The New Zealand Superannuation Fund has got itself into a Portuguese pickle as a client of Goldman Sachs.
The Super Fund has written down a US$150 million (about NZ$198 million) loan to Portugal's Banco Espirito Santo to zero after the loan turned sour.
CEO Adrian Orr says the Super Fund is one of a number of investors suing the Bank of Portugal, that country's central bank, after it transferred a Goldman Sachs arranged, Super Fund loan from the "good bank," Novo Banco, to Banco Espirito Santo, or the "bad bank"after the Portuguese bank failed and the central bank took charge.
Orr says the Super Fund has been treated "unequally and unlawfully," with its default insurance, which was also provided by Goldman Sachs, "inadvertently rendered ineffective" due to a retrospective central bank decision.
"We have a very strong legal case and a high level of confidence of success," Orr says.
Nonetheless he says the dispute is likely to be a lengthy one. Separately Goldman Sachs says it too is pursuing "all appropriate legal remedies without delay" against the Portuguese central bank.
Through the law suit, the Super Fund is striving to overturn the Bank of Portugal’s decision, which would return the loan to Novo Banco where the Super Fund's credit protection, and the money it lent, remains. On the insurance front the Super Fund says the issue it faces isn't with the credit protection per se, but with the "delinking of the credit protection from the underlying loan obligation."
The Super Fund had been expecting a return above 1% per annum of "pure net profit" from the deal with its loan having a weighted average life of 1.6 years. On the basis of zero recovery of assets, the Super Fund would lose US$150 million plus legal costs.
The Super Fund, alongside institutional investors and pension funds, is among Goldman clients that lent €835 million to Banco Espirito Santo on July 3 last year through the Dutch entity Oak Finance. The loan was financed through Oak issuing bonds to the investors, with the bondholders, including the Super Fund, effectively Oak's owners.
When Banco Espirito Santo reported an unexpectedly large half-year loss of €3.6 billion on July 30 last year, the Bank of Portugal intervened to save the troubled bank, splitting it into the good bank and run-off bad bank. It ultimately decided to leave the Goldman arranged loan in the bad bank, meaning it's unlikely to be repaid.
Bank of Portugal 'wrong'
Orr says the Bank of Portugal retrospectively decided to return the loan to the bad bank after having transferred it to the good bank. It was wrong to do so, he says, because of an erroneous view that Goldman was both an associate of Banco Espirito Santo and the lender. On July 15 last year Goldman borrowed Banco Espirito Santo shares as part of its client facilitation activity. This lead to a disclosure from Goldman under European Union transparency rules acknowledging a greater than 2% stake in the Portuguese bank.
Goldman says its actual physical holding was only 1.6% with the balance of 0.67% of its interest in cash settled swaps that didn't carry any voting interest in Banco Espirito Santo or any rights to acquire shares. However, the Bank of Portugal deemed Goldman a "qualified shareholder" with a stake above 2% meaning it couldn't benefit from a bailout.
"As Goldman Sachs has said publicly and to the Bank of Portugal, Oak Finance was an independent entity from Goldman Sachs International. We understand that at no point did Goldman Sachs hold a participatory interest in more than 2% of Banco Espirito Santo's shares," Orr says.
"Legally, the loan arranger's shareholding in Banco Espirito Santo should not be the basis for treating the Oak Finance loan as related party lending."
"We note that Novo Banco continues to have the benefit of the money that we lent," Orr adds.
"It will also be of considerable concern to any investor that the Bank of Portugal has not treated all senior debt holders equally. We understand that holders of senior bonds arranged and underwritten by at least one other financial institution have remained with Novo Banco when, unlike the position with the Oak Finance loan, the bonds were subscribed by a related party of a substantial shareholder in Banco Espirito Santo," says Orr.
'Standard investment activity'
He says by making the loan the Super Fund was providing needed liquidity to the Portuguese banking system. It protected itself against the risk of default by purchasing credit insurance from Goldman.
"This is a very standard, insured, investment activity globally that keeps the financial world liquid. The Bank of Portugal's actions, however, in treating the Oak Finance loan differently to all other senior debt obligations, appear to have had the effect of negating this insurance," Orr says.
