Sears Death Spiral Accelerates: Vendors Halt Shipments As Cost Of Default Insurance Soars

When we commented back in March on the unexpected "going concern" notice in Sears" 10-K which sent the stock crashing, we pointed out the immediate spin provided by Eddie Lampert"s distressed retailer which promised that its comeback plan may help alleviate the concerns, “satisfying our estimated liquidity needs 12 months from the issuance of the financial statements", to which however we added the footnote that "the question is what happens when vendors start demanding cash on delivery as concerns about SHLD."s liquidity concerns continue to grow."

Shortly after, we wrote "Sears Enters Death Spiral: Vendors Halt Shipments, Insurers Bail" in which we described that as Sears financial condition deteriorated, vendors were boosting their "defensive measures", such as reducing shipments and asking for better payment terms, to protect against the risk of nonpayment as the company warned about its finances.

The managing director of a Bangladesh-based textile firm said his company is using only a handful of its production lines to manufacture products for Sears" 2017 holiday sales. Last year, nearly half of the company"s lines in its four factories were producing for Sears. "We have to protect ourselves from the risk of nonpayment," said the managing director, who declined to be identified for fear of disrupting his company"s relationship with Sears.

Furthermore, precisely as we predicted, Mark Cohen, the former CEO of Sears Canada and director of retail studies at Columbia Business School said vendors will keep a close eye on Sears" finances. "Whatever vendors continue to support them are now going to put them on even more of a short string. That means they’ll ship them smaller quantities and demand payment either in advance or immediately upon delivery."

He added: "Sears stores are pathetically badly inventoried today and they will become worse."

Fast forward five month when just after Sears reported another quarter of painfully bad results including an unexpected double-digit drop in same store sales, Reuters writes that the "worst case" scenario we envisioned for Sears is now accelerating, and that Sears is having trouble stocking shelves, "as some vendors have fled while others are demanding stricter payment terms because of difficulties hedging against default risk."

One reason why Sears" supply chain is in greater turmoil than ever - in addition to Sears" woeful financials of course - is due to the scarcity and high cost of a type of vendor insurance known as accounts receivable puts, which ensure a supplier will be paid even if the retailer files for bankruptcy. Think of them as CDS contracts vendors can buy on a counterparty, in this case their (increasingly insolvent) client, and just like CDS, the puts become prohibitively expensive the closer the underlying entity is to bankruptcy.

“It’s too expensive,” Michael Fellner, owner of Montreal-based women’s wear company Lori Michaels Apparel & Manufacturing Inc, told Reuters about the specialized vendor insurance. He also said he stopped shipping to Sears in March, when his insurer stopped providing coverage.

Two other small vendors told Reuters they stopped supplying Sears this year because they could not afford the insurance, whose cost spiked after Sears warned in March of “substantial doubt” over its ability to continue as a going concern. They asked not to be identified discussing confidential commercial arrangements.

Most concerning, however, is the discovery that Eddie Lampert himself appears to be throwing in the towel on the supply chain: as Reuters explains, Sears’ vendors had previously benefited from support from Sears CEO, billionaire Eddie Lampert, who owns almost half of the company’s shares and is also its largest lender.

Through his hedge fund, ESL Investments, Lampert invested in vendor insurance contracts worth $93.3 million in 2012, $234 million in 2013 and $80 million in 2014, according to SEC filings. Lampert"s implicit support of vendors however ended one year ago: filings show no investment by Lampert in vendor insurance contracts since 2015.

A Sears spokesman said the 55-year-old billionaire is not currently investing in these contracts and declined to say why.

In addition to Sears" top stakeholder dropping support, for whatever reason, other hedge funds such as Avenue Capital Group, and traditional credit insurance firms such as Euler Hermes Group, have also exited the insurance market, brokers and investors said. They did not specify the timing of their withdrawal.

