Money Stuff: Morgan Stanley Leaked Some Deals

I always think of an investment banking group’s “pipeline” as a fairly aspirational document. “What deals do we have coming,” your boss asks you, so you go write down a list of:

• Deals on which you have a mandate;
• Deals on which you are pitching for a mandate;
• Companies that you talk to regularly and that might do a deal one of these days;
• Companies that you’ve been meaning to call but you’ve been busy;
• Companies that someone told you might be doing a deal with another bank;
• Companies that you’ve never talked to but, based on public information, they really should do a deal; and
• Other companies that exist.

And you hand your boss the list, and she looks at it and says “ah, good, you are keeping busy,” and leaves you alone for another day. This view might be extremely biased by my own experience of being an investment banker. I was bad at it. I’m sure other people just wrote down like 20 deals they were actually doing. Not me.

Anyway here’s a fascinating natural experiment:

A Morgan Stanley employee accidentally leaked an internal document listing more than 100 investment-banking deals the firm is pitching and monitoring in Asia, revealing details of the bank’s pipeline, according to people familiar with the matter.

The list contained candidates for initial public offerings, spanning from China to South Korea and India, according to a copy seen by Bloomberg News and verified by people familiar with the matter. The list — which focused mostly on Asia, along with Europe, the Middle East, and Africa — also included private equity and pension funds backing those companies, and projects that were put on hold. …

The banker had intended to send a client-facing version of the file, which largely contained general updates on the private equity sector and recent transactions, but mistakenly sent the internal version instead, some of which contained extensive price-sensitive information.

I mean, it’s not a perfect experiment. (Maybe some of the deals on this list were very real, but were canceled because of this leak.) But, like, take that list of 100 companies, construct a control list of 100 similar companies that are not on the list, and see which list produces more equity capital markets deals in the next six months. “Leaks about an imminent share placement can … weigh on the stock as investors brace for additional supply”: Construct a portfolio that is short the public companies on this list and long a basket of similar companies, and see if the listed companies’ stocks underperform. Because they do block trades. Will they do block trades? Well, they might. Morgan Stanley is working with them on doing block trades. Or pitching them. Or monitoring them. 

When I was an investment banker, if my pipeline fell into your hands, and you used it to trade stocks ahead of my deals, you’d definitely have lost money. Bloomberg News also reports:

One firm mentioned in the document, Hong Kong-based Link REIT said it’s aware of the leaked information. “Link does not have any current transaction engagement with Morgan Stanley, nor have we engaged with them in any recent deal-related discussions,” a spokesperson said in an emailed statement.

Yeah that checks out.

Umpteen bajillion dollars of bonds and loans are backed by data center leases for artificial intelligence training and inference. The big large-scale risk to the credit markets is that, in the long run, too many data centers will get built: If the AI boom turns out to be less important than people think, or if it turns out to require less compute and power and other infrastructure than people think, then some of those data centers will sit empty and the bonds won’t get paid back.

The smaller-scale but more immediate risk is that too few data centers will get built. Like, someone launches a project to build a data center and signs up a hyperscaler tenant and raises billions of dollars of bonds to finance it, but then the permits don’t come through or the bulldozer breaks down or whatever, and the data center doesn’t get built on the expected timeline. The demand for chips and power and data centers is still there, but this data center isn’t meeting that demand, because it is just an empty field with some permitting problems. The tenant finds another data center and cancels this lease, and the bonds don’t get paid back.

My impression is that most data center financing projects are pretty robust to this risk, and that some tech-company tenant or guarantor usually bears most of the risk of delays and cost overruns, rather than pushing that risk onto the lenders. [1]  But we are still early in the AI financing boom, and people are nervous. Bloomberg’s Sridhar Natarajan, Brody Ford and Paula Seligson report:

Oracle Corp. is moving to shield itself from racking up expenses on a massive data center being built in New Mexico, adding a fresh wrinkle to a project beset by opposition and regulatory setbacks.

The technology giant sent the project’s developer, a unit of Blue Owl Capital Inc., a notice citing force majeure, according to people familiar with the situation. Rather than trying to walk away as the site’s main tenant, Oracle is attempting to put off payments should the data center dubbed Project Jupiter get derailed and fail to come online in 2028 as planned, the people said, asking not to be identified discussing private matters. …

The campus designed to handle 2.45 gigawatts — enough electricity to power roughly 1.8 million homes at any given moment — has hit serious setbacks including the denial of a permit key to its plans for energy resources. It’s becoming a symbol of the growing backlash against the broader AI data center boom and a political flashpoint ahead of the US midterm elections that threatens to turn races into referendums over the build-out.

Even if the force majeure notice is intended as a precautionary step to win some wiggle room, it risks alarming lenders backing the project. The debt tied to the development is already trading at stressed levels, below 90 cents on the dollar, according to a person with knowledge of the matter.

They cite a Quinn Emanuel client alert about force majeure clauses in data center financing agreements, noting that “the AI data center buildout is entering a period of heightened construction, supply chain, and regulatory risk,” and that “force majeure clauses will be central to the disputes that follow.” If a multibillion-dollar data center project raises money and spends it and doesn’t actually open a data center, that has to be bad news for someone; the question is whom.

