Category Archives: Banks

European money market funds–charging to hold your money?

September 6, 2012 By in Banks, Industry Analysis, Investment firms, Portfolio management, Recent Market Action, Securities regulation, Strategy Tags: , , , , , , , , , 1 Comment

That’s what the Financial Times suggests is about to happen, based on what the largest European money market fund managers have told them.

money market funds

Money market funds are a kind of mutual fund that specializes in holding very short-term government and corporate debt.  They became popular as a much higher-yielding, but safe alternative to bank deposits well over a quarter-century ago.  Although not insured by governments in the way bank deposits are, their investing operations are designed to preserve net asset value at a constant level.  That’s usually $1 or €1.  Interest is paid in new shares.

defending net asset value

Over their entire lifespan, there have been only a small number of incidents, involving a small minority of funds, where investors have received less than their initial purchase price when redeeming shares.  There have been cases–only a few–where funds have made imprudent investments stretching for yield.  But the financial conglomerates sponsoring the wayward managers have invariably made investors whole, typically by buying the dud paper at the initial purchase price.

today’s situation in the EU

Why is today any different in Europe?  Two reasons:

–the European Central Bank has recently reduced the interest rate it pays on overnight deposits from 0.25% to plain old zero.  And it says it might reduce rates further, meaning it will begin to charge banks for holding their money.

–the long-running EU debt crisis has created a two-tier structure of sovereign borrowers, haves and have nots.  Interest rates on short-term French and German notes are already negative (meaning you lend €1 to either country and get €0.995 or so back when the note comes due).  Yes, a money market fund can get a positive yield by lending to Spain or Greece, but only by taking on extra risk.  Also, once your clients learn what you’re doing, they’ll probably move their funds elsewhere.

A manager can, of course, think about buying longer-dated securities that do pay interest.  But he takes on interest rate risk by doing so.  Just as important, the fund’s charter will doubtless bar, or at least limit, such investments.

To sum the situation up, money market funds promise safety + a better yield than bank deposits.  In today’s EU, they can’t deliver both.

plans being considered

According to the FT, some fund sponsors are toying with the idea of keeping the net asset value constant, but charging the negative interest rate to accounts by decreasing the number of shares an investor holds.  Others appear to be considering levying charges in some form, but outside the fund, so that neither the asset value nor the number of fund shares will be affected.

bank accounts must be in the same situation

Given that money market fund managers are usually much more efficient than their bank counterparts, the banks themselves are likely beginning to lose money on savings accounts.  So it’s possible that in the stronger EU nations, banks will begin to charge customers a monthly fee to safeguard their money.

more than an oddity

I think the most important information to take from this discussion is that the money market fund sponsors don’t expect the situation to change any time soon.  If they thought that negative returns on government notes were a three- to six-month aberration, they might quietly suffer through the losses.

But they’re not.  They’re planning on the current situation being around for a long time.

wealthy Asians are ditching western wealth management products

August 13, 2012 By in Asian economic development, Banks, emerging markets, Industry Analysis, Investment firms Tags: , , , , , , , 1 Comment

…that according to a recent article by Bloomberg.

how so?

Two quotes in the article seem to me to sum up the situation:  “We felt we could do better ourselves,” and “There is a disparity between banks’ income requirements and clients’ interest.”

The conclusion doesn’t surprise me very much.  After all, Americans have been leaving traditional brokers for a do-it-yourself approach for years.  What is news to me is that wealthy Europeans appear to be increasing their reliance on wealth managers, not paring back their exposure.

unattractive products

There are two basic reasons I find most “sophisticated” wealth management products less than compelling.

the deal structure may be poor

In many traditional tax shelter products, for example, the upfront fees and commissions that clients, as limited partners, pay can be as much as 20% of the money they put in.

Their cash flow share is usually disproportionately small.  The general partner will contribute, say, 20% of the partnership assets but collects 40% of the cash flow.  The limited partner puts in 80% and collects the remainder.  The general partner’s contribution may not be cash, but rather assets whose appraisal value is open to question–something which could tilt the sharing of cash flow further against the limited partner.

the client may not get access to the best assets

Marketing materials invariably illustrate how the investor will hold equity in, say, fast-growing privately held firms in areas where foreign ownership is severely restricted.  The apparent promise is of extraordinarily high gains.  If, however, you examine the returns investors have achieved in the past from similar offerings by the same local promoter, they’re probably equivalent to those of the local stock market.  Lots of sizzle, then, but little steak.

pressure to cover high fixed costs

Traditional wealth managers can have surprisingly high fixed costs.  They will likely have offices in high-rent buildings.  They may have extensive administrative and support staffs.  Successful salesmen may have guaranteed contracts at high compensation.  As a result, firms may need to sell a lot of products each year–whether good deals are available or not–just to cover their costs and make a contribution to corporate overhead.  In a situation like this, the pressure is typically to push iffy deals to clients with fingers crossed in the hope they will succeed.

inherited wealth in Europe?

