Sub Prime Crisis-Part 3:- Investment Banks/Bankers

The News channels and public, now scream at these guys as ‘Devils in disguise’, whom they unanimously hailed as the ‘Financial Messiahs’ a year back.  They were awarded by their bosses and markets for their Sheer Innovativeness in the financial markets. The last decade saw a wide range of products, tailored (Structured in their parlance) for every conditions or outcome of the market. Just imagine, what would have happened, if they see a vast, trillion dollar opportunity, lying untouched or handled the traditional way…yeah, what now we call as Subprime Crisis, is the financial reengineered child of these I bankers.

 

Step 1: Investment Banks purchase the Mortgage loans from Banks/Lenders

Step 2:  Segregate them into different types and rate them.

Step 3: Making these loans as underlying assets, created Derivatives

Step 4: Insure all the Instruments according to the rating, with an insurer

Step 5: The Insurer creates Credit Default Swaps (CDS) and sells it in the market.

Step 6: Investment Bank creates SPV’s (Special Purpose Vehicles) and holds all the unsold/high risky Sub Prime loans with them. These SPV’s will be their sister company, registered in Mauritius or some Island, where no questions are asked, and the parent company will invest its share capital/its clients money in the sister company.

Step 7: What else, every instrument created will be marketed well to the so called sophisticated Hedge funds, HNI’s, Corporate, Pension Funds, and even Banks in every nook and corner of the world, be it UK, Europe, Japan, and why not the conservative Indian Banks… (ICICI, SBI, AXIS bank  …)

 

Step8: All these papers a.k.a Sub Prime Mortgage Backed Securities/CDS are to be redeemed when the mortgage payments are received in full from the borrower. (If at all he pays…)

Sub PRime Crisis- Part 1:-Leverage

Leveraging is a process which is used to borrow capital through various financial instruments like Options, Futures, and Margin etc to increase the potential return of any investment.  For example, say you have $1,000 to invest. This amount could be invested in 10 shares of Infosys, but to increase leverage, you could invest the $1,000 in five options contracts. You would then control 500 shares instead of just 10. But if there is a loss of 1$, we will suffer 500 times more. Many a time, we end up losing all our capital and fall into debts.

This is what happened in all the Investment Banks who have entered in leveraging their capital and invested in Sub Prime Mortgages.

For example,

Lehman bros- Share capital- $ 50 Billion

Leverage size- 20 times i.e 20*50 = $ 1000 billion

Invested in Sub Prime Mortgage Bonds and now if the Real estate price goes down and the value of the bonds goes down by say 10%, they will be losing $100 billion.

Value of bond = -10%

So loss = $100 Billion.

Capital in hand = $ 50 Billion

So now they have lost all their share capital, also in debt of $ 50 Billion + the interest charge for the leverage they took.

So, what other option they have, other than to file for Chapter 11???

Lehman and the Indian brothers

 

All is over for now… but the ripples created by Lehman to the Indian market, industries…lot more to start dancing in India.

First, let us take the major blows that India going to witness as a result of Lehman.

1)      Lehman’s Investment in Indian companies- Private Equity Investment, FDI route

2)      Indian companies  who subscribed to Lehman Bonds/ took position in Lehman

3)      Indian IT companies who were the service providers for Lehman.

 

 

Lehman had a long and profitable relation with the Indian industries.  For long, it has been funding and nourishing Startup and Fund Striven Indian Cos, Especially IT Sector cos. In a major selling spree that started on August 21, Lehman has sold shares worth close to Rs 400 Crore in nearly 10 companies including NIIT, Cranes Software, Amtek Auto, Amtek India, Fedders Llyod, Northgate, Mastek, Triveni Engineering and Prajay Engineering.Prior to the sell-off, Lehman’s Indian equity portfolio is estimated to have been worth more than Rs 1,000 Crore.

Besides the 10 companies including Spice Communications, Spice Mobile and Tulip Telecom where Lehman has offloaded its shares, Lehman had equity holding in about two dozen firms at the end of the June quarter.

 

Thus, the sale of the equity by Lehman has substantially washed away around 1500 Crores of Market capital from these companies.

