Original Source: https://boringmoney.in/p/shapoorji-pallonji-junk-bonds

I was confused when I first read about junk bonds. They pay more than regular bonds? Then why are they junk? Well, here’s why:

India’s biggest ever high-yield rupee corporate bond, held by a number of global private credit funds, is casting a spotlight on pockets of stress within the nation’s credit markets. ‎‎‎‎‎ Some holders of the 143 billion rupee ($1.7 billion) note issued last year by Goswami Infratech Pvt are planning to ask the company for sweeteners in exchange for potentially accepting a company proposal to delay a payment, people familiar with the matter said.

This is from a Bloomberg report last month. Junk bonds promise to pay more than regular bonds, but they’re junk because the companies that issue them might just go like “sorry no money for you this month” and you’d sort of have to be okay with it.
In this particular case, Goswami Infratech, an infrastructure company part of the Shapoorji Pallonji group, issued some high-yield bonds sometime mid-last year. It wanted to revise certain terms because it couldn’t make an expected payment. The bond yield was high! 18.75% pa! For context, fixed deposit rates are around 7–8% right now.
Shapoorji Pallonji is a large 150-year old conglomerate. Why are they borrowing money at a rate comparable to that offered by those shady Chinese loan apps? [1]

Debt to repay debt

A company that’s into constructing stuff needs money. That’s perfectly fine. It will borrow money, build a bridge or a building or whatever, collect tolls or sell flats, and slowly repay the money it borrowed with interest. There is a clear one-to-one relationship between the money that it borrowed and the asset that it built. In an ideal world, that is.
In the real world, our company may not be able to repay on time. Maybe the bridge was delayed because it didn’t get environmental clearances on time. Or maybe the flats didn’t sell for the expected prices. So the company has to refinance! Basically, it has to borrow more so that it can use that money to repay the earlier loan, and then repay the new loan instead.
Shapoorji Pallonji is a conglomerate comprising many capital-intensive companies. At any given point, at least a few of them may need to refinance their existing debt. So instead of having your companies borrow relatively smaller amounts separately, why not just club them all together and borrow a large amount at once?
In June 2023, Goswami Infratech issued bonds worth a huge ₹14,300 crore ($1.7 billion), which were bought mostly by foreign investment firms. Here’s the bond offering document and here’s%20Signed_20230702132807.pdf) the debenture trustee deed. The company borrowed this money primarily to pay off a bunch of existing debts. Only about 2% of the ₹14,300 crore that it borrowed went to its own account, the rest went to make bond repayments for 7 other companies in the Shapoorji Pallonji group.
I think this makes the sweet 18.75% interest make more sense? If you’re borrowing to repay the debt of a whole family of companies, you better be prepared to give out a lot of interest.
https://preview.redd.it/mlg2mdvx3f4d1.jpg?width=749&format=pjpg&auto=webp&s=c3aa48da2ccfdcd4d28cda003797930ec123be65

Fire sale?

How is Goswami Infratech even going to repay these bonds? The junk bond money didn’t go into building an asset that it could monetise, it went into repaying past debt. But Shapoorji Pallonji is a conglomerate and has existing assets! So it’s going to sell some off. The bond documents outline exactly what and when:

1. Ports owned by SP Port Maintenance, Shapoorji Pallonji’s port owning company. By 31 December, 2023.
2. Afcons Infrastructure, one of Shapoorji Pallonji’s construction companies. By 30 June, 2024. [2]

Goswami Infratech issued the junk bonds in July 2023. Shapoorji Pallonji had to sell off some ports within 6 months of the bond sale, and (part of) a large construction company in another 6 months. If it’s unable to stick to this timeline, Goswami Infratech has to pay an additional interest to the junk bond investors. (That’s exactly what happened with one of the ports—Shapoorji Pallonji took nearly 3 extra months to sell it off, and the investors are now owed an additional 2% interest for those extra months.)
One story of why Shapoorji Pallonji issued junk bonds is that its companies are in big debt and they needed urgent money to pay off that debt. Yes, sure, that’s true and also what they did with the money. But another story is that Shapoorji Pallonji issued those bonds to buy time for it to get the right price for its assets. Not too many eligible buyers in the market for a port, after all.

Get that money out

Typically, the way bonds work is that the issuer, the company that’s borrowing money, pays the investor a fixed coupon every 6 or 12 months. Goswami Infra’s junk bonds though are zero coupon bonds. They don’t pay this fixed interest amount. Instead they pay the full amount owed right at the end.
In theory there isn’t a problem with this. The issuing company likes it because it doesn’t have to scramble for cash every few months. The bond investor doesn’t mind it because she gets compound interest at maturity. With 18.75% interest, that’s a lot.
The problem, of course, is that these are junk bonds! The investor doesn’t want to wait 3 years [3] expecting to get her principal back with that lovely interest only to be hit in the face with the company’s insolvency papers instead.
There’s a sweet spot. Yes, you want the compound interest but you also want some regular payments to be assured that the money’s actually coming back. Some leeway to make those payments is fine, but not 3 years!
Here’s where we’re standing:

1. Shapoorji Pallonji has to sell some assets within 6 and 12 months of the bonds being issued. It will get cash.
2. But the junk bonds don’t pay out a coupon like regular bonds. Selling assets can take time and is unpredictable. Being unable to make a coupon payment is a credit default, and the company would rather not go there.
3. The investors want that asset sale money before the bonds mature. But how?

