STRC’s moment of truth?

The first banking scandal to be exposed during the Great Financial Crisis was the mis-selling of Auction Rate Securities, or ARS — fixed-income securities whose yields periodically reset higher to ensure that they trade at par.

The idea is that the yield changes so the price doesn’t have to. 

Unfortunately, this gave investors the idea that ARS were a high-yield form of cash.

Banks encouraged this misperception, advising their retail customers to use them as a place to park money they might need on short notice — for medical expenses or weekly payroll, for example.

One UBS customer put $75,000 of savings earmarked for college tuition into ARS because, she said, “my broker kept assuring me nothing was safer.”

Many, many things were safer.

As the financial crisis began to unfold, yield resets were no longer enough to keep ARS trading at par. Banks stepped in, maintaining the illusion of stability by buying the ARS themselves. But in February 2008 the crisis was making too many other demands on their balance sheets — they stopped buying and the market for ARS collapsed.

Investors who thought they owned a cash-like asset they could always sell at par discovered they owned something they couldn't sell at all.

The regulatory response came unusually quickly. Just ten months later, Citi and UBS settled an SEC investigation into their marketing of ARS by agreeing to return $30 billion to retail customers.

It was an open-and-shut case of banking malfeasance. The two investment banks had “misrepresented to customers that ARS were safe, highly liquid investments that were comparable to money markets,” the SEC said. Financial justice was served and we learned something, too.

Unfortunately, every lesson in finance eventually has to be relearned.

Recently, Michael Saylor has been targeting the same kind of investors, with the same kind of resetting mechanism, and the same misrepresented sales pitch: STRC is no more like a bank account than ARS ever were.

Pitch v. prospectus

Investors who read the prospectus know what to expect from STRC. 

In it, Strategy says that its "current intention" is to adjust STRC’s dividend yield in a way that it believes will keep it trading "at or close to its stated amount of $100 per share."

But it makes no promises: “We are free to abandon our stated intent… at any time.” It warns that "the trading price of the STRC Stock could be significantly volatile."

Investors who skipped the prospectus and listened to Michael Saylor instead might have been surprised at the recent volatility: STRC traded as low as $91 last week.

That’s not exactly what we were promised. In December, Saylor likened an investment in STRC to holding cash: “Our goal is to provide you a bank account that pays you 10%.”

Or higher. At Blockworks’ Digital Asset Summit in March, he said that, because its dividends are tax deferred, for a New York City taxpayer STRC is “like a bank account that yields 23%.”

He described this as “risk-free.”

Perhaps he got caught up in the excitement of the conference, as many do. So let’s not hold him to a risk-free 23%.

But Saylor repeated versions of that pitch many times, including in an AI remake of Spinal Tap: “We can stretch all the way to 11%.”

(Saylor refers to STRC as “stretch.”)

More officially, he made this pitch on an earnings call in October. STRC, he said, “is a high-yield savings account that just pays twice your normal savings account if you understand and if you believe in Bitcoin.”

Can we hold him to that one? I guess the “if” is a disclaimer of sorts — if it turns out that STRC was not risk free, it will be our fault for failing to sufficiently believe in Bitcoin.

Hmmm. Would that line of defense survive an SEC investigation?

Asking, because we might soon find out. With STRC trading as low as $91 last week — a long way from par! — it feels like Strategy could be approaching its ARS moment.

Glenn Cameron, Global Head of Institutional at the bitcoin financial service firm Onramp, told me in an email that Strategy’s “funding engine” of selling STRC to buy bitcoin is now facing its first big test: what happens when resetting the yield on STRC is no longer enough to keep it trading at par?

Saylor has said the yield on STRC is paid with capital gains earned on bitcoin. But that must be aspirational because those gains don’t yet exist. Strategy is almost 20% underwater on its $54 billion horde of bitcoin at the moment.

With no capital gains to distribute, Strategy has been paying STRC investors with their own money instead. The reason investors don’t immediately own taxes on STRC dividends is because those dividends are a “return of capital,” not earnings. 

That presumably cannot go on forever. “A capital structure that survives volatility only by adding permanent obligations is a structure with a finite number of cycles in it,” Onramp CEO Michael Tanguma wrote in April.

Strategy has already had to raise the dividend on STRC seven times — from 9% to 11.5% — to keep it trading near par (as the prospectus promised it would try to do).

This has added $268 million of annual obligations, Cameron estimates.

Ouch.

STRC shares rebounded to $97 this morning, so perhaps another increase will get it all the way back to par again. If so, that might keep Strategy’s funding engine running just fine.

But last week’s low of $91 suggests we’re getting close to the point where it stalls. If so, Saylor may soon have to choose between selling bitcoin at a loss and suspending the dividend on STRC.

The latter seems more likely. “Investors could realistically face one to two years of a suspended product generating no income,” Cameron warns. 

That would be a problem for anyone who took Saylor’s advice to use STRC like a bank account — and given that retail investors hold roughly 80% of STRC, many likely have.

(Note: approximately 0% of retail investors have ever read a prospectus.)

The good news is that STRC is a cumulative security, so, should the dividend be suspended, the missed payments would accumulate — and compound.

“At an 18% rate,” Cameron notes, “a $100 claim grows to roughly $120 after one year, $143 after two years, and approximately $170 after three years.”

STRC holders who manage to hold on long enough may eventually be made whole. But if so, it would be bad news for holders of Strategy’s common stock, MSTR.

“Those accumulating unpaid dividends represent a senior claim on the company’s assets and cash flows,” Cameron explains. “Every month that passes increases the size of that claim. As a result, the Bitcoin price required to restore value to the common equity keeps rising, even during a recovery.”

Yikes.

Cameron is careful to stress that this is not a forecast. He’s only trying to correct the record on what STRC is, what it means for Strategy’s investors, and when it might start to matter.

“The point is not that a collapse is coming,” he told me. “It’s that [STRC] is sold as stable, like a savings account or a bank account, and it has now entered, for the first time, the kind of environment that is beginning to reveal to people that that is a misrepresentation, is misleading, and these securities have been missold.” 

For Auction Rate Securities, it took the Great Financial Crisis to expose the gap between the sales pitch and reality. The moment of truth came on February 13, 2008, when investment banks chose to protect their balance sheets over keeping their promises to their customers.

For STRC, that stress test is a falling bitcoin price — and the moment of truth will come when Strategy has to choose between its bitcoin and its investors.

— Byron Gilliam

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