(The same story happened in February, with Bear Sterns—- losses in US—- sold of equity in India—– Cos like Orchid Pharma went to the extent of hostile takeover by rivals…)

 

Indian banks have made a huge amount of overseas investments in bonds issued by Lehman, like Lehman Senior bonds, for a substantial chunk, in promise of higher returns, which again those bonds are linked to those huge subprime assets held by Lehman then. Remember, Icici   declaring a loss of around 8 million dollar in March this year as losses in overseas investment. The fair lady of Icici, Ms.Kocchar also remarked that “this is technically not a Sub Prime loss” in April. Five months later, she had to eat her own words… Icici wrote down around 80 million dollar, (in Indian Rupees, around 360 Crores!!!!!!!!!!)

Icici is just the biggest Investor overseas and as Lehman shambled, it has accepted a write down. Lots and lots of Indian Banks and Corporate have huge exposures in those bonds issued by the Once Blue Eyed banks of Wall Street… Altogether, they also have derivative exposures in those “zero value” assets. Bad time for the Indian banks…..

The Indian IT cos…

Lehman has got outsourcing and IT infrastructure contracts with the three major It companies in India- TCS, Satyam  and Wipro…there are lot more IT cos which shared the smaller pie..

 

 

Now, the Issues,

For an IT company If a project is scrapped suddenly, the workforce/resources will be moved to bench (their relative term for Jobless, but Paid) and slowly chucked out voluntarily and forcibly. In turn it affects the spending of IT cos on resource addition and might cause a Stagnation in the recruitment. Salary hikes will be minimum and will lead to reduced expenses and savings adding fuel to the roof hit Inflation.  

Banks write off huge chunks of their balance sheet towards their losses in subprime and derivative losses, they will be much more stringent in lending along with a higher interest rate. This will lead to slower economic growth, reduced consumption of goods by industries, layoffs, stagnant infrastructure development.

As a whole, the circle can be traced to that Guy who doesn’t payback his loans. He along with his co-defaulters  made the banks and Investment banks in US to bankrupt, it in turn causes IT and other Industries to slowdown, which in turn reflects in all the sectors( banking, Finance, Retail, Infrastructure etc),  there in slowed economic growth in India.

 

One single word is the reasons for all these debacles…..our Grandparents call it GREED, and we call it in different names, Financial Engineering, SPV’s, and Mortgages and so on…

 

Chapter 11- Lehman Bros and Bible :-)

Have they so stumbled, that they should fall.. God forbid! ….( Bible; Ch 11; Romans.)

“I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers,” … (Paulson, Treasury Secretary, US, on Lehman filing for Chapter 11 of Bankruptcy Law)

In the last two days, the Chapter 11 was discussed as many times as Lehman brothers is spelt. Actually, there are two basic/important Chapters of the Bankruptcy law, which governs Bankruptcy   of Individuals and Corporate in US.

They are, Chapters 7, and 11.

 When a troubled business is unable to service its debt or pay its creditors, the business or its creditors can file with a federal bankruptcy court for protection under either chapter 7 or chapter 11.

Chapter 7:

·         Complete Liquidation

·         The business ceases operations and a trustee sells all of its assets and distributes the proceeds to its creditors.

 Chapter 11:

·         Plans for Re organization

·         An attempt to stay in business while a bankruptcy court supervises the “reorganization” of the company’s contractual and debt obligations. The court can grant complete or partial relief from most of the company’s debts and its contracts, so that the company can make a fresh start.

·         Debtors in Chapter 11 have the exclusive right to propose a plan of reorganization for a period of time. After that time has elapsed, creditors may also propose plans. Plans must satisfy a number of criteria in order to be “confirmed” by the bankruptcy court. Among other things, creditors must vote to approve the plan of reorganization.

·         If a plan cannot be confirmed the court may either convert the case to liquidation under Chapter 7 or, if in the best interests of the creditors and the estate, the case may be dismissed resulting in a return to the status quo before bankruptcy. If the case is dismissed, creditors will look to non bankruptcy law in order to satisfy their claims.

·         Sometimes a company will liquidate under Chapter 11, in which the pre-existing management may be able to help get a higher price for divisions or other assets than a Chapter 7 liquidation would be likely to achieve.

If the company’s stock is publicly traded, a Chapter 11 filing generally causes it to be delisted from its primary stock exchange if listed on the New York Stock Exchange, the American Stock Exchange, or the NASDAQ. On the NASDAQ the identifying fifth letter “Q” at the end of a stock symbol indicates the company is in bankruptcy.