without Democratic votes. –Bloomberg

And according to Bookings Tax Policy Center senior fellow Steven Rosenthal, “Republicans used budget gimmicks to keep the costs down,” adding “They took deductions that would have been within the 10-year budget window and pushed them outside of the window.”

According to the report, the proposed changes were already on several lawmakers’ wish lists.

“At first glance I was like, ‘Really? Wow, way to go lobbyists,’” said Gordon Gray, director of fiscal policy at the right-leaning American Action Forum. “And then I sat down to think about it. We’ve closed a lot of businesses so some of these make sense.”