Predictably, as the number of market participants in the receivables puts market collapse, the cost of insurance contracts surged as they became harder to come by, putting pressure on Sears’ ability to maintain a robust inventory of goods. As a result, merchandise inventory at Sears fell to $3.4 billion as of July 29 from $4.7 billion a year ago, the company disclosed on Thursday. Sears has attributed the inventory decline to its transformation to an online-oriented business from bricks-and-mortar stores.

“We continue to work to manage our vendor relationships in a constructive manner… we will continue to ensure that our vendors deliver on their obligations to Sears,” Sears said in its second-quarter earnings statement on Thursday. The reality is that it simply does not have as many suppliers as it once did.

Meanwhile, those who can find puts to buy are simply unable to afford them: brokers and investors said that Sears insurance contracts for vendors are currently quoted at more than 4 percent of the value of the vendor’s shipment per month, making them uneconomical for many suppliers whose profit margins are in the single digits. Three years ago, the contracts were being quoted at about 3 percent per month.

LG Electronics Inc, which makes Kenmore-branded washing machines and refrigerators as well as LG-branded appliances, told Reuters it has not bought vendor insurance in the past year because of the cost.

Instead, LG said it negotiated shorter payment schedules to minimize the risk of not being paid by Sears. It declined to say how short the payment period was. The typical payment schedule in the industry is close to 90 days, though it can vary by item.

Of course, the shorter the payment terms, the bigger the hit to Sears" working capital and, thus, liquidity, with the most dire option being cash on delivery in which vendors simply will not provide the much needed inventory unless they are paid on the spot. Here"s Reuters:

Sears has promised to pay some suppliers within 15 days, according to a source familiar with the matter who requested anonymity to discuss confidential commercial arrangements. Sears declined to comment.

A 15-day payment schedule gives a vendor priority for repayment in the event of a bankruptcy. This is because claims received within 20 days of a bankruptcy filing are typically repaid in full.

Some vendors are so keen for this protection, that they have offered Sears a small discount of around 5 percent on their merchandise, the source said.

As noted above, the increasingly shorter terms means a sharp erosion in working capital: William Danner, president of CreditRiskMonitor.com told Reuters that at the end of the second quarter, Sears would likely have used $587 million to boost working capital – mostly from asset sales – due to the decision by some vendors to not extend as much credit. Sears’ available liquidity at the end of July was $810 million.

“Even for a huge company like Sears, finding this much more capital is a burden. This apparent loss of confidence in Sears by its vendors is greater now than it was at the end of 2016,” he said. Should more vendors demand the same payment terms, there is a risk that Sears entire liquidity cushion could disappear.

Eddie Lampert, who has valiantly fought for years to delay Sears" inevitable bankruptcy, has complained on several occasions that vendors are trying to exploit Sears’ woes to negotiate better terms. He said last month that some of its vendors reduced their support, “thereby placing additional pressure” on Sears.

Sears took the issue to court in June, when it sued Ideal Industries Inc after the maker of Craftsman-branded tools declined to fulfill purchase orders because of Sears" "known fragile financial condition," according to court documents. Ideal Industries declined to comment.

And while Lampert may no longer be funding vendor insurance, he is still supporting Sears in more "brute force." He held about $1.7 billion in debt mainly backed by the company"s real estate and inventory as of April 29, according to regulatory filings.  The reason for this shift is that unlike secured debt, vendor insurance contracts are not backed by any collateral. Underscoring his "support", last month, Lampert extended a $200 million 151-day credit line to Sears at an annual interest rate of 9.75 percent.

To be sure, not everyone has thrown in the towel on Sears: at least one investment firm, Blackstone Group LP"s distressed credit arm GSO Capital Partners is backing Sears contracts through December although they did not disclose their value to Reuters.

However, it"s only a matter of time - in this case a few more quarters of declining same store sales - before virtually everyone gives up on Sears, forcing Lampert to decide between directly funding the company"s inventory or finally admitting defeat to the Jeff Bezos juggernaut, and pulling the plug.