All bond contracts have a certain safety net for investors. If the bond issuing company does anything “bad”, the investors can do an early redemption and ask for their money back with interest. All such bad things are obviously defined and it’s stuff like defaulting on interest payments, doing something illegal, not sharing its financials, etc.
The important thing here is that there is a legal way for a company’s bond investors to ask for their money back before the agreed term. Sure, such early redemption is meant as a safety net if the company does a bad thing. But I guess the bad thing is optional? Instead of the trigger being “company does bad thing”, the trigger could very well be the opposite—“company does good thing”.
That’s how the junk bond investors are getting their money before the bonds mature even though the bonds are zero coupon. They have early redemption clauses in the contract that when Shapoorji Pallonji sells off any of a bunch of its assets, it would have to give that money to the investors.
A snippet of the different ways the junk bond investors could get some of their money back before maturity.
The bond investors are using early redemption clauses to ensure some safety too. For instance, the payment that Goswami Infratech missed that I quoted at the beginning of this article—that was an early redemption triggered because Shapoorji Pallonji had been unable to refinance another debt in time. It didn’t have anything to do with asset sales or the junk bond money at all. All it meant was that if Shapoorji Pallonji was having trouble refinancing its debt, the risk for our bond investors goes up too and they’d like some money to reduce that risk. [4] For now, Goswami Infratech has negotiated an extension.
Honestly, I haven’t read a lot of junk bond contracts to know enough, but the early redemption route looks like a pretty smart way to get some money out. Of course, whether this smartness pays off or not would depend on how much money the investors end up making at the end of all this.
Footnotes
[1] Okay, Chinese loan apps actually did sometimes go much, much higher, sometimes even up to 200% (?!) interest, according to this article. But come on, 18.75% on bonds worth $1.7 billion is pretty crazy.
[2] Shapoorji Pallonji isn’t planning on selling Afcons entirely, it’s going to do a stake sale in an IPO.
[3] The bonds mature in April 2026.
[4] The debt I’m referring to here is that of Sterling Investment Corporation, another of Shapoorji Pallonji’s companies which seems to be dedicated to just raising debt. The deal the investors had here is that if Shapoorji Pallonji had been able to refinance this debt at the original interest rate by 26 May, that’s perfectly fine. But if it has to borrow at a higher interest, the junk bond investors would immediately get an early redemption of ₹1,400 crore + the interest rate of the junk bonds would be revised to match whatever the company was paying for Sterling’s refinancing.

Life is full of surprises—some joyous, others challenging. While we can't predict the future, we can prepare for it. One of the best ways to ensure the financial stability of one’s family, no matter what life throws your way, is through life insurance.
Planning for the Unexpected: How Life Insurance Can Safeguard Your Family's Financial Future
This guide will help you understand how Life Insurance is a vital part of one’s financial planning.
1. Understanding Life Insurance.
Life insurance, a contract between an insured and an insurer, where in exchange for regular premiums the insurance company provides a payout to the beneficiaries upon one’s passing or maturity of the policy.
It ensures that your family won't have to worry about financial hardships if something happens to you.
2. Why is Life Insurance Important ?
We all hope for the best, but it's wise to prepare for the worst. Unexpected events, like accidents or sudden illnesses, can shake a family's financial foundation. Life insurance acts as a safety net, ensuring your loved ones will be financially protected, even in your absence.
3. Types of Life insurance
There are various forms of life insurance present to fulfil your needs, namely –

• Whole Life Insurance
• Term Life insurance (with the return of premium or critical illness rider)
• Unit Linked Insurance Plans
• Retirement and Pension plans
• Group life insurance
• Child Insurance Plans
• Endowment plans
• Moneyback policy

4. Benefits of life insurance

• Financial Security: The death benefit that Life insurance provides upon claim settlement that ensures the standard of living of one’s family is maintained and essential expenses, such as housing, food, and utilities are covered.
• Income Replacement: life insurance can replace your lost income if you are the primary breadwinner, helping the family meet their financial obligations and continue their daily lives without financial stress.
• Debt Repayment: Outstanding debts (mortgages, cabusiness loans, and credit card balances) can be paid off through a life insurance payout, preventing your loved ones from inheriting your financial liabilities.
• Educational Costs: The death benefit can fund your children's education, ensuring they have the financial resources to pursue higher education and achieve their career goals.
• Final Expenses: Life insurance can cover the costs associated with funeral services, burial, or cremation, alleviating the financial burden on your family during an emotionally challenging time.
• Tax Benefits: The death benefit from a life insurance policy is often tax-free for your beneficiaries, providing them with a substantial financial resource without the burden of taxes.
• Flexible Financial Tool: Permanent Life insurances accumulate cash value over time, which can be borrowed against or withdrawn for various financial needs during your lifetime.

5. Potential Threats to your protection
The claim settlement of your safety net may be threatened by a claim rejection, delay in claim process or lapsed insurance policy due to a missed payment.
For any and every such threat, there are subject matter experts to deal with all Insurance related issues, claim rejection-related issues or reinstating lapsed insurance policies.
Conclusion
Life insurance isn't just about money- it's about security, stability and contentment that your family’s financial future is secure. In challenging times, remember you have someone to fight on your behalf. So, don’t carry the burden alone.
By following this guide, you'll be well-equipped to make well-briefed decisions about life insurance.
Don't wait—start planning today!

For our schedule and links to other discussions, see the Money and Banking 2024 master post.
This is the discussion thread for Economics of Money and Banking Lecture 6: Federal Funds, Final Settlement.

• Lecture Videos
• Lecture Notes
• This lecture corresponds with Stigum Chapter 12: The Federal Funds Market.

This lecture describes how the money market can help allocate reserves among banks to allow them to meet their daily settlement obligations. This works just like in Lecture 5 when the clearinghouse members borrowed from each other to be able to settle at the end of the day. The title of the lecture is a bit strange because you borrow in the money market to delay final settlement.
The "Fed Funds" market is what we call the part of the money market where US banks lend reserves to each other overnight. Since 2008, US banks have enough reserves that they don't regularly borrow reserves from each other anymore. But financial institutions do still use the money market. And the principles of the money market that we explore in this lecture are still valid today.
Through the lens of the money market, this lecture highlights the distinction between dealers and brokers as well as the distinction between payment and funding. These topics will come up again and again throughout the course.
Perry Mehrling says:

The relative importance of the various money markets has changed since the 2008 crisis—Fed Funds is now less important—but the conceptual framework remains valid, indeed not only for dollar money markets but also for non-dollar money markets.

