Many people have been asking why their Minibond capital is affected by the bankruptcy of Lehman Brothers when it is not one of the reference entities. I think a picture would explain this relationship very clearly.
The layman explanation of how it works is this:
- You provide the capital.
- It is used by Minibond Limited to purchase a basket of AA rated credit-linked notes (often termed as synthetic collateralised debt obligations). This is called the underlying securities. You have exposure against credit default of the underlying securities.
- The coupons from the notes are paid to the swap counterparty. In return, the swap counterparty pays you the promised quarterly coupon payouts.
- Premiums are paid by the swap counterparty to insure themselves against default of the reference entities. These are the 5 or 6 companies you are told about when you bought the minibonds. In the event of a default by any of these companies, the swap counterparty will take over the underlying securities and pay you what’s left of the defaulted bonds of the reference entities minus costs, etc.
- If nothing happens up to maturity, the proceeds from the underlying securities would enable Minibond to pay back your original capital.
For a more detailed explanation, you can refer to the original pricing statement. Below is the pricing statement of series 2 for your reference.
Minibond Series 2 pricing statement
At this point, things are very unclear. Lehman Brother Holdings (they have a role of swap guarantor) have filed for bankruptcy. We do not yet know the fate of the swap counterparty, Lehman Brother Special Financing and whether Barclays have taken over any of this.
If the entire minibond arrangement is terminated, the underlying securities have to be liquidated to pay back the capital of the noteholders (minus the costs of unwinding all the positions). The problem with this is that the current market value of the underlying securities is likely to be less (and could even be much lesser) than the total obligations due to the noteholders. The cost of unwinding all of the swap positions is also unknown.
You can refer to page 50 of the base propectus to see how this is structured legally and the rights of the various parties. A bit complicated with many issues and no doubt this will take time to be worked out.
Minibond Limited base prospectus
I have spoken to HSBC Institutional Trust again and this is what they have told me is happening:
- They are in the process of working out the value of the underlying securities.
- At the current moment, they are going to treat the Minibond arrangement as still in place.
- In the event of a default by the swap counterparty on the quarterly coupon payments, HSBC will then exercise their right on the underlying securities in the best interest of the noteholders.
- This will happen when either Lehman informs HSBC explictly that they will not be paying the coupons, or the coupon payment date comes (different dates will apply depending on which series you are holding) and HSBC does not receive the money.
- If there is any update, they will inform all the noteholders accordingly. They have the contacts from CDP.