Some Of The Funds Losing Billions In Puerto Rico's Historic Bankruptcy

In the aftermath of Puerto Rico"s historic bankruptcy, a clearer picture of losses accrued by U.S. mutual funds on their holdings of Puerto Rican debt is beginning to emerge: the WSJ has calculated the red ink at as much as $5.4 billion over the last five years on total holdings of $14.6 billion.  Wall Street"s paper of record lists the funds who have piled up losses, both realized and unrealized, on the trade. These include: Franklin Resources, Oppenheimer, Vanguard, Goldman Sachs Asset Management, Western, Lord, Abbett, AllianceBernstein and Dreyfus.

Of these, Franklin and Oppenheimer are the biggest losers, according to Morningstar data cited by the Journal. Oppenheimer has lost as much as $2.1 billion, and Franklin as much as $1.6 billion. That"s compared with AUMs of $230 billion and $741 billion, respectively.

Meanwhile, six other fund families managed by Vanguard, Goldman, Western Asset, Lord Abbett, AllianceBernstein Holding and Dreyfus have racked up between $100 million and $200 million in losses each.

Of course, in the grand scheme of the funds" AUMs, the losses so far are negligible, so before retail investors assume that Meredith Whitney"s prediction is finally coming true, resulting in another muni fund panic, it is worth recalling that all these funds have at least $100 billion each in muni-bond assets under management.  Furthermore, these investors are likely in better shape than some of their hedge fund colleagues as the damage done to mutual funds, and by extension the retirees and middle-class savers to which they cater, will be an important factor in the court-mandated restructuring of the island"s debt, which begins Wednesday with a hearing in San Juan.

As a reminder, earlier this month, the island"s governing body petitioned for - and its federal oversight board approved - its own version of bankruptcy protection under Title III of a rescue law passed by Congress late last year. 

The mutual funds will have a greater incentive to agitate for maximum recovery especially since they purchased debt closer to par values.  Mutual funds were the most heavily invested in Puerto Rican debt, tempted by attractive yields - 8% at the last issuance of GOs in 2014 - along with an exemption from federal taxes.

* * *

Meanwhile, Bloomberg reports that as the island"s restructuring progresses, creditors of Puerto Rico"s insolvent government development bank today agreed to accept losses by exchanging their bonds for new securities, moving the island another step toward restructuring its crushing debt load. Under the agreement, bondholders would exchange their debts at 55 percent, 60 percent or 75 percent of face value, depending on whether they elected to receive higher interest payments or the prospect of a greater recovery through debt with less legal claim to the bank’s cash, according to terms disclosed in a bond filing.

The deal comes less than two weeks after Puerto Rico initiated bankruptcy-like proceedings, giving it power to have debts dismissed in U.S. court if creditors don’t voluntarily agree to accept less than they’re owed. Puerto Rico has already reached a similar agreement with creditors of the government electric company and officials have said they intend to continue negotiating with investors.

"This agreement is an example that the government is regaining the credibility it had lost over the past few years,” Rossello said. “We are satisfied with this agreement.”

Debt could be issued for first-lien bonds at 55 percent of par with 7.5 percent coupons, or 60 percent of par with 5.5 percent coupons. Those electing for subordinate bonds would get 75 percent of par and coupons of 3.5 percent. New issuer will receive assets of GDB, with a book value of $5.3 billion.

Despite the enforced bondholder haircuts, the agreement would allow creditors to recoup more of their investment than current trading prices suggest. Government Development Bank bonds due in August traded Monday for an average of 24.3 cents on the dollar.

The negotiation has a long way to go: Governor Ricardo Rossello said at a press conference Monday that 45% of bondholders have so far consented to the restructuring. Under the federal emergency rescue law that allows for Puerto Rico to legally cut its debts, any voluntary agreement must be approved by a two-thirds vote of bondholders.

Today"s deal included the so-called ad hoc group, comprised mostly of hedge funds managed by Avenue Capital Management, Brigade Capital Management, Fir Tree Partners and Solus Alternative Asset Management, as well as local bondholders.