Below is a 2017 article from the Cleveland Fed "Economic Commentary" that describes how the Fed Funds market changed between 2008 and then.

• The Federal Funds Market since the Financial Crisis

In this environment, the institutions willing to lend in the federal funds market are institutions whose reserve accounts at the Fed are not interest-bearing. These include government-sponsored entities (GSEs) such as the Federal Home Loan Banks (FHLBs). The institutions willing to borrow are institutions that do not face the FDIC’s new capital requirements and do have interest-bearing accounts with the Fed. These include many foreign banks. As such, the federal funds market has evolved into a market in which the FHLBs lend to foreign banks, which then arbitrage the difference between the federal funds rate and the rate on IOER.

Instead of a market that facilitates payments, the Fed Funds market looks more like a market for regulatory arbitrage. If all reserve accounts were interest-bearing and faced the same capital requirements, we might not have a Fed Funds market at all.

Before the financial crisis, the federal funds market was an interbank market in which the largest players on both the demand and supply sides were domestic commercial banks, and in which rates were set bilaterally between the lending and borrowing banks. The main drivers of activity in this market were daily idiosyncratic liquidity shocks, along with the need to fulfill reserve requirements. Rates were set based on the quantity of funds available in the market and the perceived risk of the borrower.

Next is a blog post from 2022 by Daniel Neilson that reflects on the Fed Funds market as the Fed raises interest rates.

• Positive Interest: Federal funds, then and now

For example, Minsky noted that if banks could easily borrow in the fed funds market, they would be less inclined to hold precautionary levels of unborrowed reserves. At a systemic level, the same amount of reserves would support a larger amount of credit, reducing systemic liquidity. The longer the boom has gone on, the more time this process will have had to play out, and so the more fragile financial arrangements will be.

Minsky observed that the money market is a system of "just-in-time" reserves. As long as the money market is functioning, banks don't need to hold any reserves to make the payments system go. But this forces the payments system to become dependent on the money market. The fact that today's banks have lots of excess reserves reinforces the idea that today's Fed Funds market is not the money market that Minsky was describing. It's doing something different.
Also from Perry Mehrling:

The lectures were developed over 15 years and filmed fall 2012, and much has changed since then, in particular strong regulatory shift to secured away from unsecured credit. Still interbank lending is key to creating one big bank, now globally and secured.

Even if domestic US banks no longer need the money market, there remain other institutions that do. Non-bank financial institutions, foreign banks, corporations, and governments all use the money market. Lecture 7 will examine the market for repurchase agreements (repo), which is the modern money market. Repo is a form of money-market lending secured with collateral.

Part 1: FT: European Bank Deleveraging

• FT Article: Europe's banks race to offload property loans

From a balance sheet perspective, capital—in the sense of "net worth"—is just whatever assets are not offset by liabilities. The idea of having a capital buffer to "absorb" losses just means that you have extra assets available to cover your liabilities if some of your assets lose their value. The amount of extra assets you're required to hold is going to depend on the quality of your assets and the likelihood that you'll have to write them down/off.
Here's the set of balance sheets that Perry draws on the board:
https://preview.redd.it/jplmuonskc4d1.png?width=808&format=png&auto=webp&s=ee85cd43e59a0163c25e2007d99a4fab6b59eb5f
These balance sheets are a little confusing because they don't actually show capital increasing. What they show is banks' assets being replaced with cash, which will allow their balance sheets to shrink back down, thereby allowing their existing capital to take up a greater proportion of their balance sheet. They're hoping to deleverage their existing capital.
The next step is to actually shrink the balance sheet on both sides:
https://preview.redd.it/yrlsmonskc4d1.png?width=544&format=png&auto=webp&s=ad3effa95bbcdcf5a9f23cd8c0a8d72017b970c6
Here, banks are allowing previous loans to be repaid without issuing new ones (A), which leads to a shrinkage of both loans and deposits. At the same time, banks are repaying their short-term debt using cash (B). They possibly received the cash from the sale of property loans shown in the previous set of balance sheets.
This part of the lecture also introduces the distinction between three different segments of the money market:

• Fed Funds
• Repo
• Eurodollars

There is really just one money market. These are all different aspects of the same money market. And today's money market largely operates through repo.

Part 2: What are Fed Funds?

The Fed Funds market is a market for banks to borrow reserves (deposits at the Fed) from each other overnight. It does not involve borrowing from the Fed itself. Fed Funds represents an expansion of credit within a single level of the hierarchy.
Before 2008, the Fed indirectly targeted the Fed Funds rate to speed up and slow down the economy. A higher Fed Funds rate would correspond with tighter credit and a lower Fed Funds rate would correspond with easier credit. For a few years after 2008, the Fed Funds rate was stuck at zero. Since then, the Fed Funds rate has risen and fallen, but the mechanism has changed. Instead of adjusting the amount of reserves in the banking system, the Fed just pays interest on the reserves that the banking system holds. You're generally not going to lend reserves at a rate that's lower than what you can get by holding onto them.
Here's a description of Fed Funds and interest on reserves from the New York Fed, frozen in time from 2013:

• Fedpoint: "Federal Funds"

Part 3: Payment settlement versus Required Reserves

According to Stigum, banks use the Fed Funds market to achieve two main objectives: settling with the Fed at the end of the day and meeting reserve requirements.
After 2008 though, banks were so over-stuffed with reserves that there was never any danger of failing to meet reserve requirements. The banks were no longer reserve-constrained.
After Covid hit in March of 2020, the Fed removed reserve requirements altogether.
The lecture suggests that the Fed Funds market is still marginally useful for daily settlement in the payments system. I'm not convinced.