The story of private equity is quite simple and obvious. In the olden days, there were a lot of undervalued, underlevered, inefficient companies, and a few smart daredevils left their cushy investment banking jobs with the idea of borrowing money to buy those companies, sprucing up their operations, and selling them for large profits. If you were the first or second or tenth or fiftieth or, like, three hundredth person to have that idea, you got quite rich, because there were a lot of good companies to buy and not that much competition to buy them.

Returns, however, diminished. Eventually all of the most promising private equity targets — the undervalued, underlevered, inefficiently run companies with steady cash flows and good moats that could be bought cheap and quickly resold at large profits — got bought by private equity. [2]  Private equity firms increasingly competed with one another for deals, driving up prices, and bought companies from each other rather than from some vast virgin preserve of cheap companies.

Also the competition for private equity jobs increased. Instead of leaving your banking job with three friends to raise a fund and buy some companies, now you get your banking job and immediately begin a structured process of interviewing for prestigious jobs at private equity megafunds. All of your investment banking classmates are doing the same, competition is fierce, and the private equity firms have their choice of candidates. 

Private equity makes its money with levered value investing: It finds overlooked unloved companies to buy low, and adds risk — increases the variance of returns — by borrowing money. That’s what private equity funds get paid for, buying low and taking risk.

If you are a banking analyst on the conveyor belt to a prestigious job in private equity, let me ask you:

1. Are you buying low?
2. Are you taking risk?

If the answer to those questions is “no, I am doing the most popular and safest available thing,” then a third question might be: Why do you expect to get paid? What are you getting paid for? Good grades, hard work and conformity? Meh. Bloomberg’s Allison McNeely reports:

The industry is in the doldrums after higher interest rates made it harder to resell companies and return cash to investors. And where private equity’s fortunes once largely waxed and waned alongside the rest of finance, it’s out of step with a boom in trading and investment banking, and with the AI goldrush electrifying venture capital.

Dealmakers are missing out on the personal windfalls they used to score by hitting investing home runs. These payments — known as carried interest or simply carry — are the slice of profits that investment professionals reap on winning bets, and helped make private equity among the most sought-after careers in finance. …

At all levels of private equity, the dearth of distributions from carry means more people are looking for new jobs, said Jonathan Goldstein, of the recruitment firm Heidrick & Struggles.

“You have any number of investment professionals at private equity firms whose career has stalled,” he said.

And, embarrassingly:

Banking has become an increasingly attractive alternative. Many aspiring private equity professionals start out with a two-year stint in investment banking, updating deal pitch decks until the wee hours of the morning. That means banking has long been viewed as a slog to be endured before switching to make real money on the buy side.

Now, however, investment banking is booming. Pay and bonuses appear more predictable than the money in private equity, and regulatory pressure has eased.

Private equity looks like a “lottery ticket” at present, Alan Johnson, founder of the compensation consulting firm Johnson Associates, said. For the first time in a decade or longer, he said, “you’re looking outside from private equity saying, ‘Yeah, maybe I’d be better off at a bank.’”

Right, if every single person who starts at an investment bank is like “this is for the birds, I want out of here for the real money,” then being the one person who stays is a risky contrarian decision. You’re buying an undervalued asset, when you stay in investment banking for three years!

My basic theory around here is that banks are getting narrower. The classic business model of banking is that banks issue safe, information-insensitive, short-term deposits and use the money to make risky, information-sensitive, long-term loans. Banks perform a magic trick of transforming risky assets (their loans) into safe ones (their deposits). This has some notable societal benefits, but it is also a bit unnerving. The alchemy only mostly works; there are bank runs and failures, and there is a lot of regulatory and lender-of-last-resort apparatus required to keep things functioning.

But there is another way to fund risky loans, which is for people to knowingly make risky loans. You say “I’d like to make risky loans and charge high interest rates for them,” you go out and raise a fund, people who think that’s a good idea give you money, you use their money to make the loans, and then you pay them the interest (after taking your cut). There is no alchemy, no transformation of risky loans into safe deposits, just making risky loans with investors’ money.

The idea of “narrow banking” is that deposit-funded banks should get out of the risky loans business and just park their money at the Federal Reserve, while risky loans should be funded by long-term, locked-up investors who know what they’re getting into. This is sort of a theoretical academic idea, but I have argued that it is, to some extent, happening. We don’t have narrow banking, but banking is getting narrower. Banks are doing a bit less risky lending, and long-term, locked-up lending funds — in particular “private credit” — are doing more of it.

One form that this narrowing takes is (1) private credit makes loans to businesses, consumers, etc., and (2) banks make loans to private credit. The private credit money is junior to the banks’ money; the banks have the senior claim on the underlying pool of loans. We talk about this a lot.

