Tuesday, July 14, 2009

The New Paper:The real problem? Underwriters hiding product's risk

14 July 2009

For the first time, the Monetary Authority of Singapore has banned 10 banks and brokers from selling structured notes for six to 24 months.

The ban doesn't affect other structured products. POSB still advertises 2.78 per cent interest in the first year for its five-year structured deposit linked to four Singapore blue chip companies.

That one is safe but, as usual, it is impossible to calculate the yield you can expect after five years.

Banks won't tell what we really need to know: A history of actual versus advertised yields for structured deposits.

Banks and brokers sold us billions of dollars of structured notes. Defaults stand at $686 million. Some have become worthless, like DBS High Notes 5. Others still have value, like Minibonds.

MAS report

In the just-released 119-page MAS report, 10 banks and brokers describe how they measure customer risk attitudes. It's useful but doesn't address the real problem: Underwriters hiding the product's risk.

Structured notes promise a safe-looking yield of around 5 per cent per year. But underwriters invest your money in risky bonds that yield much more, like 15 per cent. They keep the difference of 10 per cent, which is called 'expenses'.

The problem is, they don't disclose expenses or total yield in the prospectus or anywhere else. Investors see only their 5 per cent yield, which is low enough not to trigger any alarm bells.

That is half the story. The other half is a built-in conflict: Underwriters have fixed expenses and can earn more by investing your money in high-yielding, risky bonds.

Those bonds are more likely to default but underwriters have that covered too. A typical contract is written so that investors lose everything if only 10 to 15 per cent of the bonds default.

Investors must then forfeit the remaining 85 to 90 per cent of 'good' bonds to the underwriter. An example of this is Pinnacle Notes 9 and 10.

Underwriters get an even better deal when a 'reference entity' - like Lehman Brothers - defaults. It triggers transfer of 100 per cent of investors' money to the underwriter. An example is DBS High Notes 5.

In that case, DBS said it sold its rights to the $103m of investor losses. I asked, but the bank declined to say when it sold, how much it received and whether the buyer was an affiliated company.

Next, DBS set aside $70m to refund losses here and in Hong Kong.

The 7 Jul MAS report shows DBS made refunds of $7.6m to High Notes 5 investors. That is 11 per cent of the $70m DBS allocated to reimburse Singapore and Hong Kong investors.

The low payouts here may be explained by higher payouts in Hong Kong.

Compensation by HK v S'pore banks

WE HAVE heard that 63 per cent of decided structured note cases received full or partial refunds.

That is impressive, but the number falls considerably when you look at dollars paid to all investors.

The data comes from the 7 Jul MAS report, a 26 Jun speech by Senior Minister Goh Chok Tong and losses reported for Pinnacle Notes 9 and 10.

It shows $107m out of $686m of defaulted notes - 16 per cent - was returned to investors.

Contrast that with Hong Kong banks. On 7 Jul, The Standard newspaper there reported that 16 distributors for Minibonds met with the Securities and Futures Commission on 29 Jun to indicate they would pay 60 per cent of the amount invested. A few investors - aged 65 and above - would receive 70 per cent.

To recap, our banks paid investors 16 per cent. Hong Kong banks propose paying at least 60 per cent.

8 comments:

symmetrix said...

If DBS has sold its rights to the $103m of investor losses, shouldn't the monies received by DBS be returned to the investors who bought HN5? This is a fair request to ask of DBS.

Anonymous said...

The Straits Times is very good in providing simple to understand visual and graphical explanations and illustrations of incidents, events and complicated subjects.

Minibonds and Pinnnacle Notes are certainly complicated subjects worthy of such illustrative explanations.

Is ST being gagged and selective in not doing a writeup on these structured products?

Anonymous said...

Evidences are stacked high against the FIs and RMs. They will have no where to run unless they pay up.
And pay up full and that is what they must do to compensate monetarily and emotionally.
How MAS wants to punish the FIs and RMs, we are watching, the potential investors are watching, the kind of protection consumers will get after the dust has settled down.
It will the defining moment for the industry.

Anonymous said...

"To recap, our banks paid investors 16 per cent. Hong Kong banks propose paying at least 60 per cent. "

Why so unfair? Must highlight this for SGean toknow.
Must ask those resp. why so low?
Is it fair?
Why in SG, if yr edu level is above primary, u don't get compensated. In HK, every one get compensated.
What is the logic?

Anonymous said...

Wow!! So unfair.
Who would buy if they really understand?? Why would an educated person buy if he/she understand.
This is the evidence that those educated people were misled into buying. See extract below.


"That is half the story. The other half is a built-in conflict: Underwriters have fixed expenses and can earn more by investing your money in high-yielding, risky bonds.

Those bonds are more likely to default but underwriters have that covered too. A typical contract is written so that investors lose everything if only 10 to 15 per cent of the bonds default.

Investors must then forfeit the remaining 85 to 90 per cent of 'good' bonds to the underwriter. An example of this is Pinnacle Notes 9 and 10."

Anonymous said...

A good article which explain clearly.

Anonymous said...

All the FI and MAS are out to cover up this fiasco and let investors suffer for many years to come with the huge losses.

Unknown said...

Singapore FIs pay 16% compensation compared to Hong Kongs 60 to 70%. DBS compensate Singaporean 7% but compensate Hong Kongers 60% to 70% DBS sold its rights to $103m refused to disclose how much it makes. MAS sits pretty behind the castle and earns big salary while the FI's exploit Singaporeans! Why is it DBS can compensate Hong Kongers 60 to 70% but refuse to compensate Singaporeans and MAS takes a hands off policy?

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