Minibonds Allocation of Responsibility

[Goh Meng Seng]

Do you know what is the understanding?

Most People: It is just an investment of a collection of AA or AAA bonds.

Mr GohMS: It is an investment of a collection of AA or AAA bonds, which consists a Credit Risks Swap of another basket of financial entities which include CDOs.

Actual case:

It NEEDS NOT BE a collection of AA or AAA bonds, EVEN IF the "Credit Events" relates to the AA or AAA bonds.

• On one hand, "Credit Events" relates to the AA or AAA bonds. But no possession of asset is needed in the Credit Default Swap (see video in ealier post).
• On the other hand, the SPV can take your money and "buys" any assets with default concerns, directly/indirectly from Lehman (or its affiliates).

This two parts are totally "unrelated" but can be merged into one like the Bond of 6-8 banks example I mentioned earlier.

Dear Zombie,

I have no details on the Minibond contract itself. But the mechanism explained here still stands.

A Credit event may affect either the Minibond Ltd, any of the collateral AA or AAA bonds, or the arrangement institution aka Lehman in this case or any defaults on the basket of financial instruments under the Credit Risks Swap arrangement...aka financial instruments INSURED by these minibonds holders.

The potential losses depends on what occurs.

If the Minibond Ltd collapses, I do not think the potential losses would be big because it only acts as a trustee of the bonds bought.

But if any of the collateral of AA or AAA bonds issuers go bust, then the losses will depend on what is the percentage allocated to them.

If Lehman collapse, HSBC Trustee has explained that the Credit Risks Swap ceased and the collateral of AA or AAA bonds will be sold and cashed out, money return to mini bond holders. If this is the case, then losses will be minimum.

But if the insured instruments (including CDOs, bonds, junk bonds etc etc) under the Credit Risks Swap go into default, then the potential losses will be huge. The minibond holders, as insurers to these financial instruments, will have to compensate Lehman for its losses in this event.

But now, we have an interesting scenerio. If Lehman collapse and at the same time, the basket of insured financial instruments includes Lehman's own issued bonds and such, will the minibond holders have to pay for the defaults of these bonds?i.e. it means that Lehman's insolvency will have two implications:
1) as the entity that arrange such Credit Risks Swap, the minibond contract will have to cease since Lehman went bankrupt
2) Lehman's insolvency may affect the basket of financial instruments under insured. Minibond holders may have to pay compensation for such defaults due to Lehamn's insolvency.

It is yet to be clear what the basket of financial instruments under Credit Risks Swap entails.

There is a slight confusion at first, but the mechanism itself has been well explained by the HK Economic Daily. The only problem is, nobody knows exactly what that Credit Risks Swap entails.

Goh Meng Seng

 

[Goh Meng Seng]

Ignoring the part between Minibond Ltd and the minibonds investors.

Between Lehman and Minibond Ltd is Credit Default Swap (and ignoring the swap of interests & currency).

Now See [w w w.youtube.com/watch?v=P2cUh-e_Qkc&feature=related]

Points to note:

1) Box: in green=Lehman, in red=MinibondLtd, in purple=Bonds6-8Banks

2) In movie: No physical swapping taken place until CE. Swap is a contractual obligation (a promise) at the beginning. Then see 3 below.

3) In our situation because of the contract:

a) Before CE, physical swap already taken place (like 3:42 in Movie, purple line). Lehman sells the bonds (with credit risks) to Minibond Ltd at 100% face value for cash, which can be invested into other things.

b) When CE, Minibond Ltd sells the bonds back to Lehman at "great discount". This price would be that best price Minibond Ltd can sell in the open market to recover cash.
Combining with a above, at the end when there is CE, Lehman takes back the bonds and Lehman received (100% - recoverable price) from Minibond Ltd. This is shown at 3:23 in movie, red dotted line.​

4) The main reason of 3a above, is that Lehman can distance itself totally from the bonds. This is protection at its best. Everything about the bonds sticks with the SPV, Minibond Ltd. You as investor will bear the risks.