He says it's concerning for investors in Portuguese banks that senior debt can be treated on a similar basis to equity and subordinated debt, solely by virtue of the debt arranger's, not lender's, shareholding in the bank.
"We are not entering into these legal proceedings lightly and have made the decision only after exhausting all other options," Orr says.
He says the Oak Finance investment was part of a credit strategy the Super Fund had operated successfully for several years. Although significant in dollar terms, it represents just 0.7% of the NZ$27 billion the Super Fund manages.
"Even after factoring a conservative write-down of the loan to zero, the (Super) Fund has returned 16.71% over the last 12 months, as at 31 January 2015, after costs, before tax," the Super Fund says.
It says these types of loan make up about 2.5%of the Fund's net asset value and overall have proven successful.
Here's a good back grounder on the broader dispute from Reuters' Neil Unmack.
Here's a press release the Super Fund issued, a back grounder it provided here and a timeline it provided here.
45 Comments
Who ever at NZ Super Fund signed off on investing a in a Portugese Bank should be sacked immediately - perhaps the upper echelon/board should all be fired over this. Who would even think about investing in a Bank in that country in the current environment - absolute madness
Sounds familiar doesnt' it
Reading the article I got as far as this obscure little gem - and stopped - no need to go any further
On July 15 last year Goldman borrowed Banco Espirito Santo shares as part of its client facilitation activity
In broking parlance, brokers "borrow" shares in order to "short sell" them
On the face of it, what that means is, Goldman Sachs were tipping their clients in, while at the same time GS were shorting the shares of the company their clients were lending to
Client facilitation activity indeed
Too bad GS didn't hire smart people like you as its trader, I guess.
So borrowing a stock can only be for the sole purpose of shorting it? and as a broker, a middleman? The definition of a middleman is to take a toll on the traffic, not take a directional bet. In this particular case, could be GS has 2 clients, 1 (say, a passive index tracker) with BES shares sitting idle in its portfolio, while the other wants exposure to BES for a period of time but for some reason (e.g regulatory) cannot access the shares directly? GS, as the middleman, can borrow from 1 for an interest, and then provide the exposure to 2 for a (higher) interest? GS facilitate the transfer of return/risk of BES shares from 1 to 2, and charge a toll (interest spread) from the traffic?
Given their past behaviour, why do you now think that they have changed their behaviour?
GS were found to have put their interests ahead of their clients, and to have bet against their clients. Were they not fined many millions of dollars, were they not bailed out?
While I agree with the alternative scenarios you refer to, I refer you to the above .
If they were a true broker they would not trade on their own account, they do, so at any time they take a position in the market and this position will have an impact on their behaviour. Quite different than from a broker.
If GS had not done this then your response would be more credible.
If GS had hired "smart people" which I assume includes ethical, then they probably would not have lost the trust and respect that they once held.
Suggest you read "Traders Guns and Money". These big firms prey on the unsuspecting whether they be individuals, corporates or governments.
Just remember everyones trying to nick your stuff, as opposed to rationalising the positives of the financial shennanigins.
What you've said are true - but I tend to look at them at a different angle.
Certainly GS puts its interest above clients, especially when they are the 2 sides of a transaction. I see selfishness as the foundation of capitalism. Remember GS is not a "fiduciary" to its clients, and if you are a grown-up in the financial world to face GS (institutions, large corporates, etc) you should do your homework and not expect to be taken care of by anyone else.
The reason I challenged the interpretation above is taking a position means taking on risk - something GS would be very hesitant to do - they are way more comfortable to just be the middleman and take a toll on the traffic. By the way GS always trade on its own account - it's not a Fund or a commercial bank, but an investment bank, so all trades are proprietary. One of the accusations on them in causing the GFC is the way they create traffic, packaging toxic assets from mortgage originators to "unsuspecting" investors. I dare challenge those investors (AIG, banks, pension funds) - what have you done, or not done, analysing these assets and investing other people's money in them?