Part 4: Payment elasticity/discipline, Public and Private

During the day, banks make payments to each other through the Fed's Fedwire payments system. This system allows banks to pay via overdraft if they run out of reserves. If Bank A pays Bank B using a daylight overdraft at the Fed, that automatically adds new reserves (actual money) to Bank B's deposit account at the Fed.
https://preview.redd.it/816n4onskc4d1.png?width=815&format=png&auto=webp&s=b693ade5a917acf6eca5fc8d20988b5283e9ceaf
This is called a Real-Time Gross Settlement System (RTGS) because the payment happens immediately (real-time), and it can happen through a balance-sheet expansion (gross) when insufficient existing reserves are available. The one-big-bank credit-based payments system from Lecture 5 was another example of an RTGS.
But Fedwire doesn't accept gross settlement forever. The Fed's daytime balance-sheet expansion is meant to automatically collapse back down at the end of the day when all the banks settle with the Fed.
The expansion of overdrafts during the day highlights the credit-based nature of the payment system. This is perhaps closer to how the payment system worked prior to 2008. Since 2008, the part of the payment system that the Fed interfaces with directly has looked less like this.
As you can see in the below chart, the volume of daylight overdrafts tanked after 2008.
https://preview.redd.it/quujronskc4d1.jpg?width=600&format=pjpg&auto=webp&s=422b71c7aef8d81886f71be1c07df0003579e72b

• Federal Reserve Board — Daylight Overdrafts and Fees

We can compare this to bank reserves, which were on the order of $42 billion pre-crisis and were recently closer to $1.5 trillion before starting to blow up even further in March and April of 2020.
https://preview.redd.it/qb92mnnskc4d1.png?width=1318&format=png&auto=webp&s=475c8adbf53ec2da822eb64384b5b3ae605eec06
It seems that US commercial banks aren't coming up against the settlement constraint as much these days. This tension is perhaps being pushed to other parts of the system. US Commercial banks may have plenty of reserves, but perhaps there are other institutions that might not.
The Clearing House Interbank Payments System (CHIPS)
CHIPS is a private clearing system run by The Clearing House, which is the modern name for what was originally the New York Clearing House Association we discussed in Lectures 3 and 5. Daytime expansion and contraction of credit happens on the balance sheet of CHIPS as well.
https://preview.redd.it/kjgtapnskc4d1.png?width=1093&format=png&auto=webp&s=50ad640cae1ffb4b3d10bb7100987539b4f5576d
Instead of overdrafts, members post collateral at the beginning of the day and record due to's and due from's throughout the day.
https://preview.redd.it/1wz5jrnskc4d1.png?width=736&format=png&auto=webp&s=6d600e011af72c503574cd2ea11c7e1ddbdee0b4
Unlike reserve deposits at the Fed, banks don't treat the liabilities (due from's) of CHIPS as reserves/money. This means that CHIPS is not an RTGS. Banks wait until the end of the day to clear with CHIPS and settle their remaining cash commitments over Fedwire. That's when the reserves actually flow. The Fed sits above CHIPS in the hierarchy of money and credit.
As of 2017, in addition to CHIPS, the Clearing House also provides an RTGS called Real-Time Payments (RTP). And the Fed launched a 24/7 RTGS called FedNow in July 2023.

• RTP
• FedNow

Part 5: The Function of the Fed Funds Market

In a closed system, the payments surpluses and deficits at the end of the day always net out to zero. The surplus and deficit agents just need to find each other. That's what the money market facilitates.
https://preview.redd.it/7xrc0unskc4d1.png?width=818&format=png&auto=webp&s=2519f8b6efbd1e26261392250b8a22377c8c4417
The creation of a Fed Funds loan moves reserves from a surplus agent to a deficit agent.
https://preview.redd.it/bpdfvnnskc4d1.png?width=339&format=png&auto=webp&s=a59b7b1caab750d6e42df85e0d2f201637fc565a
Below is a set of balance sheets that shows how daylight overdraft payments cause an expansion of the Fed's balance sheet that then contracts back down again after the deficit agent (Bank A) borrows reserves in the Fed Funds market.
https://preview.redd.it/o042lpnskc4d1.png?width=1116&format=png&auto=webp&s=7cdb760b91ad4a754f557365c08bc55fb68006ff
Notice that the Fed Funds loan remains. At the end of the day, the expansion of credit is still there. It's just no longer on the balance sheet of the Fed.
https://preview.redd.it/vykfgtnskc4d1.png?width=722&format=png&auto=webp&s=7e0f2937e93096498750ec5b734625802073962f
From the lecture notes:

To appreciate the importance of this constraint at the end of the day, it is useful to appreciate the way that banks are allowed to relax the survival constraint during the day. Indeed that violation is essential for the smooth working of the payments system because it allows banks to be the “first mover”, to make payments before they receive payments. The institutional form that violation takes is the “daylight overdraft”.

But it's also true that Bank A could have borrowed in the Fed Funds market first instead of paying via overdraft only to borrow Fed Funds to repay the overdraft later.
https://preview.redd.it/g7v57onskc4d1.png?width=1066&format=png&auto=webp&s=3699ca60bf510fa5fb7042478a42fd0f6be0a9d4
In the first case, the Fed's balance sheet expands and then contracts back down. In the second case, the Fed's balance sheet stays the same size throughout.
In either case, Bank A has "paid" Bank B by promising to pay the next day. The asset Bank B receives as payment is a Fed Funds loan instead of reserves.

