This post is a continuation of What Happened to my Lehman Minibonds?
Just to recap, the Lehman minibonds will be negatively affected when something adverse happens to either
- The reference entities; or
- The underlying securities
So by right, both should be thoroughly investigated before considering any investment in this minibond.
As taken from the minibond pricing statement for series 2 (I’m not too sure whether it is the same for the other series. You can probably find and refer to the pricing document), the underlying securities for this Series of Notes will consist of portfolio credit-linked notes (often termed “synthetic collateralised debt obligation securities”) (CDOs) that have the following characteristics:
- USD-denominated principal amount equivalent to the total principal amount of the Series of Notes issued, which will be determined on or around the Fixing Date; (bad news since the USD has dropped quite a fair bit)
- Coupon rate of 3-month USD LIBOR plus a margin, to be determined by the Arranger on the Fixing Date
- Interest that is payable quarterly on a day that is no later than the corresponding payment date of the Notes
- Are rated AA or Aa2 by any one of the Rating Agencies: Standard & Poor’s, Moody’s and/or Fitch
- Not be subject to any negative Credit Watch of Standard & Poor’s or review for possible downgrade on Moody’s Watchlist or not be subject to Fitch Rating Watch Negative
- Be acceptable to the Swap Counterparty as a lending source for the obligations of the Issuer under the swap arrangements
- Mature on or before the maturity date of the Notes
In determining the rating of the Underlying Securities, the Rating Agency will perform detailed due diligence on the structure of the Underlying Securities and the Portfolio (as defined below). The underlying Securities for this Series of Notes is expected to be secured by a note, a fund or cash, in a principal amount equivalent to the total principal amount of the Series of Notes issued.
The Underlying Securities will reference a static pool of entities/obligations (the “Portfolio”) and redemption at maturity is dependant upon the credit performance of the Portfolio. The Underlying Securities will be exposed to the credit risk of the Portfolio and follow credit event definitions similar to those outlined in this Pricing Statement for determination of when losses occur: such as bankruptcy, failure to pay and restructuring. The level of credit enhancement provided against loss on the portfolio of the Underlying Securities is expected to represent a minimum of 105% of that required by the applicable rating agency for the assignment of a “AA” or “Aa2” rating, as the case may be.
When an entity in the Portfolio experiences a credit event, a determination will be made if the market value of one of the entity’s debt obligations (a “Deliverable Obligation”) has fallen below its principal amount (i.e. less than 100 per cent.). If it has fallen, then a loss amount for the Portfolio is calculated based on the fall in market value below 100 per cent. and the weighting of that entity in the Portfolio.
In a nutshell,
- I have been sold something that has exposure to a basket of CDOs
- I do not know what is in that basket
- I do not know whether there are any subprime loans in that basket
- I do not know the current valuation of that basket and how it might affect the final redemption price
In other words, I have been (fill in the blanks).
If the underlying securities (made up of the CDOs) are repaid early for any reason (given as default, tax reason or reduction in principal amount), the notes will be redeemed early and there will be capital losses.
I have to say I was a bit complacent at the time I invested in the minibonds. There was a one-liner in the product brochure that said the “security of the investment is in AA rated securities“. Together with the sense of safety given by the reference entities, I didn’t see much that could go wrong.
Remember at that time, very few people were even concerned about CDOs and subprime loans. The world has since realised that many tranches of CDOs containing subprime loans were incorrectly rated.
If you happen to own the Lehman minibonds as well, don’t despair yet as not all is doom and groom.
Last week, I managed to obtain a copy of the pricing quoted by Lehman if we wanted to sell our minibonds back to them. The prices actually ranged from 84.75% to 89.75% of the initial face value. I do not know whether the discount to the face value is due to a drop in value of the underlying securities, or based on some other criteria. For a normal bond, the current price will definitely be higher than the face value due to the decrease in interest rates.
Anyway, if I count the dividends that I have received so far, I will incur a loss of about 5% if I sell the notes back to them now. That is still not too bad if you look at the writedowns that has taken place at all the banks.
I am going to see whether I can find out more details on the underlying securities for my particular series before deciding whether to hold or sell my minibonds. If you have the Lehman minibonds, you might want to seek your own independent advice as your circumstances might be very different from mine.