I would expect GS very very rarely take a directional bet. sometimes assets do appear on its books, typically GS is warehousing for its clients - taking on its books for the client who due to some constraints can't own the assets but like the exposure. It's part of the reason they incurred losses during the GFC. during the packaging & selling of mortgage bonds, GS need to "own" the bonds for a period of time until it line up investors to onsell to. when the market crashed those bonds are stuck on its books and written down - it's not like GS are betting on them, but more like building a bridge but the opposite shore quickly receded.
What you've said are true - but I tend to look at them at a different angle.
Certainly GS puts its interest above clients, especially when they are the 2 sides of a transaction. I see selfishness as the foundation of capitalism. Remember GS is not a "fiduciary" to its clients, and if you are a grown-up in the financial world to face GS (institutions, large corporates, etc) you should do your homework and not expect to be taken care of by anyone else.
The reason I challenged the interpretation above is taking a position means taking on risk - something GS would be very hesitant to do - they are way more comfortable to just be the middleman and take a toll on the traffic. By the way GS always trade on its own account - it's not a Fund or a commercial bank, but an investment bank, so all trades are proprietary. One of the accusations on them in causing the GFC is the way they create traffic, packaging toxic assets from mortgage originators to "unsuspecting" investors. I dare challenge those investors (AIG, banks, pension funds) - what have you done, or not done, analysing these assets and investing other people's money in them?
I would expect GS very very rarely take a directional bet. sometimes assets do appear on its books, typically GS is warehousing for its clients - taking on its books for the client who due to some constraints can't own the assets but like the exposure. It's part of the reason they incurred losses during the GFC. during the packaging & selling of mortgage bonds, GS need to "own" the bonds for a period of time until it line up investors to onsell to. when the market crashed those bonds are stuck on its books and written down - it's not like GS are betting on them, but more like building a bridge but the opposite shore quickly receded.
The reason I challenged the interpretation above is taking a position means taking on risk - something GS would be very hesitant to do
I think not - Goldman Sachs is a major proprietary trader for it's own book.
During the 2008 Financial Crisis, the Federal Reserve introduced a number of short-term credit and liquidity facilities to help stabilize markets. Some of the transactions under these facilities provided liquidity to institutions whose disorderly failure could have severely stressed an already fragile financial system.[37]
Goldman Sachs was one of the heaviest users of these loan facilities, taking out numerous loans from March 18, 2008 – April 22, 2009. The Primary Dealer Credit Facility (PDCF), the first Fed facility ever to provide overnight loans to investment banks, loaned Goldman Sachs a total of $589 billion against collateral such as corporate market instruments and mortgage-backed securities.[38] The Term Securities Lending Facility (TSLF), which allows primary dealers to borrow liquid Treasury securities for one month in exchange for less liquid collateral, loaned Goldman Sachs a total of $193 billion.[39]
Goldman Sachs's borrowings totaled $782 billion in hundreds of transactions over these months.[40] This number is a total of all transactions over time and not the outstanding loan balance. The loans have been fully repaid in accordance with the terms of the facilities.[41][42]
Hardly the stuff of a firm collecting rent from customer capital as it passes through the firm.
Dude... just because say Pak'n'Save bought some shitty goods that it cannot sell to customers, and say need "bailout" from whoever (Foodstuffs?), doesn't make Pak'n'Save an end consumer - it is still an intermediary. Again GS "bought" the mortgage bonds to onsell to investors, and market crashed, leaving the worthless shit stuck with GS, which doesn't have enough capital to shoulder the losses. It doesn't mean GS are betting on those shit. GS doesn't usually take directional bets as short a stock. And it doesn't mean GS doesn't take on risk, just often not directional risk.
Also GS IB is not a deposit taking entity, nor in fund management business, all their trades are proprietary, with own money...
I know it's only a article and may be only half the story but I'd side with the Portuguese on this. Goldman Sachs put their clients in a untenable position.
This will mean that NZSF and the other affected clients will never deal with GS again, won't it, isn't that how business works, isn't it?
