By Larry Haverkamp
BANKS sold us billions of dollars of risky structured products called 'linked notes' for short. They came with big risks, which have led to big losses.
DBS High Notes 5 are now worthless. Loss: $103 million.
Merrill Lynch Jubilee 3 are worthless. Loss: $28 million.
DBS High Notes 2 sell for 22 cents on the dollar. Loss: $55 million.
Lehman Brothers Minibonds are in limbo. Loss: unknown.
There are more.
Sales have been in the billions over the past 10 years. Banks admit to mis-selling to the elderly and uneducated. But the problem is bigger. Mis-selling extended to everyone since the prospectus mis-stated costs and risks.
Issuing banks have never disclosed their charges for linked notes. Is this serious enough to require a full refund to all investors?
A precedent exists. In the US and Europe, global banks were required to repurchase $80 billion of auction-rate notes and pay $750 million in fines. Even now, the issuing banks refuse to disclose their charges. They say the law doesn't require them to.
DBS told me: 'Pls understand that certain (pieces of) information, especially re remuneration payouts or the detailed breakdown of how a product is being calculated, are proprietary information. Where required under regulatory or statutory guidelines, we will disclose the necessary.'
Two risks are not disclosed in the prospectus.
First, default of a 'reference entity' causes the structured product to become worthless. Prospectuses show that risk is less than 1per cent for each entity. Linked notes' first-to-default structure, however, makes the risks additive. For DBS High Notes 5, it adds up to 8 per cent. No one knew the risk was so high. The prospectus never mentioned it.
Second, many linked notes are invested in AA-rated collateralised debt obligations (CDOs), which the prospectus describes as safe.
It says: 'A borrower rated 'AA' has very strong capacity to meet its financial commitments. It differs from the highest rated borrowers only in a small degree.'
While this is true for regular bonds, it is not for CDOs. Ratings are not comparable because CDOs are much riskier.
For example, the default rate of regular bonds ranked Baa by Moody's is only 2.2 per cent. CDO bonds with the same Baa ranking have a default rate of 24 per cent. Only now are we seeing effects of the high risks. Many CDOs have been downgraded. Some are near default.
It explains why banks repurchase structured products at a discount. DBS pays only 22 cents on the dollar to buy back its High Notes 2.
Is this fair? It is hard to say since investors have very little information about the underlying bonds and CDOs.
Hong Kong investors have been more aggressive. In a protest outside DBS headquarters on Oct 20, a sign in Chinese read: 'Product has poison. Asking and reprimanding DBS.' DBS gave in. It distributed a list of the CDOs for each structured product AND had a bank officer explain it.
Singapore investors also have a right to this data. DBS confirmed this when it told me: '...The list of CDOs for the respective Notes are available to clients if they asked for them.' The problem is most investors don't know what to ask for or how to interpret the list. If banks truly wanted investors to know, they could explain on their websites how they arrived at the structured product's value.
Otherwise, there is no way to know if banks are taking advantage of their information monopoly to buy back these investments at too steep a discount. Take High Notes 2. DBS buys them from investors at 22 cents on the dollar. Assuming no defaults, it can simply wait until maturity in 2011 and then redeem at 100 cents on the dollar. For the bank, it is a 350 per cent profit.
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11/09 - 11/16
- New swap counter party to replace Lehman Brothers
- God help the righteous
- High risk is not disclosed in Prospectus
- High risk of credit linked notes, inadequate retur...
- Retrenchment Loan
- Complexity of Credit Linked Notes
- Be careful if you wish to redeem your credit linke...
- Banker fill up complaint form, but did not disclos...
- Structured products linked to Lehman Brothers
- Why You Need to be at Hong Lim Park Tomorrow (15 N...
- Retrenchment and its impact on Singaporeans
- SCMP:Divine intervention in Legco debate
- Adequate saving for retirement
- Financial Advice for Young People
- Reuters: Financial crisis politically awakens Sing...
- Hear the voices of High Note 2 investors
- Open letter to chairman of DBS Bank
- Unexpected surge - 700,000 visitors to my blog
- Trustees act to terminate the swaps
- SCMP:Approval ratings of finance chiefs drop
- Rebuttal to "invest with your eyes open"
- SCMP:Legco probe best hope for minibond mess
- Morgan Stanley hotline for Pinnacle notes
- Accountabiliy, transparency and social justice
- Reply from MAS on the 3 petitions
- Letter to Prime Minister on Credit Linked Notes
- Speaker's Corner - 15 November 2008
- Sunday Times article on Petitions
- Call to the Government to be fair to the affected ...
- Business Times: Look at pricing structure, risk di...
- SCMP:Time to reconsider class action lawsuits
- SCMP:Two investors reach settlement with bank befo...
- SCMP:Legco likely to pass bill on minibond investi...
- New Paper: Structured Products: "What banks don't ...
- CBS Videos on derivatives, etc
- Obama's Speech at Election Night
- Did the RM explain "first to default" ?
- Sued for misleading investors
- Joseph Stiglitz
- Quality of financial advice and fact find
- Leadership styles
- Investigate the creators of the structured product...
- Decisions of FiDREC
- Investors should be aware about the risk: MM
- HK: Probe into minibonds bankers wins support
- Credit default of Pinnacle Notes Series 9
- Loss in the Singapore reserves
- Obama's Day
- Is this fair?
- SCMP:Bank admits substandard tactics
- SCMP:Minibonds meeting ends in recriminations
- Exchange currency in a bank - an analogy
- Rejection letter by DBS
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