Stigum makes a point that some banks are natural sellers of funds and others are natural buyers. Put another way, the regular business of some banks causes their daily cash inflow to exceed their daily cash outflow, and for some other banks it is just the reverse. Concretely, it seems that the former are small banks in isolated areas that don’t face much demand for loans, while the latter are large city banks that can lend out all their deposits plus more. So the Fed Funds market channels excess funds from the country banks to the city banks. Viewed in this way, we can think of the Fed Funds market as analogous to the older pattern of correspondent banking. This country-city flow was largely intra-regional in the past, and so it remains today. (The regional character of correspondent banking is reflected in the location of the 12 Federal Reserve Banks.)

Part 6: Payment versus Funding: an example

Here are the balance sheets from the mortgage example in the lecture.
https://preview.redd.it/h27lpsnskc4d1.png?width=1157&format=png&auto=webp&s=47f42f3c4c4480db3fa4bf9efb29bbb0171f0faf
These balance sheets show HSBC starting with reserves. But all of this can still work if nobody starts with any reserves. The necessary reserves can be created through daylight overdrafts to be eliminated at the end of the day.
https://preview.redd.it/7oh8conskc4d1.png?width=1154&format=png&auto=webp&s=8253d5d06b9e40d4568d81446243d417114254a0
part6-1b-x1-mortgage-overdrafts.png
I've left out the balance sheet of the Fed. In the background, the Fed acts as an intermediary, expanding and contracting reserves and overdrafts by expanding and contracting its balance sheet on both sides.

After all this is done, Citibank has a mortgage loan asset that is funded by overnight money. Clearly this is not ideal funding, and the bank has some more work to do, but we leave that aside for the moment to concentrate on the payment rather than the ultimate funding. (The issue of ultimate funding is centrally addressed in Lecture 17.)

Notice that the seller of the house is indirectly funding the mortgage loan to the buyer of the house. This might seem strange. But it's really just an extension of the swap of IOUs. When I borrow from a bank, I am funding my own loan.
https://preview.redd.it/udk23unskc4d1.png?width=783&format=png&auto=webp&s=eac169cd05ee02e0e2f2023f73a6c5bc4ee7ab11
Payments, on their own, can benefit from a temporary expansion of credit that then contracts back down once the payment is complete. Funding is an expansion of credit that remains on the books for a period of time to allow someone to establish and maintain a position on their balance sheet. For example, if I invest in a project that's expected to provide a return over time, I might take out a loan to fund that project.
In this case, from the perspective of the home buyer's balance sheet, the mortgage is a long-term loan that funds ownership of the house. And from the perspective of Citibank, the Fed Funds loan funds the ownership of the mortgage.
Because HSBC is both borrowing and lending Fed Funds, that makes HSBC like a dealer in the Fed Funds market. Dealers are going to continue to come up in this course. The home-buying example shows the mechanics of how HSBC might act as a dealer in the Fed Funds market. The key thing to remember about dealers is that they act as both buyers and sellers in the market. If there are plenty of dealers in a market, then there's always someone to buy from and always someone to sell to (at different prices). In other words, the market is liquid.
If there's nobody to buy from and nobody to sell to, then there is no market. So, in the sense that dealers offer to do both, they're "making markets."
Withdrawing Lots of Cash
Just for fun, let's look at what happens if you withdraw your deposits in cash after selling the house:
https://preview.redd.it/nhpd1tnskc4d1.png?width=1101&format=png&auto=webp&s=718c3327c4ac788141d3f35e3f7f9eb719317eb5
Chase's balance sheet has contracted, and you end up holding liabilities of the Fed (cash) as money.
https://preview.redd.it/pn7mbrnskc4d1.png?width=810&format=png&auto=webp&s=2efb3f20bc0c4b7fa22e4d9dfe70264ae24d496a
This is what we called an "internal drain" in Lecture 5. The Fed can always handle this kind of thing because it can issue the cash that everybody is shifting into. Moreover, the Fed can help out the banks who lose their deposit funding by replacing that funding themselves or by ensuring that those banks can borrow in the money market.

Part 7: Brokers versus Dealers

https://preview.redd.it/62ahxunskc4d1.png?width=813&format=png&auto=webp&s=cef4984c65dc5155d27c3e9735f45b25dac0e9b9
The Fed Funds market was never really a dealer market, in the sense that nobody made a business out of simultaneously borrowing and lending in the Fed Funds market to profit from the interest rate spread. If a bank was both borrowing and lending Fed Funds at the same time, it was usually just a side effect of some other activity.

For present purposes, the important point is that dealing activity expands the balance sheet of the dealer, while simple brokering does not.

Part 8: Payments Imbalances and the Fed Funds Rate

The money market helps the balance sheet of the Fed shrink back down. But it doesn't shrink overall credit. The credit just moves off the balance sheet of the Fed and CHIPS and onto the balance sheets of the private banks and the money-market borrowers and lenders.
Payment imbalances (after netting) in a reserve-constrained system manifest as an expansion of balance sheets in the money market.
Because the Fed Funds market is a market, the Fed Funds rate is a market rate. It is not a single rate but an average of all the rates banks pay in the market.
The Fed participates in the money market in various ways. Primarily, they offer standing borrowing and lending facilities. There are prices at which the market can always borrow from the Fed through, for example, the discount window, or the standing repo facility. There are also prices at which the market can lend to the Fed, such as the overnight reverse repo facility. These facilities are set at fixed rates. If the money-market rate moves away from the Fed's standing rates, nobody will go to the Fed.
The Fed does not technically participate in the Fed Funds market because the Fed Funds market is defined to be a part of the money market that's not on the balance sheet of the Fed. It's also unsecured. The Fed's standing facilities require collateral.
The Fed also participates in the open money market at the market rate to manipulate the quantity of reserves in the system. These actions are called "open-market opertaions," and they normally use repo—i.e. collateralized money-market lending and borrowing.
https://preview.redd.it/2peursnskc4d1.png?width=813&format=png&auto=webp&s=8e6ebd708d033b36f991dee43e9f7e2c946542b0

Part 9: Secured versus Unsecured Interbank Credit

The mortgage loan is secured by the house as collateral. If you fail to pay the mortgage, the bank takes your house. Fed Funds lending, on the other hand, is unsecured. There is no collateral.
While it's true that nobody is pledging (or taking) collateral, the banks are in a network, and they know each other. They're always keeping track of their exposures, and they impose limits on how much they want to lend to any given counterparty. They keep a diversified portfolio of Fed Funds lending.
When people stop trusting each other, they stop lending unsecured.
Repos are a form of secured money-market lending that often has Treasury Bills as collateral.

