Tan Kin Lian's Blog: Why the credit linked notes are highly risky

Sunday, October 12, 2008

Why the credit linked notes are highly risky

Some anonymous postings claimed that the structured products are linked to six entities that are rated A or higher at the time of issue, and are therefore safe. Nobody could have forseen that these companies could get into bankrupcy.

This argument is not correct. These structured products are highly risky for the following reasons:

1. The structured products take a bet on the six reference entities. The failure (or credit event) on any one entity could cause the loss of the entire capital. The presence of six entities (i.e. swaps) increases the risk six-fold.

2. The money received under the structure is invested in lower quality assets, such as collateralised debt obligations (CDO) to earn a high rate of return. Additional bets (i.e. swaps) could be taken on the failures of these underlying assets.

I estimate that the income stream of the structure could be 10% or more each year. If so, this will classify the structure as a junk bond, which is highly risky. However, it seems that only 5% is given to the investors for the high risk that they are shouldering.

These figures are just my guess. I hope that the Monetary Authority of Singapore will carry out the investigation, as asked by the Petition, to will look into the actual accounts of the structure, i.e. the income stream, the expenses and profits that are taken out, and if the parties had observed their fiduciary duty to the investors.

8 comments:

Anonymous said...: Dear Mr. Tan,
Before I invested, I read the brochures and that is what the brochures implied. I read the prospectus too but it is difficult to understand and my interpretation is heavily influenced by what the brochures have stated. That is we are investing in the referenced entities and only failure in the referenced entities would create a credit event. I dont think the prospectus spelt out how the whole structure would work based on what you have outlined or at least I am not expert enough to read between the lines.

I invested based on my understanding of the misleading brochures and unclear prospectus. I understand that I have no case against the FI and I have given up. I may have a case against Lehman but Lehman is bankrupt so I have to move on with a lot of pain.; October 12, 2008 9:14 PM
Anonymous said...: Dear Anonymous,
We are all in the same boat. Please don't give up. At the very least, please lodge a formal complaint. It can be similar to what you have posted. You don't have to spend money and you have nothing to lose. It will also serve as feedback to enable MAS to review its supervision.; October 12, 2008 10:54 PM
Anonymous said...: Agreed. We were told the money were invested in "AA" rated bond and kept by the trustee.
It turn out that the securities are of low quality and the value kept dropping. This is misleading.; October 12, 2008 11:36 PM
ym said...: the logic of these RMs (effectively self-glorified salesmen, merchants of toxic waste) are flawed and used to cover their a$$es only..

these products effectively :
1) duped retail investors into becoming credit insurers..
2) insures only handful of companies and if any 1 of them goes bust, the principal is lost..
thats clearly super-high risk to me..

these salesmen's logic is akin to saying - the today's 4D 1st prize of 8658 chance is very very small, so any uncle/aunty can earn a safe low risk income of $1.. but if shit happens, you lose $5,000..; October 12, 2008 11:49 PM
Anonymous said...: Can a retail investor become an insurer? Do you hv the capacity to loss? Sad.; October 13, 2008 7:49 AM
Anonymous said...: I find now is the time for the goverment(MAS?) using 'Top-down' approach to give the people an explanation and to redress for the affected victims, instead of pushing the responsibiliy to the victims to gather together to make an appeal/petition('Down-Top' approach), for the latter will be quite difficult for the ordinary folks here and can never be an effective way as compare to the former, also seeing that not many of them will aware of such an appeal activity going on here. Why isn't the authority doing anything? Isn't it very clearly now this is a very deceitful deal, and many many people in other countries as well(besides Singapore) are also affected. They all can be sound witnesses, aren't they? Do we still need further prove or investigation? I really don't understand what the top is thinking? I think clearly this is the very first priority the relevant authority should take care now (but unfortunately we did not heard of any yet):(; October 13, 2008 3:02 PM
Anonymous said...: The contrast in the approach to this saga between HongKong and Singapore is well documented by Lucky Tan blog
http://singaporemind.blogspot.com/2008/10/break-news-minibond-holders-in-hk.html

From the above, I gathered that the underlying asset that this "minibond" are the CDO and that CDS are purchased to insure against the default of this asset.
CDS as I understand is insurance with a different fancy name so that they can avoid regulation by the authority. If the CDS is issued by Lehman, then of course there is nothing to say but if the CDS is issued by other financial entities like Goldman Sach, JP Morgan,etc then there is a recourse to claim from this financial institution. It would be odd that Lehman issued the CDO and also the CDS as there is definitely a "conflict of interest"; October 13, 2008 5:01 PM
Anonymous said...: I am trying to understand, if insurance(CDS) are purchased to insure against the default of these underlying assets(AA rated..) as you mentioned, where is the risk of losing the capital even if one of the entity failed. As I heard from other blog for some series, that most of the underlying assets are big time China comapanies. If CDS were bought from Lehman brother(major conflict of interests) and none of the underlying assets entities defaulted, the minibond holder should not lose anything neither, right?? If assumed, one the entities failed, Lehman(seller of the CDS) could come up with money to pay, there are still underlying other assets which in the long run will not cause much lose of capital, right??? Can someone trying to explain to me how the poor investors lost their capitals?? My guess is that the investors of minibond/bank who sell the minibond are not the buyer of the CDS(credit default swap insurance) but seller of the CDS that is when one entities defaulted , the buyer of insurance(CDS) demand their payment and the bond holders(aunties uncles/banks/lehman brother) need to come up with money which they do not have and thus selling the underlying asset/capital to pay(lost capital) and Bank selling those CDS has to cover the payments, thus the big write-off (many millions) by singapore big banks....Please, please, please can someone explain to me if the banks are the seller of CDS or are they the buyer of CDS..for these exotic notes that there are offering??? Do you think that some of the local banks are actually involved in selling CDS? In wall street journal there is article mentioned that the tamasek was involved in selling CDS as well....Hmmm; October 14, 2008 6:52 AM