Category Archives: capital

Swazi King not sure he wants the conditions attached to the loan

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This is really fantastic news.  The Swazi King is apparently reluctant to accept the loan from South Africa because of the conditions imposed in the agreement. I was quite harsh in criticising the granting of the loan with only conditions for improvement far down the line.  (I still believe the first condition should be an immediate unbanning of political parties.)

Hearing that the conditions are sufficiently onerous that the borrower may not want it is great news. At the very least this reflects a balanced package rather than one heavily in favour of the undemocratic absolute monarchy of our neighbour.

I wonder how many of these conditions were added or modified after the initial public announcement. Cosatu, amongst other powerful groups, has also been very outspoken against the loan.

Clear, Simple and Wrong

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The reason opinions are so cheap is that everyone has one and nobody wants to buy anyone else’s. I’m no different.

I’m not going to try to sell you mine. I would like to present you with some ideas to think about before you overpay for someone else’s though.

Jon commented on a recent post of mine and, guessing I’d be interested, directed me to a fascinating opinion piece by Mark Gilbert on Bloomberg covering a range of current economic issues. I suggest you read it now. It’s ok, I’ll wait.

Right, some pretty compelling points are made there. I disagree with many of them, but they are pretty compelling at first read. Here’s my rebuttal to those I’ve heard discussed most commonly in recent times (typically with head nodding all around).

Gold is not the answer to all our currency problems

All of a sudden it’s popular to talk about how fiat currencies are not worth the paper they’re printed on, how it’s a scam, how we’d be better off with a metal-backed currency. They’re wrong. This is a complex area so I’ll only touch on the points rather than try to explain each of them in detail.

Broken promises and speculator spectacles

A metal-backed currency is only as good as the government’s promise to stick to the standard. History shows this promise has been broken regularly. By attempting to stick to a standard, it’s like waving a red, pheromone-doused flag to an amorous bull (a.k.a. currency speculators. The Bank of England was hit by this in the 1930s and again, albeit with a different kind of peg, in the early 1990s by Soros). Continue reading →

Junk bonds in place of an IPO

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The 30 second intro to Junk Bonds

Junk Bonds, also known as High Yield Bonds, are debt instruments issued by companies with poor credit ratings, or are the debt instruments of companies that were issued as high quality bonds from strong companies that have since fallen on hard times (“Fallen Angels”).

Typically these are any bonds that are not classified as Investment Grade (BBB rated or better).

Junk Bonds behave very differently from Investment Grade bonds. Their value depends only marginally on market interest rates and far more on the underlying economic strength and operational performance of the issuing company.

Junk Bond return characteristics

They don’t often the unlimited upside of ordinary equity, but with the high starting yield (10% to 25% depending on the circumstances) it can provide a very healthy return if the company doesn’t default. There is also a chance for rerating where if the strength of the company improves dramatically, the bond may be repriced to a lower market yield, resulting in a significant capital gain.

Founders keeping control

So company founders can issue junk bonds rather than diluting themselves by issuing equity and still provide attractive returns to investors and an opportunity for savvy investors (and those who just think they are savvy) to “pick” their company with the prospect of fantastic returns if it performs really well. Continue reading →

Too Small To Succeed

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According to a Fin24 story this morning, the FSB is probing smaller unit trusts.

The economics of a fund manager depends entirely on growing funds under management so that revenues (based on assets under management) grow to be larger than costs (significantly fixed and at most semi-variable). Details of performance fees and the second order impact of investment performance aside, a successful fund manager must attract positive net client cashflow, and lots of it.

Half the 960 available unit trusts have less than R100m in AUM. Some of these may be rapidly growing new funds, but many have been stagnant with slow growth for several years.

The FSB’s attention presents opportunities for consolidation between funds and should place larger funds in a stronger position competitively. Total Expense Ratios (TER) for these funds with significant scale should already be lower than smaller funds. Maybe it’s time the larger funds made more if their size and cost efficiencies. If they are going to take the heat for being too large to be nimble, they might as well reap the benefits too.

It will be interesting to see what this means for white labelled funds and whether the economics of these convince the regulator that they should survive.

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Regulations creating operational risk (and how it relates to POPI)

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Ok, so that is an unfair title. But you’ll understand what I mean:

Zurich Financial Services has just been fined £2.3m for a data loss event incurred in 2008 in South Africa.

Zurich joins HSBC, Nationwide and Norwich Union in the club of companies fined by the FSA now.

In fairness, the fine wasn’t so much for losing the data, but rather for:

  • losing
  • unencrypted data
  • and not having monitoring and controls in place
  • so that it was only discovered and reported to regulators a year later

The South African perspective

The FSA’s seriousness about these issues is mirrored in our looming Protection of Personal Information Bill. This is not the same as the disturbing proposals for a Protection of Information Bill which covers public or government information. Continue reading →

Basel III likely to be tempered

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The FT has an article (Banks win battle to tone down Basel III) describing how the proposed new rules for banking capital requirements might have some of the new requirements around liquidity removed or weakened.

Key amongst these new considerations is the limitation of mismatches between the term of assets and liabilities, which would limit the danger of a removal of deposits and wholesale funding in a crisis scenario. The problem is that this has been fundamental to the business model of banks for decades. Short-term assets (call, overnight, 30 day deposits) have been used to finance long-term liabilities (vehicle loans, home loans, business loans).

Retail deposits, even those technically call deposits, are generally quite sticky. This is in spite of the easily recallable image of queues of depositors wanting to get their money back. Typically, this is still a small fraction of total depositors (certainly in countries with retail deposit protection). Further, other banks have usually pulled or tried to pull their short-term funding (or simply not renewed overnight lending) well before the public even gets wind that there might be risks. As banks rely increasingly on wholesale finance, the risks of a liquidity and credit crisis are amplified as this money is teflon-coated and greased in terms of stickiness.

The banks argue there are other ways of managing the risk. It’s understandable that regulators around the world have had their confidence in banks’ risk management ability dented.

The real danger of overregulation of banks is not “too safe banks”, but rather an increase in the cost of providing banking and credit services to the economy (individual countries as well as the global economy) which could make limit economic growth and the replacement of jobs lost during the recession.

It’s going to be interesting to see how this develops.

Back-test that

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May 6 2010.  Dow falls more than 1,000 points intraday, including a drop of P&G from around $60 to (according to some accounts) below $40. The Dow recovered most of the falls quickly, but these trades are now part of the historical time series.

Banks and others using risk management tools often back-test their models against historical data to see how whether the models capture past market movements in estimating potential future market movements. This blip may appear as an anomaly in these tests for some time.

(It’s more typical for the tests to use only closing prices rather than intra-day prices. However, this actually reflects a weakness in the typical models and is only a fortunate escape from today’s problems)

New operational risk guidance from Solvency II

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CEIOPS issued additional guidance around the standard formula for calculating capital requirements in respect of operational risk late last year.

Why was a new OpRisk formula needed?

The original formula for OpRisk proposed in QIS4 was widely condemned. Complaints included being too simplistic, being insensitive to risk (and basely primarily on business size) and the impossibility of calibrating to 99.5% in a meaningful way. CEIOPS accepts most of this criticism, but counters by reminding stakeholders that the aim of the standard formula is partly about being simple.

A more serious problem is that in comparison against companies’ own internal models, the standard formula produced results lower than companies’ own assessment. Median internal model requirements for OpRisk were 133% of the standard formula and 13 out of 16 countries reported higher requirements under their insurers’ internal models.

One of the aims of the standard formula is to be slightly conservative to provide an incentive for insurers to develop their internal models. Clearly this objective is not being achieved. Continue reading →