The returns of the fund have been very impressive- I'm rather envious of their 9.8% a year over the last 10-15 years including the GFC. Presumably to achieve that return they have been at the riskier end of a reasonable number of investments, and haven't yet had too many go bad. Nevertheless they should be open to reasonable scrutiny/transparency/audit in terms of what they have invested in, especially as putting $200 million into Portugal post the GFC just has a feel of being imprudent at best, if not downright reckless.
Finally some reasonable thinking.
Remember NZSF is not your typical pension fund, which typically are low risk, and matches its assets to future pension liabilities/cash flows (timing) closely. NZ has a pay as you go Super scheme, and it is not NZSF's objective (as defined in the Act) to provide all future Super payments, and bear the full risk of it. NZSF has an incredibly long time horizon (NO drawdown till 2030s), and hence possesses an incredibly high level of risk tolerance and very low level of liquidity needs. If you take a long term view, in general only higher risk can provide higher return, and thus fluctuations (by definition of risk) along the road is inevitable. In a world of negative interest rates, 10%+ return (on a 27b fund that 2b+ per year) don't come by easily or without costs.
I cannot agree - term US government bond investments have provided an extraordinary return due to extraordinary high risk central bank policy settings aimed at directly monetising fiscal deficit financing. Hence the UST 30 year moved from a 15.0% yield in 1982 to ~2.30% more recently. There are good reasons why large US banks maintain a large and increasing inventory of domestic sovereign obligations to sell at a later date - remember yields can half to infinity, hence net present values of a stream of historically high coupons can keep rising.
I haven't done any hard research on the reasons of the drop in UST yield drop - but suspect the 15% yield in 1982 is a remnant of the 1970s hyper-inflation era, and hence the start of the 1980 - now cycle when yields are down - and I don't think the 1970s hyper-inflation is a norm in history. More relevant is the current 2% UST 10y yield, and the negative yields in German and Japan treasuries (true triple-A rated, as risk-free as you get - US at AA+?) which means if invested in by NZSF, NZ taxpayers are PAYING interest for the priviledge of LENDING to Germany or Japan...
Plus banks are a whole different category of financial institutions than NZSF, within their own objectives, constraints (e.g. regulatory), and bank investments are typically more conservative, more liquid, and serves other purposes (balance sheet management, liabilities matching) than pure return. Not surprising banks hold more treasuries than a growth fund like NZSF - and certainly not holding treasuries for higher returns.
Many others saw the sense of buying term US sovereign debt and made off like bandits - the arbitrage of the Yen carry trade could not be ignored by one very significant demand sector. Certainly large enough to finish Bill Gross' tenure at Pimco. Why mess about in Portugal?
While Pacific Investment Management Co.’s Bill Gross is recommending short-term U.S. debt, Japanese bond investors are finding value in longer-dated Treasuries as U.S. consumer prices rise the least since 2009. Prime Minister Shinzo Abe’s stimulus policies are also weakening the yen by the most in three decades this year, bolstering the allure of dollar-based assets.
“There’s tremendous deflationary pressure in the U.S.,” Yusuke Ito, a senior fund manager at Mizuho Asset Management, which oversees about $32 billion, said in a telephone interview from Tokyo on Dec. 4. “For bonds, the longer the maturity, the better” as slowing inflation preserves the purchasing power of fixed-rate interest payments.
Ito said the company held most of its U.S. debt in Treasuries due in five years and more and predicts yields on 10-year notes will fall to 2.10 percent by the middle of 2014 from 2.85 percent today. Mizuho Asset’s holdings also had a longer average maturity than those in the benchmark index it uses to gauge performance, he said. Read more
JGB 10yr yields remain positive
Not sure what you are suggesting here... admittedly treasuries have had some spectacular run thanks to UNPRECEDENTED monetary stimulus and the worst financial crisis since 1930s, but how much higher can they go at the current yield level? You mention yields dropped from 15% in 1982 to 2% now, that's a great return for bondholders - but you need yields to drop to what, -11%? to enjoy a similar return going forward? or do we just buy in now and enjoy the 2% UST return, in face of the saga just happened? What of currency risk, and what if the vast amount of USD printed by Fed truely start to circulate and drive inflation in the US crazy - if yield goes back to 15%, investors in UST would lose their shirt, and pants, and pantis. What about unpredictable event risk like 911?