Part 10: Required Reserves, redux

Mehrling says that reserve requirements are the least important part of how banking works. If there's always a price at which banks can borrow their needed reserves, then what matters is that price, not the reserve requirements. This was true even before 2008. Since 2008, banks don't typically need to borrow reserves anyway. They hold excess reserves well above the requirements.
Not every country even has reserve requirements. And, as of the Covid crisis, neither does the United States. It's not clear to me whether this made much of a difference or whether reserve requirements will ever be coming back.
In a world of modern (and global) finance with shadow banking and market-based credit creation outside of the commercial banking system, it can be a challenge to regulate credit creation/expansion.
Please post any questions and comments below. We will have a one-hour live discussion of Lecture 5 and Lecture 6 on Monday, June 3rd, at 2:00pm EDT.

Original Source: https://boringmoney.in/p/shapoorji-pallonji-junk-bonds (my newsletter Boring Money. If you like what you read, do visit the original link to subscribe and receive future posts directly in your inbox)

I was confused when I first read about junk bonds. They pay more than regular bonds? Then why are they junk? Well, here’s why:

India’s biggest ever high-yield rupee corporate bond, held by a number of global private credit funds, is casting a spotlight on pockets of stress within the nation’s credit markets. ‎‎‎‎‎ Some holders of the 143 billion rupee ($1.7 billion) note issued last year by Goswami Infratech Pvt are planning to ask the company for sweeteners in exchange for potentially accepting a company proposal to delay a payment, people familiar with the matter said.

This is from a Bloomberg report last month. Junk bonds promise to pay more than regular bonds, but they’re junk because the companies that issue them might just go like “sorry no money for you this month” and you’d sort of have to be okay with it.
In this particular case, Goswami Infratech, an infrastructure company part of the Shapoorji Pallonji group, issued some high-yield bonds sometime mid-last year. It wanted to revise certain terms because it couldn’t make an expected payment. The bond yield was high! 18.75% pa! For context, fixed deposit rates are around 7–8% right now.
Shapoorji Pallonji is a large 150-year old conglomerate. Why are they borrowing money at a rate comparable to that offered by those shady Chinese loan apps? [1]

Debt to repay debt

A company that’s into constructing stuff needs money. That’s perfectly fine. It will borrow money, build a bridge or a building or whatever, collect tolls or sell flats, and slowly repay the money it borrowed with interest. There is a clear one-to-one relationship between the money that it borrowed and the asset that it built. In an ideal world, that is.
In the real world, our company may not be able to repay on time. Maybe the bridge was delayed because it didn’t get environmental clearances on time. Or maybe the flats didn’t sell for the expected prices. So the company has to refinance! Basically, it has to borrow more so that it can use that money to repay the earlier loan, and then repay the new loan instead.
Shapoorji Pallonji is a conglomerate comprising many capital-intensive companies. At any given point, at least a few of them may need to refinance their existing debt. So instead of having your companies borrow relatively smaller amounts separately, why not just club them all together and borrow a large amount at once?
In June 2023, Goswami Infratech issued bonds worth a huge ₹14,300 crore ($1.7 billion), which were bought mostly by foreign investment firms. Here’s the bond offering document and here’s%20Signed_20230702132807.pdf) the debenture trustee deed. The company borrowed this money primarily to pay off a bunch of existing debts. Only about 2% of the ₹14,300 crore that it borrowed went to its own account, the rest went to make bond repayments for 7 other companies in the Shapoorji Pallonji group.
I think this makes the sweet 18.75% interest make more sense? If you’re borrowing to repay the debt of a whole family of companies, you better be prepared to give out a lot of interest.
https://preview.redd.it/yzbfelm5jb4d1.jpg?width=749&format=pjpg&auto=webp&s=eff26bf8f51a822e866d4146667c162268eb1a5c

Fire sale?

How is Goswami Infratech even going to repay these bonds? The junk bond money didn’t go into building an asset that it could monetise, it went into repaying past debt. But Shapoorji Pallonji is a conglomerate and has existing assets! So it’s going to sell some off. The bond documents outline exactly what and when:

1. Ports owned by SP Port Maintenance, Shapoorji Pallonji’s port owning company. By 31 December, 2023.
2. Afcons Infrastructure, one of Shapoorji Pallonji’s construction companies. By 30 June, 2024. [2]

Goswami Infratech issued the junk bonds in July 2023. Shapoorji Pallonji had to sell off some ports within 6 months of the bond sale, and (part of) a large construction company in another 6 months. If it’s unable to stick to this timeline, Goswami Infratech has to pay an additional interest to the junk bond investors. (That’s exactly what happened with one of the ports—Shapoorji Pallonji took nearly 3 extra months to sell it off, and the investors are now owed an additional 2% interest for those extra months.)
One story of why Shapoorji Pallonji issued junk bonds is that its companies are in big debt and they needed urgent money to pay off that debt. Yes, sure, that’s true and also what they did with the money. But another story is that Shapoorji Pallonji issued those bonds to buy time for it to get the right price for its assets. Not too many eligible buyers in the market for a port, after all.

