Figures add up nicely for GE Life
By Larry Haverkamp, For The Straits Times
Taken from the Straits Times , August 27, 2009GREAT Eastern Life Insurance looks to be everyone’s pick for the most generous company of the year.
The company wants to help its policyholders by buying back their GreatLink Choice (GLC) structured notes. These are similar to minibonds but there are more of them. Minibonds worth $508 million were sold to 10,000 investors, while $594 million worth of GLC notes were sold to 18,000 investors.
If the notes default over the next four years, investors would lose the $594 million they had sunk in. The company says it will lose $250 million by buying the notes back. It looks generous.
Great Eastern will require its agents to pitch in too. They will return the $12 million they made in commissions from selling the notes.
This glowing story has been widely reported. On the surface, it might appear investors would be foolish to turn down Great Eastern’s offer. But that may well be wrong.
GLC comes in five tranches. GLC 1 and 2 make up one similar group while GLC 3, 4 and 5 are another. A Sunday Times report by Ms Lorna Tan correctly calculated that GLC 1 and 2 are safer investments than GLC 3, 4 and 5.
Does that mean the buyback is not in the best interests of GLC 1 and 2 investors? In a word: Yes.
Does that mean the offer would benefit Great Eastern at the expense of these investors? In another word: Yes.
Instead of helping GLC 1 and 2 investors, it would bite them a second time. The first was when Great Eastern sold GLC without disclosing the total returns of the underlying bonds. That is the standard way for structured notes to conceal risks. The public is shown only the investor yields – such as 3.5 per cent to 4.9 per cent annually for GLC. This lulls investors into thinking risks are moderate. They never see the high-risk returns produced by the note’s underlying assets of junk bonds and credit default swaps.
The second bite comes now with the offer to buy back the notes. It will take a safe 17.5 per cent return from GLC 1 and 2 investors and give it to Great Eastern.
Less generous than it appears
BY 6PM tomorrow, Great Eastern will have bought back many of its GLC notes and written them down to ‘fair value’. It says the write-down will result in a $250 million loss. That estimation could help the company sell its buyback offer. Investors see $250 million as a lot of money to turn down.
In fact, Great Eastern’s loss may be much less:
- First, the $12 million clawback of commissions from agents will go entirely to the company. Investors will not get a dollar.
- Second, Lion Global was the fund manager for GLC. Its management fees totalled 8 per cent to 11 per cent on the $594 million value for all five GLC tranches. Much of that was paid upfront – and unlike the clawback of agent fees, Lion Global will not be required to return its fees.Lion Global is 100 per cent owned by Great Eastern and OCBC Bank, while OCBC owns 87 per cent of Great Eastern.
- Third, GLC 1 and 2 are likely to produce high profits for Great Eastern. They make up $209 million – or 35 per cent of the $594 million worth of notes sold.Just over half the investors have accepted Great Eastern’s buyback offer so far. Why so many when it is not in their interest? The current price for the notes is set at 61 cents on the dollar, according to the company website’s pop-up ad and newsletter – a buy-only price, set by the underwriter, which is Deutsche Bank for GLC 1 and 2. Investors who redeem early must sell at that price and sell only to the underwriter. This is likely to bias the price downwards. Great Eastern’s offer is valued at $1 minus the dividends already paid of 10.5 cents. So $1 – $0.105 = $0.895 – easily more than 61 cents. Investors would conclude: ‘It’s a no-brainer. I accept!’ Besides the downward price bias noted above, the 61 cent price on the website is out of date. The more recent price is 73 cents, which makes the offer less attractive to investors. It can also be found on the website, though not as easily.
- Fourth, GLC 1 and 2 investors must give back 10.5 per cent in clawed-back dividends. They must also forgo the 3.5 per cent that was to be paid at the end of September and October, plus another 3.5 per cent due at maturity in 13 and 14 months. So 10.5 + 3.5 + 3.5 = 17.5 per cent – that is the ‘one year’ return investors will receive if they reject the offer and hold GLC 1 and 2 to maturity.
While that 17.5 per cent yield is high, the risks remain low for two reasons:
- One, GLC 1 and 2 have underlying collateralised debt obligations (CDOs) that reference bonds rated BBB- by Standard & Poor’s (S&P). Their time to maturity is just over one year. S&P data shows the one-year default rate for BBB- global corporate bonds from 1981 to last year was only 0.6 per cent. That is less than one bond out of 100 defaulting.