The main reason of 3b above, is that Lehman may have for example contractual agreement to deliver the bonds to someone else. It would be better to ensure availablility of the bonds for later delivery than to buy from the open market some times later.




<object width="425" height="344"><param name="movie" value="http://www.youtube.com/v/P2cUh-e_Qkc&hl=en&fs=1"></param><param name="allowFullScreen" value="true"></param><embed src="http://www.youtube.com/v/P2cUh-e_Qkc&hl=en&fs=1" type="application/x-shockwave-flash" allowfullscreen="true" width="425" height="344"></embed></object>

Dear Zombie,

I am not sure whether your illustration here is valid or not.

I do not think Lehman sold the reference assets to Minibond Ltd. It is not logical when you are just doing a Credit Risks Swap. Besides, Lehman going bankrupt, does not mean these reference assets will devalue, as long as these reference assets under insure has nothing to do with Lehman i.e. issued by Lehman.

And on top of that, there is no way Lehman could buy back the Reference assets (assuming it is sold to Minibond Ltd) when it is technically insolvent or bankrupt!

The Youtube video you have shown, is only one part of the whole deal; what the credit risks swap entails. Minibond holders, via Minibond Ltd, has to have its own collateral assets as the basis to provide or sell the risk protection. This is what I understand from the HK Economic Daily. To me, this explanation is more logical.

Because, you cannot use Minibond holders to buy the exact reference assets to insure Lehman from the very asset it seeks to insure! If this is the case, if the aim is to let Lehman convert illiquid reference assets into liquidity, Lehman must well sell the reference assets altogether. Why would it still want to pay a risk premium for these reference assets for which it already sold to Minibond Ltd? And buy it back on maturity? It does not make sense to me.

Goh Meng Seng

 

[Zombie]

Mr Goh

The model you got from the HK papers(?) could very well be a general basic model. There are so many ways to structure these kinds of things.

This is minibond series 2, which you can download and read up.
http://www.lioninvestor.com/code/uploads/minibond-series-2-pricing-statement.pdf

This is another dug up by some news website. I cannot verify the accuracy, but the structure looks sound. The SPV for this case is another company. Also, one other empty shell company is set up to acquire Debts and then sell CLNs to the SPV. So instead of putting money into AAA bonds, SPV bought the CLNs using the cash from the individual investors. Effectively, SPV bought over the Debts from this empty shell company.
The AAA bond Credit Default Swap that SPV sells to Lehman is just to generate extra cash for interest payments.
http://www.mpfinance.com/ftp/Finance/20080929/ea/29rm101.gif


If you notice, most minibonds are CDOs. Look at the (HK) list.
http://www.bochk.com/images/upload/retail/pdf/lbhipe.pdf

 

[Zombie]

Mr Goh

http://www.hkbea.com/FileManager/EN/Content_2396/20080923qa_e.pdf

This is from Lehman Brother Asia Limited for HK investors(?)

Read "What is the collaterals for Minibonds?"
It only says Debt obligation of Lehman and CDOs, and this means SPV bought them (and not AAA bonds). If Lehman cannot pay debts and the CDOs are losing value because of market fear, what is the value of the collaterals?

But again, any minibond series that have bought AAA bonds (eg series 2) would not suffer too much.

FYI

 

[Goh Meng Seng]

Mr Goh

http://www.hkbea.com/FileManager/EN/Content_2396/20080923qa_e.pdf

This is from Lehman Brother Asia Limited for HK investors(?)

Read "What is the collaterals for Minibonds?"
It only says Debt obligation of Lehman and CDOs, and this means SPV bought them (and not AAA bonds). If Lehman cannot pay debts and the CDOs are losing value because of market fear, what is the value of the collaterals?

But again, any minibond series that have bought AAA bonds (eg series 2) would not suffer too much.

FYI

Hmm... Then something is really fishy if this is the case.

For example, if you are Lehman or the one that is buying the credit protection, would you just sell those reference assets to those who are selling you the credit protection? I mean, you just need to have credit protection but yet, collection returns from these assets!