Get that money out

Typically, the way bonds work is that the issuer, the company that’s borrowing money, pays the investor a fixed coupon every 6 or 12 months. Goswami Infra’s junk bonds though are zero coupon bonds. They don’t pay this fixed interest amount. Instead they pay the full amount owed right at the end.
In theory there isn’t a problem with this. The issuing company likes it because it doesn’t have to scramble for cash every few months. The bond investor doesn’t mind it because she gets compound interest at maturity. With 18.75% interest, that’s a lot.
The problem, of course, is that these are junk bonds! The investor doesn’t want to wait 3 years [3] expecting to get her principal back with that lovely interest only to be hit in the face with the company’s insolvency papers instead.
There’s a sweet spot. Yes, you want the compound interest but you also want some regular payments to be assured that the money’s actually coming back. Some leeway to make those payments is fine, but not 3 years!
Here’s where we’re standing:

1. Shapoorji Pallonji has to sell some assets within 6 and 12 months of the bonds being issued. It will get cash.
2. But the junk bonds don’t pay out a coupon like regular bonds. Selling assets can take time and is unpredictable. Being unable to make a coupon payment is a credit default, and the company would rather not go there.
3. The investors want that asset sale money before the bonds mature. But how?

All bond contracts have a certain safety net for investors. If the bond issuing company does anything “bad”, the investors can do an early redemption and ask for their money back with interest. All such bad things are obviously defined and it’s stuff like defaulting on interest payments, doing something illegal, not sharing its financials, etc.
The important thing here is that there is a legal way for a company’s bond investors to ask for their money back before the agreed term. Sure, such early redemption is meant as a safety net if the company does a bad thing. But I guess the bad thing is optional? Instead of the trigger being “company does bad thing”, the trigger could very well be the opposite—“company does good thing”.
That’s how the junk bond investors are getting their money before the bonds mature even though the bonds are zero coupon. They have early redemption clauses in the contract that when Shapoorji Pallonji sells off any of a bunch of its assets, it would have to give that money to the investors.
A snippet of the different ways the junk bond investors could get some of their money back before maturity.
The bond investors are using early redemption clauses to ensure some safety too. For instance, the payment that Goswami Infratech missed that I quoted at the beginning of this article—that was an early redemption triggered because Shapoorji Pallonji had been unable to refinance another debt in time. It didn’t have anything to do with asset sales or the junk bond money at all. All it meant was that if Shapoorji Pallonji was having trouble refinancing its debt, the risk for our bond investors goes up too and they’d like some money to reduce that risk. [4] For now, Goswami Infratech has negotiated an extension.
Honestly, I haven’t read a lot of junk bond contracts to know enough, but the early redemption route looks like a pretty smart way to get some money out. Of course, whether this smartness pays off or not would depend on how much money the investors end up making at the end of all this.
Footnotes
[1] Okay, Chinese loan apps actually did sometimes go much, much higher, sometimes even up to 200% (?!) interest, according to this article. But come on, 18.75% on bonds worth $1.7 billion is pretty crazy.
[2] Shapoorji Pallonji isn’t planning on selling Afcons entirely, it’s going to do a stake sale in an IPO.
[3] The bonds mature in April 2026.
[4] The debt I’m referring to here is that of Sterling Investment Corporation, another of Shapoorji Pallonji’s companies which seems to be dedicated to just raising debt. The deal the investors had here is that if Shapoorji Pallonji had been able to refinance this debt at the original interest rate by 26 May, that’s perfectly fine. But if it has to borrow at a higher interest, the junk bond investors would immediately get an early redemption of ₹1,400 crore + the interest rate of the junk bonds would be revised to match whatever the company was paying for Sterling’s refinancing.
Original Source: https://boringmoney.in/p/shapoorji-pallonji-junk-bonds

Original Source: https://boringmoney.in/p/shapoorji-pallonji-junk-bonds (my newsletter Boring Money. If you like what you read, do visit the original link to subscribe and receive future posts directly in your inbox)

I was confused when I first read about junk bonds. They pay more than regular bonds? Then why are they junk? Well, here’s why:

India’s biggest ever high-yield rupee corporate bond, held by a number of global private credit funds, is casting a spotlight on pockets of stress within the nation’s credit markets. ‎‎‎‎‎ Some holders of the 143 billion rupee ($1.7 billion) note issued last year by Goswami Infratech Pvt are planning to ask the company for sweeteners in exchange for potentially accepting a company proposal to delay a payment, people familiar with the matter said.

This is from a Bloomberg report last month. Junk bonds promise to pay more than regular bonds, but they’re junk because the companies that issue them might just go like “sorry no money for you this month” and you’d sort of have to be okay with it.
In this particular case, Goswami Infratech, an infrastructure company part of the Shapoorji Pallonji group, issued some high-yield bonds sometime mid-last year. It wanted to revise certain terms because it couldn’t make an expected payment. The bond yield was high! 18.75% pa! For context, fixed deposit rates are around 7–8% right now.
Shapoorji Pallonji is a large 150-year old conglomerate. Why are they borrowing money at a rate comparable to that offered by those shady Chinese loan apps? [1]

Debt to repay debt

A company that’s into constructing stuff needs money. That’s perfectly fine. It will borrow money, build a bridge or a building or whatever, collect tolls or sell flats, and slowly repay the money it borrowed with interest. There is a clear one-to-one relationship between the money that it borrowed and the asset that it built. In an ideal world, that is.
In the real world, our company may not be able to repay on time. Maybe the bridge was delayed because it didn’t get environmental clearances on time. Or maybe the flats didn’t sell for the expected prices. So the company has to refinance! Basically, it has to borrow more so that it can use that money to repay the earlier loan, and then repay the new loan instead.
Shapoorji Pallonji is a conglomerate comprising many capital-intensive companies. At any given point, at least a few of them may need to refinance their existing debt. So instead of having your companies borrow relatively smaller amounts separately, why not just club them all together and borrow a large amount at once?
In June 2023, Goswami Infratech issued bonds worth a huge ₹14,300 crore ($1.7 billion), which were bought mostly by foreign investment firms. Here’s the bond offering document and here’s%20Signed_20230702132807.pdf) the debenture trustee deed. The company borrowed this money primarily to pay off a bunch of existing debts. Only about 2% of the ₹14,300 crore that it borrowed went to its own account, the rest went to make bond repayments for 7 other companies in the Shapoorji Pallonji group.
I think this makes the sweet 18.75% interest make more sense? If you’re borrowing to repay the debt of a whole family of companies, you better be prepared to give out a lot of interest.
https://preview.redd.it/sm3qj4uwdb4d1.jpg?width=749&format=pjpg&auto=webp&s=4fb98f48354eb3979dd815ae4ef5e7aa18ad1bde

Fire sale?

