Tan Kin Lian's Blog: Credit default swaps

Tuesday, October 07, 2008

Credit default swaps - who benefits?

Someone should me a chart showing the cost of credit default swaps. Before the financial crisis, the swap rate is at average of 100 bps p.a. for well rated companies. If the structured product sells the swap to insure 6 entities, the total payout is 6% p.a. The money received from the investors were invested in CDOs and low quality bonds, which are likely to earn another 6% p.a. (this is my estimate).

It is possible that the structured product could earn up to 12% p.a. But, this is not the return given to the investors. They are given a low return of about 5% p.a. The question is, "where does the rest of the money go"? I suspect that they are taken away as charges for distribution and profit. There amounts are not disclosed to the investors.

The figures indicated by me are estimates and may not be accurate. It will be better to look at the actual figures. So far, the trustee or the arranger are not disclosing these figures. Perhaps the authority can step in and ask for these figures to be disclosed.

Even if the actual figures are lower than my estimates, there is still a question whether the charges are reasonable or excessive, and whether there is any breach of fiduciary duty.

9 comments:

Anonymous said...: Yes, I always suspect that the structured products are able to earn much more than what the bank is willing to pay the investors. The bank is not stupid. It will not be doing all the work and come up with the complex products and offer to investors for free.
I would agree to let the bank cream off some profit, as long as the products are truly safe and the payout reasonable.
However, as the truth started to unfold now, structured products are actaully highly risky. Risk-adverse investors feel being cheated as such products were sold to them as low-risk products. Banks so far have not been transparent enough about their actual profit in such complex investment instruments. It is time that the authority should step forward to investigate thoroughly to ensure that the people of Singapore are not being cheated by some greedy bankers.; October 07, 2008 4:46 PM
Anonymous said...: cannot agree more with you, Mr. Tan. That's one of the reasons that make us investors angry.

Besides, I am wondering now that after insuring the 6/8 entities, the issuer can still use the money to buy CDOs, is it possible that the pool of money was actually invested in other fields, say, house loan, after being invested in CDO? as for CDO, the seller does not really pay money to the buyer until there is credit event.; October 07, 2008 5:08 PM
Anonymous said...: For ordinary folks, after this expensive lesson learned, is to steer clear of these products. Then the banks will have no chance to "cheat" and the RM positions will also "disappear" due to market forces.

Learn to save regularly and live within one's means and stick to FDs, small but steady like a tortoise and also compounded and guaranteed. Which is what I have been doing all along. This does not make me very rich but I am not poor either. Just an above average Joe who does not believe in luck or big quick bucks.; October 07, 2008 7:45 PM
Anonymous said...: Upon knowing the fatal news, we told the RM that we thought our understanding for the Note 5 is $ placed with a few underlying banks and should one of it goes bust, will only loose that said portion related to one bank. Obviously, now he claimed this is not the case and also mentioned that $ was not "physically" placed with those underlying banks but rather this note was looked upon to one of those underlying bank's performance on don't know what asset class. Shamful to say till now still don't understand how this note works ?? When I stressed to him the complexity the RM said it has never such case and is very simple ONE bank bust, the whole thing gone! Sharks, if only he mentioned that a year ago (during the sales talk)! Still remember when we asked him whether what will happen to our $ if one bank goes bankcrupt, he said that the possiblity is as low as ZERO and he did not mention the zero recovery facts! So expect us to read the fine print but refuse to highlight or mention it to us and not accuse us of not being careful and to take full responsiblity for our oversight! Sigh :(; October 07, 2008 10:53 PM
Anonymous said...: in the 1st place, why does mas allow such non-disclosure to happen? when insurance product has to disclose the full distribution cost.

can the public sue mas on this? to some extent the frame work 'discriminates' certain group, and thus lead to consumers' mishap; October 08, 2008 1:52 AM
Anonymous said...: We are given a raw deal. This is very unfair and one-sided.
The investors are always on the lossing end.
These products should not be offered to the retail market at all.; October 08, 2008 8:07 AM
Lucky Tan said...: I was pondering on the same point also especially with the DBS High Notes 5 in which investors became insurers for 8 entities. The return of 5% seems extremely low and gives the false impression of low risk.

How much was the actual CDS valued at? ....10%? The return would have indicated the actual high risk of the products and breach of fiduciary duty.; October 08, 2008 1:17 PM
Anonymous said...: DBS Bank bought more than 160 types of securities with HN5 investors fund.

I am waiting for their reply on the total monetary value of all 8 reference entities used in the CDS with Constellaton and also the premium DBS Bank pay to Constellation for this CDS.; October 08, 2008 11:35 PM
Anonymous said...: yes this is a good point.
I used to work in DBS.
I know of RMs who were selling ELNs (Equity linked notes) and Dual Currency Deposits like hot cakes.
Because option premiums are not transparent to the public, the option (for instance) might have paid 25% but the investor was only given 7%. The bank also does not regulate or impose guidelines as to how much premiums are being passed onto the investor. To make matters worse, Sales targets are measured by sales REVENUE and therefore it's further incentive for RMs to "earn" an unreasonable fee for the product.; October 16, 2008 11:34 PM