And if you are the ones that are selling the credit protection, does it make sense for you to buy all those reference assets? If this is so, you must well buy those assets in the market instead going through an intermediary and gives them management fees!

Soemthing is not very right here.

Goh Meng Seng

 

[Zombie]

For example, if you are Lehman or the one that is buying the credit protection, would you just sell those reference assets to those who are selling you the credit protection? I mean, you just need to have credit protection but yet, collection returns from these assets!

You got "reference assets" mixed up.

On one side, SPV uses money (from minibond investors) to buy CDO etc.
On the other side, SPV gets into CDS with Lehman and the reference assets are those AAA bank bonds (no money involved).

In common language, SPV uses CDO as the financial assets backing, to insure the AAA bank bonds.

So,
if AAA bank bonds fail (unlikely), minibond investors die (low casualty).
if CDO fails (maybe easier), minibond investors also die (higher casualty).
if Lehman fails (already), minibond investors also die (because CDO will lose value)

The whole idea is to boost interest income (from different sources) for minibond investors, but the risk is very high.

 

[Goh Meng Seng]

You got "reference assets" mixed up.

On one side, SPV uses money (from minibond investors) to buy CDO etc.
On the other side, SPV gets into CDS with Lehman and the reference assets are those AAA bank bonds (no money involved).

In common language, SPV uses CDO as the financial assets backing, to insure the AAA bank bonds.

So,
if AAA bank bonds fail (unlikely), minibond investors die (low casualty).
if CDO fails (maybe easier), minibond investors also die (higher casualty).
if Lehman fails (already), minibond investors also die (because CDO will lose value)

The whole idea is to boost interest income (from different sources) for minibond investors, but the risk is very high.

Err... this is going to be very confusing! LOL!

How can a more risky assets used to insure a safe AAA bonds? Which one needs insurance more? AAA bonds or CDOs? Yes, you are right, I am really confused here. It does not really make sense to me at all if this is really the case. And I really wonder who will buy such minibonds if they really know what's going on there!

And to get 5% from CDOs as well as risk premium from Lehman's reference assets that consists of AAA bonds? The risk-return is really not proportionate.

Goh Meng Seng

 

[Zombie]

Err... this is going to be very confusing! LOL!

How can a more risky assets used to insure a safe AAA bonds? Which one needs insurance more? AAA bonds or CDOs? Yes, you are right, I am really confused here. It does not really make sense to me at all if this is really the case. And I really wonder who will buy such minibonds if they really know what's going on there!

And to get 5% from CDOs as well as risk premium from Lehman's reference assets that consists of AAA bonds? The risk-return is really not proportionate.

Goh Meng Seng

You can read this

http://www.cnfstar.com/news/2008/20080926/200809261038655.shtml

而事实上，迷你债券是一种高风险的金融衍生产品。此次雷曼兄弟是通过由其成立的独立机构Pacific International Finance Limited（PIF）发行的迷你债券。PIF向投资者筹集到足够资金后，便购入担保债务凭证（CDO），由HSBC Bank USA National Association作为受托人，并以此发行了一个信用违约掉期（CDS），和八家金融机构的信贷挂钩（美国银行、花旗银行、高盛、汇丰、摩根大通、美林、摩根士丹利和渣打），如果这些机构出现破产，PIF便以手上CDO换取破产机构相关的债券，为投资者提高回报，但同时投资者也将面临这些机构的信贷风险。

 

[Goh Meng Seng]

You can read this

http://www.cnfstar.com/news/2008/20080926/200809261038655.shtml

而事实上，迷你债券是一种高风险的金融衍生产品。此次雷曼兄弟是通过由其成立的独立机构Pacific International Finance Limited（PIF）发行的迷你债券。PIF向投资者筹集到足够资金后，便购入担保债务凭证（CDO），由HSBC Bank USA National Association作为受托人，并以此发行了一个信用违约掉期（CDS），和八家金融机构的信贷挂钩（美国银行、花旗银行、高盛、汇丰、摩根大通、美林、摩根士丹利和渣打），如果这些机构出现破产，PIF便以手上CDO换取破产机构相关的债券，为投资者提高回报，但同时投资者也将面临这些机构的信贷风险。

Thanks Zombie, this is to me, a very stupid financial instrument! LOL! Now the question is, why was it rated AAA? LOL!