- Two, the rules for GLC 1 and 2 do not place them near default. Only six out of more than 100 bonds held by either tranche have suffered ‘credit events’ in the past four years. Another 11 bonds must go bad before investors lose any capital. With the improved economy, it is unlikely that 11 more bonds will go bad within 14 months.If this scenario plays out and GLC 1 and 2 do not default, investors will get back 100 per cent of their investment in little more than a year. Though there is a slight risk, that 17.5 per cent return more than compensates for it. In its automated e-mail messages, Great Eastern gives the opposite advice: ‘Do not miss this chance to accept the offer,’ it says.
Accept the buyback for GLC 3, 4 and 5
GLC 3, 4 and 5 – valued at $385 million – are different. The underwriter has priced GLC 3 at 36 cents on the dollar, and GLC 4 and 5 at 23 cents. These figures probably understate the value of the bonds for the same reasons as for GLC 1 and 2, but in this case, it does not matter. The value of these bonds is so far underwater – below the buyback price – that some degree of under-pricing won’t affect the investor’s decision.
- First, the underlying CDOs of GLC 3, 4 and 5 are rated CCC- by S&P. Their time to maturity is three to four years. S&P data shows that the three-year default rate for CCC- global corporate bonds from 1981 to last year was 39 per cent. The four-year default rate was 42 per cent.
- Second, the CDOs backing GLC 3, 4 and 5 reference more than 100 bonds each. The contract requires that an additional 10, seven and five bonds in GLC 3, 4 and 5 must go bad before investors lose their capital. This is more likely to happen since the time to maturity for these tranches is three times longer than for GLC 1 and 2 and their bond quality is much lower.
There is no need to feel sorry for Great Eastern. The buyback is not as expensive as it seems, even for GLC 3, 4 and 5. The notes are structured as a wager rather than an investment and work like this: Only 10 per cent to 15 per cent of the underlying bonds need to suffer credit events before investors must forfeit the other 85 per cent to 90 per cent of good bonds to ’someone’. That someone is usually the underwriter or arranger – Goldman Sachs for GLC 3, 4 and 5.
Great Eastern could simply inherit this deal from investors. Or it might reduce its risks by first entering into a hedge or re-insurance agreement with Goldman Sachs or others. Great Eastern has not said if it did this although it would not be unusual.
The company’s losses on GLC 3, 4 and 5 would be further reduced by: One, the expected profits from GLC 1 and 2; two, the clawback of agent commissions; three, the management fees earned by Lion Global; four, the profit sharing – if any – with the underwriter; and five, tax savings should losses occur.
Four years from now – when the notes have all matured – the net loss to the OCBC group is likely to be substantially less than the trumpeted figure of $250 million.
The writer is a financial columnist for The New Paper and Adjunct Professor of Economics and Statistics at Singapore Management University.
Thursday, August 27
Monday, August 24
Wednesday, August 19
Friday, August 14
Sunday, August 9
My view on the POSB MyHome Fund
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POSB MyHome Fund is a fund that invests in two ETFs, namely the DBS STI ETF 100 and the ABF Singapore Bond Index Fund. It aims to maintain a fixed proportion of equities and bonds in these two ETFs, depending on the type of MyHome Fund that one invests in. The 1st type is the HomeSteady, which has 20% of its holdings in the DBS STI ETF 100 and 80% in the ABF Singapore Bond Index Fund while the 2nd type is the HomeBalanced, which has 50% of its holdings in the DBS STI ETF 100 and the ABF Singapore Bond Index Fund.
POSB MyHome Fund is a fund that invests in two ETFs, namely the DBS STI ETF 100 and the ABF Singapore Bond Index Fund. It aims to maintain a fixed proportion of equities and bonds in these two ETFs, depending on the type of MyHome Fund that one invests in. The 1st type is the HomeSteady, which has 20% of its holdings in the DBS STI ETF 100 and 80% in the ABF Singapore Bond Index Fund while the 2nd type is the HomeBalanced, which has 50% of its holdings in the DBS STI ETF 100 and the ABF Singapore Bond Index Fund.In my opinion, the main attraction for this fund is that it will automatically rebalance your portfolio to the predetermined proportion of equities and bonds, depending on the type which you have chosen. Why is this important ? A portfolio of a mixture of equities and bonds is less volatile than equities alone and this may be suitable for investors who cannot bear to stomach a huge drop in the valuation of their equities. Let us consider a simple example below.
