The Banks Holding Elon's Beer

The Fed is culminating scary season, META is underperforming the S&P for the first time since it went public, and thousands of future investment bankers ruined their careers in one high school costume last night. The outlook isn't much brighter over in Europe, whose inflation just spiked to a record high of 10.7% in October while its GDP growth shrunk to 0.2% in Q3.

That's why today we'll deep dive into the banks left holding the bag for Chief Twit, who always reminds us how much worse life would be if your MD had social media.

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• Israelis are voting on today in their fifth election in less than four years, with former prime minister Benjamin Netanyahu campaigning for a comeback with help from the rising extreme-right.

• ECB head Christine Lagarde went on an Irish late-night talk show and proclaimed the inflation crisis has come from “pretty much nowhere” (The Journal).

• Some European countries are considering easing trading rules for banks that manage their debt in hopes of coping with the market environment. The Swiss National Bank has lost ~$143B this year as of September.

But first, a quick note from The Information.

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Deep Dive: The Banks Holding Elon's Beer

When banks, led by Morgan Stanley, agreed to help finance Elon Musk’s purchase of Twitter, they were hype to have a seat at the table of the world’s richest person. Now, they’re stuck footing the bill.

Morgan Stanley’s bankers devised the $44 billion offer. Musk didn’t want to cover the full cost himself, so he found banks that would loan him money. One of those lenders was Morgan’s own bank. Morgan Stanley happened to like Musk so much that it broke its normal protocol of limiting personal loans to the mega-wealthy (FT).

Morgan Stanley took the largest role in a consortium of 12 banks giving Musk $12.5B in margin loans, secured by shares in Tesla. Morgan Stanley lent $2B+ alone. The sum is larger than what it has offered wealthy individuals in the past. The biggest margin loans it has offered to clients, through its private bank, have typically been below $1B.

Morgan Stanley couldn’t have been more wrong. Since April, technology stocks fell around the world. Musk spent months trying to get out of buying Twitter by publicly, accusing the company of tolerating fraud.

Nothing is normal about Elon, and neither was his deal. In similar deals, the lead bank tries to quickly sell debt to investors. This is a process called “syndication,” which is effectively just flipping. But the impending market environment and court deadline left Morgan Stanley in the cold. The price of Twitter’s debt is influenced by current interest rates, which made older debt less attractive.

Another $3B of Twitter’s purchase price is being funded by unsecured junk bonds that the banks signed contracts to buy. “Junk” implies they are considered high risk, or non-investment grade. “Unsecured” means there is no collateral backing them. In other words, if a bank can’t afford the interest payments, lenders can’t turn up at Morgan Stanley’s Broadway address demanding to be paid in coffee.

The borrower’s ability to repay the money will affect the price, too. In Twitter’s case, it is only occasionally profitable. That puts Twitter’s confirmed kills, formally known as its “lenders,” at: Bank of America, Barclays and Mitsubishi. Their losses would amount to ~$500M or more if the debt was sold today.

Embarrassing for everyone

But the banks can’t just wait until the loans are repaid. They have to “mark to market,” which means their loans have to be declared on their balance sheets at market prices. If they fall in value, that becomes a loss.

Now, the tension sets in for whose bonus has to take the hit.

Banks hope to sell some of the debt in early 2023, assuming market prices improve. Analysts predict the debt could be divided up to make it easier to sell.

Six of the ten largest take-private deals since 2000 happened in 2007, driven by easy money and optimism for future earnings.

That didn't end well.

Firms became saddled with debt, suffering difficulty servicing the interest payments when business ultimately declined. Time will tell if Twitter becomes yet another recession signal by surpassing 2007-8 numbers.

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