How is Goswami Infratech even going to repay these bonds? The junk bond money didn’t go into building an asset that it could monetise, it went into repaying past debt. But Shapoorji Pallonji is a conglomerate and has existing assets! So it’s going to sell some off. The bond documents outline exactly what and when:

1. Ports owned by SP Port Maintenance, Shapoorji Pallonji’s port owning company. By 31 December, 2023.
2. Afcons Infrastructure, one of Shapoorji Pallonji’s construction companies. By 30 June, 2024. [2]

Goswami Infratech issued the junk bonds in July 2023. Shapoorji Pallonji had to sell off some ports within 6 months of the bond sale, and (part of) a large construction company in another 6 months. If it’s unable to stick to this timeline, Goswami Infratech has to pay an additional interest to the junk bond investors. (That’s exactly what happened with one of the ports—Shapoorji Pallonji took nearly 3 extra months to sell it off, and the investors are now owed an additional 2% interest for those extra months.)
One story of why Shapoorji Pallonji issued junk bonds is that its companies are in big debt and they needed urgent money to pay off that debt. Yes, sure, that’s true and also what they did with the money. But another story is that Shapoorji Pallonji issued those bonds to buy time for it to get the right price for its assets. Not too many eligible buyers in the market for a port, after all.

Get that money out

Typically, the way bonds work is that the issuer, the company that’s borrowing money, pays the investor a fixed coupon every 6 or 12 months. Goswami Infra’s junk bonds though are zero coupon bonds. They don’t pay this fixed interest amount. Instead they pay the full amount owed right at the end.
In theory there isn’t a problem with this. The issuing company likes it because it doesn’t have to scramble for cash every few months. The bond investor doesn’t mind it because she gets compound interest at maturity. With 18.75% interest, that’s a lot.
The problem, of course, is that these are junk bonds! The investor doesn’t want to wait 3 years [3] expecting to get her principal back with that lovely interest only to be hit in the face with the company’s insolvency papers instead.
There’s a sweet spot. Yes, you want the compound interest but you also want some regular payments to be assured that the money’s actually coming back. Some leeway to make those payments is fine, but not 3 years!
Here’s where we’re standing:

1. Shapoorji Pallonji has to sell some assets within 6 and 12 months of the bonds being issued. It will get cash.
2. But the junk bonds don’t pay out a coupon like regular bonds. Selling assets can take time and is unpredictable. Being unable to make a coupon payment is a credit default, and the company would rather not go there.
3. The investors want that asset sale money before the bonds mature. But how?

All bond contracts have a certain safety net for investors. If the bond issuing company does anything “bad”, the investors can do an early redemption and ask for their money back with interest. All such bad things are obviously defined and it’s stuff like defaulting on interest payments, doing something illegal, not sharing its financials, etc.
The important thing here is that there is a legal way for a company’s bond investors to ask for their money back before the agreed term. Sure, such early redemption is meant as a safety net if the company does a bad thing. But I guess the bad thing is optional? Instead of the trigger being “company does bad thing”, the trigger could very well be the opposite—“company does good thing”.
That’s how the junk bond investors are getting their money before the bonds mature even though the bonds are zero coupon. They have early redemption clauses in the contract that when Shapoorji Pallonji sells off any of a bunch of its assets, it would have to give that money to the investors.
A snippet of the different ways the junk bond investors could get some of their money back before maturity.
The bond investors are using early redemption clauses to ensure some safety too. For instance, the payment that Goswami Infratech missed that I quoted at the beginning of this article—that was an early redemption triggered because Shapoorji Pallonji had been unable to refinance another debt in time. It didn’t have anything to do with asset sales or the junk bond money at all. All it meant was that if Shapoorji Pallonji was having trouble refinancing its debt, the risk for our bond investors goes up too and they’d like some money to reduce that risk. [4] For now, Goswami Infratech has negotiated an extension.
Honestly, I haven’t read a lot of junk bond contracts to know enough, but the early redemption route looks like a pretty smart way to get some money out. Of course, whether this smartness pays off or not would depend on how much money the investors end up making at the end of all this.
Footnotes
[1] Okay, Chinese loan apps actually did sometimes go much, much higher, sometimes even up to 200% (?!) interest, according to this article. But come on, 18.75% on bonds worth $1.7 billion is pretty crazy.
[2] Shapoorji Pallonji isn’t planning on selling Afcons entirely, it’s going to do a stake sale in an IPO.
[3] The bonds mature in April 2026.
[4] The debt I’m referring to here is that of Sterling Investment Corporation, another of Shapoorji Pallonji’s companies which seems to be dedicated to just raising debt. The deal the investors had here is that if Shapoorji Pallonji had been able to refinance this debt at the original interest rate by 26 May, that’s perfectly fine. But if it has to borrow at a higher interest, the junk bond investors would immediately get an early redemption of ₹1,400 crore + the interest rate of the junk bonds would be revised to match whatever the company was paying for Sterling’s refinancing.
Original Source: https://boringmoney.in/p/shapoorji-pallonji-junk-bonds