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Nickels, Meet Steamroller: Embattled Bank Suckers Hedge Funds Into EM Insurance Bet

Tyler Durden's picture




 

Are you looking to make a terrible investment decision?

Well sure you are, isn't everyone?

And thanks to the fact that it appears we may now be testing the limits of the market’s collective patience with the notion of central bank omnipotence, there are plenty of bad investment opportunities out there to choose from. 

That said, you always want to go big or go home, which is why what you might want to do is go out and ask a struggling emerging markets lender what its worst “assets” are and then offer to insure those assets against default so that said lender can then go out and invariably make more terrible decisions on the way to hopefully creating a non-negligible amount of systemic risk. 

If that sounds crazy to you, that’s because it most certainly is, but don’t tell the buysiders who inexplicably decided to go long EM credit risk at the worst possible time in decades via their participation in a synthetic CLO from none other than Standard Chartered. Here’s Bloomberg:

Imagine this pitch: Buy a complicated, derivatives-based deal tied to emerging-markets debt. Right now. In a shaky credit market.

 

The expected response might be laughter -- or speechlessness. But Standard Chartered pulled off just such a deal in the past few weeks, selling a $236.3 million piece of a synthetic collateralized loan obligation to a group of hedge funds in a risk-transfer maneuver.

 

Did I mention this is Standard Chartered? The London-based bank has been accused of breaching U.S. sanctions against Iran, shook up its upper management a few months ago and does a lot of business in China. Its shares have lost more than 20 percent so far this year.

 

Standard Chartered’s deal was aimed at lowering the amount of money it must hold to offset riskier holdings. The bank reduced its capital charges by millions of dollars on a $3.5 billion pool of debt by paying hedge funds to insure against potential losses.

 

The bank had a ready-made audience,and other big banks have completed billions of dollars of similar deals in recent years.

 

But this one took an extra leap of faith. About 17 percent of the reference loans were domiciled in China, some 17 percent in Hong Kong and 7 percent in India, according to the prospectus dated Sept. 23. Also, this deal came after Standard Chartered shook up its upper management and as China’s slowest growth in more than two decades roils Southeast Asia.

Now look, there’s never really a “good” time to start moving credit risk from imperiled banks onto your own balance sheet, and apparently, the hedge funds that got into the mezz tranches here are getting something like an 11% yield which looks great in a world dominated by ZIRP, but one can’t help but wonder if this isn’t going to be a disaster. 

Bloomberg characterizes this as “a complicated, derivatives-based deal,” which is a typical characterization for synthetic CDOs. Not to take anything away from that description (because bless their hearts, it’s probably just a well meaning attempt to warn readers that they’re about to be subjected to some financial alphabet soup), but these deals aren’t really all that complicated conceptually. Here’s how this works: I have some loans I made that I think are probably bad and it’s keeping me from making more bad loans because the regulators don’t like the amount of risk I’m taking, so what I’ll do is I’ll periodically pay you some spread over a benchmark rate I probably manipulated and then you’ll agree to pay up when these loans go bad. Because they aren’t my problem anymore, I get to go to my regulators and say “see, these guys are on the hook, not me, so now please let me go out and make more of these bad loans” and of course because the cost of capital is zero, it’s a sweet deal for me, even if I fooled you into believing that the CDS premium I’m paying you is attractive. 

In case that’s not clear enough, allow us to simplify further: metaphorically speaking, the hedge funds that participated in this deal just knowingly issued a whole bunch of flood insurance on a bevy of homes in New Orleans knowing that hurricane Katrina is coming. 

Of course there are no certainties in the world and if EM doesn’t suffer a complete meltdown, then anyone who agreed to provide doomsday insurance in return for a thousand basis points of yield is going to look very, very smart and we certainly won’t begrudge them their (fiat) profits, but just note that you heard it here first - this is picking up nickels in front of a steamroller.

 

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Mon, 10/05/2015 - 21:09 | 6633623 buzzsaw99
buzzsaw99's picture

boo hoo for the hedge funds /s

Mon, 10/05/2015 - 21:44 | 6633735 Billy the Poet
Billy the Poet's picture

We Rachel Corried some folks.

Mon, 10/05/2015 - 22:02 | 6633781 El Oregonian
El Oregonian's picture

The ghost of Billy Mays must of been resurrected in order to be able to sell these piles of crap.

Tue, 10/06/2015 - 09:13 | 6634932 Ouagadoudou
Ouagadoudou's picture

Be a little fly in this room during the pitch ....

Mon, 10/05/2015 - 23:28 | 6634061 junction
junction's picture

Standard Chartered may be run run by crooks but that bank is run by amateurs compared to the criminals Andy Cuomo has hired for his RICO enterprise called the New York State government.  Standard Chartered has to find some way to make money to replace the $340 million they had to pay to Cuomo's goombah shakedown artists.  

Bank Settles Iran Money Case Standard Chartered to Pay New York Regulator $340 Million; Other Probes Loom By
Liz Rappaport, Wall Street Journal

Updated Aug. 15, 2012 10:28 a.m. ET

Standard Chartered PLC agreed to pay $340 million to a New York regulator to settle allegations that the bank broke U.S. money-laundering laws in handling transactions for Iranian customers, after a weeklong, trans-Atlantic regulatory drama.

Mon, 10/05/2015 - 21:22 | 6633665 antonina2
antonina2's picture

Hahahaa!  Someone pays these people to make these decisions!  So, sad...

Mon, 10/05/2015 - 21:30 | 6633695 jeff montanye
jeff montanye's picture

and wage slaves pay higher tax rates to make up for the lower ones hedge fund managers pay.

http://www.nytimes.com/2013/02/25/opinion/carried-interest-an-unjust-pri...

Mon, 10/05/2015 - 21:33 | 6633701 SillySalesmanQu...
SillySalesmanQuestion's picture

Those nickels used to belong to someone who caught falling knives...

Mon, 10/05/2015 - 22:32 | 6633875 IntercoursetheEU
IntercoursetheEU's picture

Nickels are one of the best investment choices out there, risk free hedge, cash-commodity pair.

Mon, 10/05/2015 - 21:34 | 6633712 azusgm
azusgm's picture

Sounds way too familiar.

Gotta remember that it took three months for the Lehman/AIG tide to go out and expose Bernie Madoff's nakedness. That was during the 2008 shemitah. No reason to get too relaxed from the 2015 shemitah until at least after December.

Mon, 10/05/2015 - 23:49 | 6634114 armageddon addahere
armageddon addahere's picture

Come and buy my Synthetic High Income Total Treasury Yield bonds or S.H.I.T.T.Y. bonds for short.

Tue, 10/06/2015 - 01:19 | 6634280 SweetDoug
SweetDoug's picture

'

'

'

Cui bono?

 

 •?•
V-V

Tue, 10/06/2015 - 01:42 | 6634314 SmittyinLA
SmittyinLA's picture

Probably good bets, most 3rd world lenders get collateral that's worth more than the loan, with continuous debasement payback's a snap if default the collateral will go up in value from default printing, lenders keep the land and pay back the loan with debased fiat currency.

Tue, 10/06/2015 - 04:51 | 6634483 Gracy101
Gracy101's picture

24p ( 29c) investment here. Bargain!  The Bankers Song

http://www.cdbaby.com/cd/thatguybloke

Do NOT follow this link or you will be banned from the site!