April 2, 2021
Every year billions are bet on the NCAA basketball tournament that is fondly referred to as March Madness. Many fans around the country lament their bets as the proverbial underdog scores an upset sending Vegas and brackets into chaos. This March, there was another kind of bet that went wrong and some are calling it the biggest single-firm meltdown since the 2008/2009 financial crisis. Archegos Capital Management, run by Bill Hwang, reportedly lost approximately $8 billion in just 10 days in March from just a handful of large bets on major stocks. That in and of itself would be headline-making news, but is not the reason why Hwang and Archegos are in the headlines. The losses came to light when Japanese bank Nomura Holdings Inc. stated it is owed about $2 billion by a U.S. client and Credit Suisse Group AG reportedly is facing $3 billion or more in losses. JPMorgan is reporting the losses to banks could be in the range of $5 billion to $10 billion.
How could this have happened? The Wall Street Journal recently published an investigative report that sheds some light on that. It appears that a variety of factors combined to lead to the collapse. Archegos, a “family office” that manages the fortunes of wealthy individuals and does not market to outside investors, is very lightly regulated and does not have to regularly disclose its investments. Hwang reportedly adopted a strategy of owning only a handful of stocks and shunning the long running belief that you need to be diversified in your investments. Archegos was wildly successful in this strategy, accumulating billions under its management. However, that same strategy appears to have led to the massive losses in recent days.
It appears that the $8 billion in losses was due to just a handful of risky bets. Archegos reportedly made these bets with total-return swaps, which are investments made by banks on behalf of clients for a fee, which obscured the fact that it was Archegos behind the bets. Archegos reportedly used some of the largest banks in order to make these bets – Goldman, Morgan Stanley, Credit Suisse, Nomura, Deutsche Bank, and UBS. Archegos was making bets using borrowed money, putting up collateral and effectively taking out loans to trade with.
So how did this strategy collapse? Last week one of the stocks Archegos had invested heavily in, ViacomCBS, announced it would sell new shares, which put downward pressure on the stock sending it down as much as 25%. That drop in Viacom hit Archegos especially hard because of how concentrated its positions were and reportedly Archegos started selling other stocks in its portfolio to make up for the losses on Viacom. Because Archegos’ holdings were so concentrated, those sales sent other stocks plummeting, including Discovery Inc. While the sales raised money, Archegos had a new problem: the sales actually sent the stock of those companies like Discovery tumbling and very quickly the collateral Archegos had posted to make their bets went tumbling too. As a result, Archegos’ lenders (the banks) made margin calls to Archegos demanding that Archegos put up more collateral to back up the bets. As the week went on, Archegos couldn’t cover the margin calls. As the banks are entitled to do, they started selling off Archegos’ collateral, which worsened the problem and in some cases did not solve the problem. Some of the banks have reported they were quick to liquidate the positions and have not suffered a material loss.
The effects of the collapse are far reaching. The Wall Street Journal reports Archegos is teetering on the edge of bankruptcy. Some of the banks are reporting potential massive losses and their stock price has declined. Shares of the stocks Archegos invested in have plummeted. And of course the stock price declines in these companies and banks affects investors in those companies and banks, including many who have 401ks who may not even realize that their retirement funds include these companies and banks in their portfolios. It truly is an event that has a remarkable reach.
So how did this happen? It seems likely there were a few different factors at play, although the SEC will be looking very closely at this question. It has been reported that the various banks were not aware that Archegos had taken out such large positions with other banks. In effect, each of the banks thought they were the only ones loaning money to Hwang to make these risky bets. The status of Archegos as a family office and the use of total-return swaps appear to have obscured the massive positions Archegos had built.
It has been reported that the SEC has opened a preliminary investigation and has issued subpoenas to the lenders. The SEC will be looking into what exactly did the lenders know, when, what efforts did they make to know more, and a whole host of other questions. It’s likely the SEC will ultimately look at whether family offices should face more regulation and how to address what appears to be a loophole in the disclosure requirements that allowed the use of total-return swaps to obscure the massive positions Archegos built. It is also likely that the SEC will be looking into how some of the lenders had positions with just one counterparty so large that the collapse has reportedly had a material effect on their financials.
It’s still early days in this investigation and we expect that more details will come out in the coming weeks/months. Stay tuned.
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