In year 1, you bought $100 worth of equities and $100 worth of bonds and the proportion of equities and bonds is equal at 50% each.In year 3, the stock market has turned bearish by causing a drop of an average of 50% in the price of equities and the $100 worth of equities which you bought in year 1 is now only worth $50. However, the $100 worth of bonds which you have bought in year 1 is now worth $110 since stocks are inversely correlated with bonds generally and bonds are less volatile.Now if you bought $200 worth of equities in year 1, you would have suffer a portfolio drop of 50% at the end of year 3. The portfolio of a mixture of equities and bonds as described earlier would have suffer a drop of only 20%.On the other hand, if the stock market turned bullish at the end of year 3, the portfolio of equities will have a higher paper gain as compared to the portfolio of a mixture of equities and bonds.
The choice of HomeBalanced for the POSB MyHome Fund will be appropriate for those who wish to hold this in the long term but is not able to bear a high level of volatilty in their investment portfolio. I do not consider the HomeSteady to be a wise choice as the proportion allocated to bonds is too high. One might as well buy into the ABF Singapore Bond Index Fund without the additional charges layered for the POSB MyHome Fund. Another point is that stocks has outperformed bonds in the long term in the past so it is better to go for the HomeBalanced.
Unfortunately, another thing that is standing out like a sore thumb is the high initial sales charge, which stands at 3% but if you can only afford a small sum for investment, this may be a good choice.
Wednesday, August 5
Sunday, August 2
GE to return $250m
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GE to return $250mI applaud Great Eastern Life for taking this unprecedented move in contrast with other financial institutions. Bear in mind though that the GreatLink Choice has not defaulted yet as mentioned by Lioninvestor so GE would still have to refund the premiums at the end of maturity if it does not run into default down the road. Overall, it is a win-win situation since the investors can get back their funds while the reputation of GE has been enhanced tremendously by this move that they have taken. You can check out the official media press release by GE at here.
Surprise move related to investment-linked products sold to 18,000
By Lorna Tan, Senior Correspondent(Taken from the Straits Times on 1st August 2009)IN A stunning development, about 18,000 Great Eastern Life customers who bought investment products similar to the ill-fated Lehman Minibonds will get all of their money back. And they did not have to ask for it. The move by GE Life, which will cost the insurer a whopping $250 million, is purely voluntary.
The products in question are called GreatLink Choice (GLC) - a series of single-premium investment-linked insurance products sold in five tranches between 2005 and 2007, netting $594 million in investments.
Like Lehman Minibonds, GLC was linked to a class of complex financial instruments whose value has been badly hit by diving financial markets. So despite diversifying the risk and building in various loss-protection features, the values of the GLC plans have plummeted between 40 and 80 per cent.
'Great Eastern understands that these steep discounts have given rise to concerns among GLC policyholders,' group chief executive Ng Keng Hooi said in a statement on Friday.
'To address GLC policyholders' concerns in these extraordinary times, we have taken a decision to make this one-time offer, as a gesture of goodwill, to redeem these products. Our offer is voluntary, and is made without any admission of liability.'
The GLC plans, available for a minimum investment of $5,000, had aimed to provide investors with fixed annual payouts ranging from 3.5 to 4.9 per cent. They also aimed to return to investors their principal on maturity, though both the annual payouts and principal repayment on maturity were not guaranteed.
The plans came with a five- or seven-year maturity period and the first tranche would have matured in September next year. But policyholders can now opt, anytime from Monday to Aug 28, to redeem their investments and receive a sum equal to their original investment, less total payouts received to date.
The unprecedented move comes three weeks after a lengthy investigation by the Monetary Authority of Singapore (MAS) into the selling of similar structured products in the banking and securities sectors.
About 9,900 people lost most or all of their investments totalling about $520 million in structured products such as Lehman Minibonds and DBS Hi Notes 5. Ten financial institutions were penalised, and 3,900 investors received a total of $107 million as compensation.
GE's surprise offer on Friday to redeem up to $250 million is more than twice that amount, and that immediately drew high praise from consumer advocates such as the Securities Investors Association of Singapore (Sias).
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