Why are Europeans content with at best so-so treatment?  I don’t know.

Bloomberg says it’s because wealthy Europeans tend to have inherited their money, and are therefore more patient (does this mean clueless?), while wealthy Asians (at least potential wealth management clients) are self-made men and tend to be less tolerant.

“good” families and “bad”

I’d offer a slightly different thought.

Anyone who studies Asian equity markets soon realizes that the region contains many family owned conglomerates.  Virtually always, the family will have its assets in both privately held and publicly held companies.  In all cases, the private company does better than the public one.  That’s just life.

What separates the public companies of “good” families from “bad” is how they treat minority shareholders in the public entities.  “Good” families will select assets/projects for the public to hold that have strong profit characteristics; “bad” families will select ones where they have already squeezed out most of the profit potential in the private company.  In the former case, the public investors can consider themselves sort of junior family members, maybe distant cousins.  In the latter, they’re just a disposal service.

I think wealthy Asian investors have concluded that western wealth management looks much more like the work of “bad” families than “good.”  They’re probably right.

European clients may not be as hands-on, and their more mature equity markets may not invite the same good company/bad company comparison.

chit funds, crowdfunding and p2p banking (II)

April 19, 2012 By in Accounting, Asian economic development, Banks, chit funds, chit funds, Current Market Thoughts, emerging markets, Industry Analysis, P2P lending Tags: , , , , , , , , , , 1 Comment

two lessons from history

Thailand

I was just getting acquainted with Thailand when the Ms. Chamoy Thipyaso chit fund scandal broke.  “Mae” (=Mother) Chamoy, the wife of a Thai Air Force officer, appeared to be running a very large chit fund investment operation that was stringing together a sequence of startlingly high investment returns.  She had agents throughout Thailand collecting new money for her.  Money was pouring in.

The fund turned out to be a gigantic Ponzi scheme, however.

The scheme sustained itself for an unusually long time.  It continued to operate even after it had become so large (US$100 million+) it was implausible to think Mae could find enough lucrative “secret” microfinancing opportunities in Thailand.  Several reasons for this:

–people wanted to believe.

–the fund appeared to have the backing of the military, the ultimate source of political and business leadership in Thailand.  This gave an implied assurance that the investment results were real.  Prominent high-ranking Air Force officers invested with Mae, and forcefully urged their subordinates to do so as well.

–investors who thought about withdrawing some of their “profits” were pressured not to do so, with the threat that if they took money out they would be blacklisted and not allowed to invest in the fund thereafter.

Interestingly, large investors in the Chamoy fund continued to urge their friends and work subordinates to plow money into the fund even after they realized it was a Ponzi scheme.  Their rationale?   …it bought them more time.  That extra time allowed them to continue to enjoy a lifestyle they knew was going to end when the fraud was discovered.  And it allowed them to arrange their financial affairs in a way that would minimize the negative impact on them personally.  To followers of the Bernie Madoff case in the US, this must certainly sound familiar.

my thoughts

In my reading about microfinance, it seems that Ponzi schemes have been a constant problem wherever third-party chit funds–not the ones where friends and neighbors lend to one another–operate.  That means virtually everyplace in South Asia and Africa.  There seems to be an especially large amount of study done of the industry in India, which I have no practical experience with (because the stock market isn’t easily open to foreigners–and I think the political environment is particularly unfriendly toward equity investors.)

Personally, I’d worry more about Ponzi schemes in the US springing up among the firms that the JOBS Act will allow to raise equity.  These are the entities that won’t have adequate financial controls or accounting statements for shareholders.

My chief p2p banking concern is a more prosaic one–that the present very low loan loss rates will prove to be more a function of the industry’s newness rather than of the creditworthiness of borrowers.  Time will tell.  And, unlike fraud, this is a risk we can take precautions for.