But there are other forms. For instance, consumers could fill out an application for a loan, and a bank could evaluate the applications. The good risks — the consumers with good credit — could get a loan from the bank. The less-good risks — the consumers with so-so credit — could get funneled to a private credit firm for a loan. Sort of a different kind of tranching: The bank gets the first tier of safe loans; the private credit firm gets the second tier of not-so-safe loans. The bank, with its cheaper but riskier funding, makes the safer but lower-yielding loans; the private credit firm, with its more expensive but safer funding, makes the riskier but higher-yielding loans. 

Here’s a fun Wall Street Journal story about co-branded credit cards:

JPMorgan Chase recently explored a way to ease a longstanding point of contention with credit-card partners such as airlines and retailers, a plan that would open the door for private credit to get a new piece of consumer debt. …

There is often a tension between the two parties, with the merchant trying to get the bank to approve more applicants than meet its credit underwriting and other requirements.

JPMorgan, the biggest U.S. credit-card issuer by purchase volume, recently started looking into whether other funding sources could approve some of the cards that it rejects, according to people familiar with the matter. The bank sent out requests to more than a dozen entities to discuss whether they would be interested in so-called second-look applications, which would allow them to take on the risk of approving applications the bank denies, according to people familiar with the matter. …

Blue Owl, Blackstone, KKR, and Sixth Street are among the lenders whose executives have been approached about JPMorgan’s program, the people said. Documents on the matter were shared with at least some of them, the people said. 

A partnership with JPMorgan would signal another level of acceptance into mainstream finance. The bank has some of the largest co-brand partnerships, including with United Airlines, Amazon, Marriott and the Apple card that JPMorgan is preparing to take over.

Retailers want all of their customers to be approved for credit, because (1) that’s good customer service, (2) then they’ll spend more and (3) they’re not on the hook for credit losses. Banks are conservative about approving customers for credit, because they are on the hook for credit losses, and because banks have strict regulation and deposit funding and have to be very careful about credit losses. Private credit funds are also on the hook for credit losses, but they are institutionally better suited to bear those losses, so they can be a bit less careful. 

If you work at a public company that produces baked goods, and you get daily updates on your company’s egg costs, and those costs are trending higher than the market expects, and you short your company’s stock because you expect your margins to be disappointing, that is probably illegal insider trading. (Not legal advice!)

If, instead, you buy egg futures contracts because you expect egg prices to be above market expectations, is that insider trading? Umm. A few points here (still not legal advice!):

1. Clearly your company could, for its own account, buy egg futures. Commodities futures are different from stock; companies are supposed to be able to hedge their input costs using commodities futures. Buying egg futures because you expect your egg costs to go up is fine. Commodities insider trading is illegal only if it involves “misappropriated confidential information in breach of a pre-existing duty of trust and confidence to the source of the information,” because of “the special characteristics of the derivatives markets, where end users necessarily trade on the basis of their own proprietary information in order to hedge their risks,” as a regulator once put it.
2. But if you buy egg futures, for your own account, arguably you are misappropriating your company’s information. Arguably not, though. Maybe your company doesn’t care. Most companies have policies like “you cannot use any information you get at work to trade stock,” but they might not have policies like “you cannot use any information you get at work to trade commodities futures.” If you are an oil trader for an oil company, trading on your inside information about your own company’s oil purchases might be illegal insider trading: You’re pretty clearly violating your duty to your employer, by front-running it. But if you’re a baker at a bakery company, maybe trading eggs using your knowledge of your company’s purchases is fine?

This is a bit fanciful because, as far as I can tell, there are no egg futures listed on US commodities exchanges. [3] (You can substitute “wheat” if you want.) There are, however, binary event contracts listed on Kalshi that allow you to bet on, or hedge, the price of eggs. Kalshi is a commodities futures exchange regulated by the US Commodity Futures Trading Commission, so these effectively are egg futures, and the analysis above would apply. With one additional caveat, though, which is that Kalshi has stricter insider trading rules than the law does. “Kalshi's rulebook defines insider trading as trading by …  any person who has access or is in a position to access material non-public information before such information is made publicly available,” with no requirement that the person violate any duty to anyone. Is your daily update on egg costs “material nonpublic information”? Ehh, I don’t know, maybe; depends on how material it is. You might know more about egg prices than the average person, but less than the average, um, egg trader.

This is all inconclusive and dumb, but here’s a funny animated Kalshi advertisement basically encouraging bakers to trade on knowledge of egg prices that they obtain from their jobs. Legally ambiguous!

Starting next year, people who get Medicaid will need to meet a “work requirement.” At AEI last week, Kevin Corinth wrote a good reductio ad absurdum of those requirements. Basically:

1. The “work requirement,” nominally 80 hours per month, can be satisfied by demonstrating tax-return income of $580 in one month during any six-month period.
2. Gross gambling winnings count as income for tax purposes.
3. You can generally bet both sides of a football game (against the spread) at -110, meaning that if you bet $638 on the Patriots and $638 on the Jaguars, you will make $580 on the winning bet, lose $638 on the losing bet, and pay a net $58 for six months of Medicaid coverage.

The main point I would make here is that gambling is not crucial to this, and “you can meet the work requirement by reporting $580 of income” is the load-bearing element. But the gambling does make it interesting.

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