And speaking of hedge funds, as we documented previously, here"s a rundown of the other biggest losers, which include a handful of hedge funds and bond insurers - not to mention the Puerto Rican people, about half of whom live in poverty and will likely be forced to cope with cuts to basic services mandated by an austerity regime not unlike those seen across Europe.

• General Obligation bondholders include: Aurelius Capital Management, Autonomy Capital and Monarch Alternative Capital LP,


• Sales tax revenue-backed (Cofinas) bondholders: Scoggin Capital Management, GoldenTree Asset Management, Merced Capital, Tilden Park and Whitebox Advisors have held Cofinas.


• Bonds insurers: roughly $12 billion of the island’s $70 billion in outstanding debt is insured. It will be up to the bond insurers to fill the gap when interest and maturity payments are missed. Insurers backed a wide swath of bonds from Puerto Rico, complicating the island’s ability to prioritize payments. Among the companies with the biggest exposure to Puerto Rico debt include Ambac Financial Group, National Public Finance Guarantee Corporation, Assured Guaranty Ltd. and Financial Guaranty Insurance Company.

PR"s constitution requires the government to pay back GO bondholders in full, and the island has already offered a restructuring that favored GO bonds, over COFINAs, which are backed by tax revenue. However, other recent municipal bankruptcy cases have seen GO investors accept huge losses, according to data from Moody"s Investors Service.

• In Harrisburg, Pennsylvania, bondholders took a 25 cents on the dollar haircut


• In Stockton, California, the haircut was 50 percent.


• In Detroit, where pensioners suffered losses of about 18 percent, bondholders were slapped with a 75% haircut, taking home just 25 cents on the dollar.

Despite this, Moody"s rates PR"s GO and COFINA debt on equal footing, forecasting holders of both securities will recoup between 65 and 80 cents on the dollar, higher than the less than 35 cents expected for holders of debt from Puerto Rican agencies like the Government Development Bank.

With much left undecided, it"s pointless at this stage to anticipate how long this case may take, and what any final settlement might look like; nobody can say for sure whether the courts will find that they have the legal authority to issue a ruling. At some point, the Supreme Court may need to make a ruling.

Stock investors, for one, appear to be biding their time: While Detroit"s decision to file for bankruptcy back in 2013 shook markets, the Puerto Rican newsflow has barely registered outside of muniland.

Investigation Into Suicide Of Arrowgrass Capital Trader Reveals Ties To Organized Crime, Fraud And David Brock

Via Disobedient Media

On March 1st, 2017, the New York Post reported the suicide of Kevin Bell, head of credit risk at British hedge fund Arrowgrass Capital Partners LLP. He had previously worked at Saba Capital Management, Citadel Investment group, Citigroup and Deutsche Bank, according to his Linkedin page. An investigation into Arrowgrass Capital Partners in the aftermath of his death has revealed that Arrowgrass was connected to think tanks tied to DNC propaganda chief David Brock, has ties to a number to individuals and corporations with histories of fraudulent financial activity and uses a web developer which appears to be a shell company. Mr. Bell"s suicide provides a glimpse into a more shadowy element of the finance world where the line between legitimate business and organized crime becomes increasingly thin.

I. Number Of Arrowgrass Employees Had Come From Sabu Capital Management, Arrowgrass Is Connected To Establishment-Run Think Tanks

Arrowgrass Capital Partners appears to have had a number of employees present at their firm who had recently come from Sabu Capital Management. In November 2015, Bloomberg reported that Paul Andorio, a former partner at Sabu, was joining Arrowgrass to work alongside Bell in credit risk. Andorio was one of multiple former Sabu employees who had recently moved to Arrowgrass after the firm had lost several employees in its credit trading group.