Taiwan

There was a unique twist to the Taiwanese chit fund industry that I encountered in the mid-1980s.   Chit fund loans were secured by post-dated checks issued to the borrowers by the lenders.  In Taiwan at that time, “bouncing” a check–having insufficient funds in the account to cover payment–was a felony, punishable by the check writer serving time in prison.

The threat of jail time was thought to be sufficient incentive to ensure repayment.  So no one worried too much about the creditworthiness of the borrowers, which–as it turned out–included large publicly-traded companies.  American accountants I met, who’d been sent to Taiwan to break into the auditing business there, told me that they could see the fact of unaccounted-for money sloshing around in potential client companies.  They just couldn’t see how much.  Because of this, they were reluctant to take any engagements.  And they were continually undercut by local accounting firms who charged virtually nothing for “audits.”   American bank lending officers told me the same thing.

The chit fund business received a major shock, during a mild economic downturn, some large companies had made hundreds of millions of dollars in chit fund loans–all unrecorded in the financial accounts–that they couldn’t repay.  Bankruptcies resulted.

my thoughts

This is another potential problem for equity holders in firms crowdfunded under the JOBS Act.  Without audited financials, it’s impossible for an outside investor to determine what the capital structure of a company is.

I also think, à la Taiwan, a legitimate auditor will simply walk away from a suspect company rather than make a public outcry.  Non-disclosure agreements may force it to do no more.  A less fastidious auditor, one nobody ever heard of, might take the business and issue a clean opinion.  After all, Bernie Madoff got one for years, didn’t he?

chit funds, crowdfunding and p2p banking (I)

April 18, 2012 By in Banks, Current Market Thoughts, emerging markets, Industry Analysis, P2P lending Tags: , , , , , , , , Leave a comment

chit funds in emerging markets

I began to look at smaller Asian markets as an investor in 1985.  It was there that I encountered the informal self-help savings and lending associations that are typical in developing economies.  My introduction came through chit funds in Thailand and Taiwan, but these structures exist throughout the developing world.

what they are

the simplest

In their simplest form, the associations are groups of friends of neighbors who contribute a specified amount of money to a pool on a regular basis.  The funds pooled each time the group meet are lent to a single participant, determined either by the implied interest rate bid or on a rotating basis.

more complex

At a higher level of organization, groups come to a designated place at a specific time–like by having a meal at a certain restaurant on Saturday–and offer to third parties the money they’re willing to lend.  They may signal their intent simply by piling their money in the center of their table.  Prospective borrowers move from table to table to negotiate loan terms.

the pinnacle

For the largest such chit funds, agents for the fund do the collection and forward the money to the fund’s central headquarters.  Lenders don’t have any direct contact with the borrowers.

why chit funds?

There are a number of motivations, normally all based on the idea that the formal banking system doesn’t function well. For instance:

1.  There may not be any local banks.

2.  Banks may offer very low interest rates to depositors.

3.  Banks may decide to lend only to large companies.

4.  Potential depositors may worry about bank solvency–the possibility that they’ll lose their money in a bankruptcy or nationalization.

5.  People may not want to reveal the extent of their wealth, or the extent of their taxable income.

the US equivalent

Interestingly enough, this emerging world form of microfinancing is beginning to make a strong showing in the US.  It’s taking two forms:

–Congress recently passed the JOBS (Jumpstart Our Business) Act.  JOBS greatly simplifies the procedures for a small company to make an offering of equity.  For companies with less that $1 billion in annual sales, JOBS does away with the requirement that they present audited financials to potential investors (not a stellar idea, in my opinion).  JOBS also defines the maximum amount that low-income investors can put into a given offering.  By so doing, it legitimizes the efforts at equity crowdfunding (see my post) now underway in the US.

–John Mack, former head of Morgan Stanley, recently joined the Lending Club, a P2P (peer to peer) lender.  P2P lending is chit funds come back to life, but on the internet instead of in your local restaurant.  You can go to the websites of P2P firms like Prosper and Lending Club and select the borrowers you wish to lend to by yourself.  Or you can hire a financial advisor to do this for you.

why now?

To start with the obvious, the technology needed to run P2P or equity crowdfunding is readily available.

Interest rates have been low for a long enough period of time–with little relief in sight–that more conventional means for savers to obtain high returns have been exhausted.  Not only that, but getting a return above 2% in Treasury bonds requires committing money for a very long time, exposing the lender to the risk of loss as/when rates eventually begin to rise.