But at this moment, Lehman's insolvency will not affect much; only that after liquidating those collatoral of CDOs, they may suffer immediate losses from such sales.

Goh Meng Seng

 

[Goh Meng Seng]

You can read this

http://www.cnfstar.com/news/2008/20080926/200809261038655.shtml

而事实上，迷你债券是一种高风险的金融衍生产品。此次雷曼兄弟是通过由其成立的独立机构Pacific International Finance Limited（PIF）发行的迷你债券。PIF向投资者筹集到足够资金后，便购入担保债务凭证（CDO），由HSBC Bank USA National Association作为受托人，并以此发行了一个信用违约掉期（CDS），和八家金融机构的信贷挂钩（美国银行、花旗银行、高盛、汇丰、摩根大通、美林、摩根士丹利和渣打），如果这些机构出现破产，PIF便以手上CDO换取破产机构相关的债券，为投资者提高回报，但同时投资者也将面临这些机构的信贷风险。

Dear Zombie,

I still cannot believe this is the way it is being arranged!

I mean, imagine, if AAA references like those big banks are to go bankrupt, the CDO in the collateral will be worthless as well! Well, CDOs will definitely become worthless before these big banks go bankrupt, isn't it?

Whoever arrange such minibonds is really funny in the mind. LOL!

Goh Meng Seng

 

[Zombie]

But at this moment, Lehman's insolvency will not affect much; only that after liquidating those collatoral of CDOs, they may suffer immediate losses from such sales.

Before SPV buys the CDO, Lehman would have used its influence to "upgrade" this CDO. This means that SPV may have bought the CDO at a very high market price (above its real value).

When Lehman falls, so will its influence. CDO would drop heavily in market value.

 

[Zombie]

I still cannot believe this is the way it is being arranged!

The joke is, if you look at the picture you gave earlier,

http://3.bp.blogspot.com/_97gTacH4hNg/SODP6KroSfI/AAAAAAAAAJE/FJJrt9a-L4k/s1600-h/minibond.gif

the answer is always there, and I did not see it.

The "AA xxx" in blue circle on the right is "AA NOTES" (eg CDO, Debts). I thought it says "AA Bank Bonds".

The one in blue circle on the left is "Bond Assets" (so must be Bank Bonds etc). I thought it says something like "Credit-Risky Assets".

So, it is AA Notes "insuring" Bank Bonds,
and not such a thing as, AA Bank Bonds "insuring" Credit-Risky Assets, for the minibonds.

Looks like I have to learn Chinese all over again. Had I not read wrongly, I would not have gone one big round on something that is now considered irrelevant, which have made things confusing. :p

 

[Goh Meng Seng]

The joke is, if you look at the picture you gave earlier,

http://3.bp.blogspot.com/_97gTacH4hNg/SODP6KroSfI/AAAAAAAAAJE/FJJrt9a-L4k/s1600-h/minibond.gif

the answer is always there, and I did not see it.

The "AA xxx" in blue circle on the right is "AA NOTES" (eg CDO, Debts). I thought it says "AA Bank Bonds".

The one in blue circle on the left is "Bond Assets" (so must be Bank Bonds etc). I thought it says something like "Credit-Risky Assets".

So, it is AA Notes "insuring" Bank Bonds,
and not such a thing as, AA Bank Bonds "insuring" Credit-Risky Assets, for the minibonds.

Looks like I have to learn Chinese all over again. Had I not read wrongly, I would not have gone one big round on something that is now considered irrelevant, which have made things confusing. :p

Dear Zombie,

Well, that's ok. Sometimes we do go in circles before we really learn something. Thanks for your very informative discussions here. Else I will still be wondering why anyone would use more risky credit assets to insure AAA Bank Bonds. LOL!

Goh Meng Seng