The presence of multiple former employees from Sabu at Arrowgrass is interesting given the colorful history of Sabu"s founder. Boaz Weinstein is a chess and gambling savant turned hedge fund manager. Weinstein has achieved a legendary status in the financial world, although his career has been marked by controversy. In 2012, the New York Times reported that Weinstein was one of a number of traders who benefitted from a "hunch" about multi-billion dollar losses incurred by JP Morgan after a number of bad transactions that were booked through its London branch. Mr. Weinstein was also accused of fraud in 2015 by Canada"s Public Sector Pension Investment Board (PSP Investments) after Saba Capital reduced the value of PSP"s portfolio right before paying out on a redemption request, marking the value back up shortly after the money was cashed out.

Weinstein"s connections to the world of organized crime were revealed when it emerged that he was a member of a private, high stakes poker group along with billionaire and Avenue Capital Group cofounder Marc Lasry. In 2013, Lasry was forced to withdraw his name from a list of contenders for Obama"s U.S. Ambassador to France when it emerged that the FBI was sniffing around his "close friendship" with Illya Trincher. Trinchner, an alleged Russian mobster, was arrested along with three dozen others in connection with a $100 million betting and money-laundering scheme that included Hollywood personalities accused of facilitating illegal gambling events for celebrities such as Tobey Maguire, Matt Damon, and Leonardo DiCaprio and was laundering money through a Carlyle hotel art gallery. Lasry"s Avenue Capital Group has teamed up with Donald Trump in the past as Trump attempted to navigate the mob-controlled gambling scene in Atlantic City. Weinstein"s various connections to crime figures and his penchant for courting accusations of fraud raise questions about why Arrowgrass was bringing on so many employees from Sabu Capital Management in the years before Mr. Bell"s suicide.

The head of Arrowgrass Capital Partners, Michael Edwards, is also affiliated with centrist think tank Third Way. Despite its purported mission to return politics to a more neutral, middle of the road environment, Third Way recieves most of its funding from Wall Street donors and in effect serves as little more than an outlet for ideas which promote the interests of their donors. Third Way and other special interest-supported figures such as David Brock have been widely panned by the media for promoting censorship and propaganda instead of substantive ideas. Brock has directly involved Third Way in conferences held with donors in the past and is utilizing Third Way employees in efforts to help the DNC regain power in the 2018 congressional elections.

II. Arrowgrass" Web Developer Appears To Be Front Organization

In addition to having ties to firms with suspicious connections, the group providing online support for Arrowgrass appears to be a front organization, listing an address that leads to a small, nondescript building as its office despite having a multitude of large name clients in finance. Arrowgrass" website lists CAPTEC Systems as its web developer. CAPTEC"s other clients include several Swiss accounts such as Argentière Capital, set up in 2013 by J.P. Morgan’s former global head of prop trading Deepak Gulati, and LindenGrove Capital. LindenGrove was founded by Borut Miklavcic, the former head of global inflation trading business at the infamous Lehman Brothers who also began his career at JP Morgan.

An examination of the listed address on CAPTEC Systems" website leads to a small structure in Oxford, England that does not even feature CAPTEC"s logo on the exterior. The nondescript, ramshackle building is odd given CAPTEC"s role as a web developer for several multibillion dollar corporations.

Street view of CAPTEC Systems" listed office address

The apparent anomalies with Arrowgrass" web developer and its connections to various Swiss groups run by individuals tied to companies involved in the 2008 financial crisis creates questions about what appears to be either a front company with no real place of business or CAPTEC"s attempt to conceal the true location of their office.

It is not clear what caused Mr. Bell to take his own life earlier this month, although in 2015 a deal with Foundation Capital to buy Deutsche Bank’s stake in Arrowgrass Capital came undone amid speculation that Arrowgrass" principals did not wish to dilute their ownership, and that the head executive of Foundation was facing a contempt-of-court order over debts he owed to Los Angeles based City National Bank. While an anonymous source informed the New York Post that Bell was depressed, Arrowgrass" use of an apparent shell company for their web development and the presence of a number of employees at Arrowgrass from Sabu Capital Management raises concerns given the accusations of fraud that have been levied against the group and their founder"s connections to figures involved in organized crime.