MiniBonds and Structured Products...

[Sabian]

STRUCTURED PRODUCTS SAGA

 

5 myths banks want you to believe

 

By Larry Haverkamp (Doc Money)

[email protected]

 

16 December 2008

 

1. Banks and brokers are repaying investors for the money they lost

 

As of 10 Dec, Hong Kong banks had settled 60 of the 40,000 structured product cases (0.2 per cent).

Investors got back $3.9 million of the $2 billion they invested (0.15 per cent).

 

In Singapore, the amount is unknown.

Our banks and brokers refuse to disclose it.

 

2. Both issuing banks and distributors are to blame for losses

 

True, but issuing banks deserve more of the blame since they put the deals together.

 

That is why DBS is at the centre of the storm.

It structured the products - like High Notes - as well as sold them.

 

Other issuing banks include Merrill Lynch (Jubilee Notes), Morgan Stanley (Pinnacle Notes) and Lehman Brothers (Minibonds).

 

3. Based on the high returns, people should have known they were getting into a high-risk investment

 

What high returns?

Take Minibonds, with sales of $508 million.

 

It promised a 5 per cent return, which was only 1 or 2 per cent more than the same maturity government bond yields three years ago, when Minibonds were sold.

 

A 5 per cent return did not trigger any alarms. It was reasonable.

But the 5 per cent is a 'net' and not a 'gross' return since it doesn't include costs.

 

Add the costs to get gross returns, which are much higher.

 

Then it is easy to see that the structured product would need to take big risks to earn so much.

 

The problem is, issuing banks around the world have an unspoken agreement: They do not reveal charges for credit and equity-linked notes.

All costs are either buried in the initial pricing or deducted from the yield.

No issuing bank will disclose them.

 

4. Issuing banks don't gain from investors' losses

 

This is an issue with High Notes 5.

Investors lost $103 million and a counterparty made $103 million.

What counterparty?

 

The prospectus says it is DBS, but DBS says it sold off its claim.

Sold it to what party? For how much? Sold when?

 

DBS won't say.

It has taken the stand: 'Where required under regulatory or statutory guidelines, we will disclose the necessary.'

 

5. Sellers are returning investors' money

 

DBS has charged $70 million against earnings to pay back investors.

 

But there is a wrinkle.

The $70 million also includes payments to Hong Kong investors, who suffered more losses.

DBS won't say how much money goes to Hong Kong versus Singapore.

 

It told me: 'As a matter of policy, we do not discuss individual cases, thus will not divulge how much will be paid to investors in each country.'

 

It also won't say how much it re-purchases from investors at a discount, holds to maturity and then redeems for a profit.

 

For example, DBS stands ready to buy back its High Notes 2 for 20 cents on the dollar.

If it holds to maturity and redeems at $1.00, the bank makes a profit of 80 cents.

 

In the worst case, High Notes 2 would default and the counterparty - DBS - gets the money that investors lose.

Either way, the bank wins, thereby reducing the final costs to less than $70 million.

 

DBS says it will not disclose the final costs - or profits - it expects from reimbursing Singapore investors.