The amount of money concerned here, and particularly its significance to the welfare of all NZers, mean that it cannot be tied to any asset, asset class, trade, or strategy, but to a very well diversified portfolio, and harvest the Fund's true competitve advantages - it's long time horizon, risk tolerance, low liquidity needs, etc, to generate higher return. Kiwis should understand the Fund's purpose, strengths, constraints, and hence strategies better and make informed judgements there.
Agree with Stephen L and PattyZ.
The Super Fund isn't playing tiddlywinks here. The best way to provide for NZ's future is to invest in growth, not zero coupon government stock.
It's classic risk-reward. I would expect some investments to go sour in pursuit of close to 10% growth.
Here's a Moody's note on the lending to Banco Espirito Santo.
https://www.moodys.com/research/Moodys-assigns-B3-to-Oak-Finance-Luxemb…
Here's a Hollywood version of such stories (re taking a loss)
https://www.youtube.com/watch?v=0Qg94ltTqAA
I think I want my money back.....
It is tempting for people to focus on this particular stuff up and claim that people should lose their jobs etc over this. Investing successfully is not easy and even the best of them make mistakes at times. What matters is the portfolio's performance overall and over a reasonable period of time and what risks have been taken to achieve that performance. That is not to say that NZSF can be easily excused for this. The board has to question the size of the exposure they took here, how prudent was it in the context of the risk and whether due diligence was thorough and properly considered the very high risk of the Portuguese government re writing the rules. And the optics of duff lending to a Portuguese bank look much worse than doing something wrong closer to home when you are answerable to the NZ public. NZSF has a somewhat unique performance objective which allows them to invest in some fairly unusual things at times. Perhaps these somewhat less demanding performance objectives and greater freedoms have, along the back of some good historical returns, created an atmosphere of hubris, supported by a trend to manage funds inhouse? In a closed shop environment the chances of proper arms length critique become limited and may become captive to the likes of Goldmans etc.
Keeping company with the likes of GS and lending money to a Portuguese bank!! A case of: ' If you lie down with dogs, don't complain if you get up with fleas'.
The Portuguese courts are "Inquisitorial" (secret triibunals) so don't expect too much sympathy for the NZ Super Fund there.
These fund managers have all been on the same courses. Diversity is the strategy. Internationally, sectors etc. Obviously this chain of parties were a bit naive in this case. What I would like would be for them to tone down on the excuses. And to include the write-down in their books in the same way that they book profits. ie Don't treat it like a one off exception. Treat it as the direct result of their strategy. See what effect it has on annual performance and review the strategy if required.
If the value of the $NZ drops dramatically when money is being withdrawn from the fund, almost any money "invested" overseas will represent a huge windfall. Letting the fund managers off the hook for the odd "lemon".
But as things stand, this is quite a hit.
a) Well it was apparantly covered but the Central bank acted illegally.
b) bear in mind they hedged themselves with an insurance policy, from goldman sucks though, maybe a bit naive.
For me its not so much making a mistake as not making the same mistake twice. I also think there will be a lot more of such events.
Watch a) the legal case is going to be interesting. Bascially it means that a CB can do anything it wants with foreign or even domestic investors $s. Those NZers who are putting thier money into OZ as its "safe" should take note.
NZSF need to be providing more detail on the credit insurance provided by GS on this asset. While typical for this sort of insurance to be rendered unenforceable in the event of fraud (by the Banco Espirito Santo or its shareholders), there are more serious issues if GS were actually writing this insurance themselves (as the article suggests), and further the depth of due diligenece (i.e. lack of) undertaken in the lead up to settling this trade. Clear lack of expertise and experience of the GS deal team on that one!
It seems reading between the lines Mr Orr is glossing over the credit insurance aspect (GS's provision thereof) and mixing it up with the decision by the Bank of Portugal to re-classify the Oak Finance loan to Banco Espirito Santo back under the "bad bank". While it may be partly related, its not the only reason this insurance wasn't immediately enforceable.
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