I see the JOBS ACT as an attack (maybe as the first step in a prolonged attack) by Washington on the current IPO practices of Wall Street investment banks.  Conventional IPO costs in the US are very high by world standards, and a private individual stands about the same chance of getting an IPO allocation as a snowball in northern hemisphere July.

The naming of the JOBS Act suggests that Washington wants to be seen as doing something to create jobs.  What a commentary if this is the best they can do.

My first reaction to P2P is that it may be a true innovation, like money market funds and junk bonds were in their day.  P2P could end up being a very big business–unlike JOBS, which I see, in its present form, as gimmicky and filled with opportunities for fraud.

That’s it for today.  Tomorrow:  historic problems with P2P lending, including a word on Bernie Madoff.

collective action clauses: Greece’s deus ex machina

March 8, 2012 By in Banks, Derivative instruments, Industry Analysis, Trading Tags: , , , , , , , , , 1 Comment

Greek sovereign debt restructuring under way

Greece is in the final stages of restructuring €270 billion in government debt.  Its deadline for holders to “voluntarily” exchange their bonds for new debt that’s worth only a little more, on a present value basis, than a quarter of what creditors were originally promised, is today at 8pm London time.

For the past few months, EU governments have been engaged in high stakes behind the scenes duel with their major commercial banks, which hold a majority of the Greek securities, over whether the financial institutions would agree to the Greek offer.  During the past couple of days, the banks have all been falling in line and saying they’ll take the Greek deal.  I don’t think the banks ever seriously considered doing anything else.  The discussion has all been, I think, about what quid pro quo they would receive in return.

That leaves private holders  …who don’t stay up at nights worrying that the bank examiners will be unusually thorough this year or that their applications to open new branches might be denied.  So both the threat of future bureaucratic ill will and the call to make a patriotic sacrifice of their (own and their clients’) capital fall on deaf ears. That’s where collective action clauses come in.

collective action clauses

A collective action clause is a stipulation in a bond indenture saying that if holders of a certain majority percentage of the issue agree to a given proposal by the issuer, then the rest can be forced to go along with the decision of the majority.

About one outstanding Greek government bond in seven was issued under English law and have had collective action clauses in the indentures from the outset.

The rest were issued under Greek law.  Being subject only to local law isn’t the norm for emerging markets debt, but I guess buyers weren’t concerned because Greece is part of the Eurozone.  Until a few days ago, those bonds had no collective action clauses.  Then the Greek parliament passed a new law to retroactively include them in its government bond indentures.

Not only that, but the lawmakers conveniently set a low threshold of around 60% acceptance (usually, it’s 75%) as the point at which the clauses can be invoked.  EU banks who have been arm-twisted into agreeing to the restructuring will doubtless lift Greece past that mark.  So, like it or not, private holders will be forced to accept the huge haircut Greece is proposing.  The maneuver is all perfectly legal.  The move isn’t a surprise to the bond market, no matter what you hear in the news.  It has been anticipated by bond pundits for at least a couple of years.

the English-law bonds

The case of the English-law bonds is more interesting.  From what I’ve read, their collective action clauses are set at 75% acceptance.  Early betting is that Greece won’t come close to that amount.

But Greece has already announced that if holders don’t tender in lat least large enough amounts to allow it to exercise the collective action clauses, it simply won’t pay anything.  The holders can see Greece in court.  Tomorrow we’ll see how much of this is bluff–and how successful the tactic has been.

rating agencies have already declared a Greek default

Major credit rating agencies have already declared that Greece has defaulted on its bonds.  So far, the body that decides whether credit default swaps (effectively, insurance policies against default) must be paid off is saying that no default has yet occurred.  That’s because the language of the swap agreements that describes what a default is contains an accidental loophole.  The government-inspired “voluntary” restructuring doesn’t qualify, even though holders are losing almost three-quarters of their money.   If Greece invokes collective action clauses and forces bondholders to take the new securities, however, that may change.

not many Greek CDSs?

Reports I’ve read say that Greek CDSs amount to a relatively small €3+ billion.  If that figure is correct, it’s hard to see why the EU has put so much effort into arranging a “voluntary” restructuring that avoids triggering them.  Maybe bank issuance of CDSs on Spanish and Italian debt is immense and contagion is the worry  …or the official figures may substantially understate bank exposure.

This time tomorrow we’ ll have more answers.