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Credit Derivatives

Sometimes investment banks invest in their own investment products. This is especially reassuring to investors when the product carries a certain level of risk. Imagine someone you don’t really trust giving you some cake and then also eating a piece. At least you know it’s not poisoned right? Maybe a more realistic example is an waiter that eats the food served at their restaurant. There’s a certain amount of comfort knowing that a person who witnesses the food preparation isn’t totally repulsed by what’s being served. But what happens when the bankers invest in the deal and make a ton of money at the bank’s expense? In 2009 Deutschse Bank employees structured a transaction that was meant to mitigate the investment bank’s risk in a deal with another client. The senior tranche was purchased by AXA SA and the junior tranche was sold to Greengate SAM, a hedge fund in Monaco. A portion of the junior tranche was also purchased by six Deutsche Bank employees. Fast forward to today: the trade will close off at the end of this year and the six employees (who invested about $4.5 million) will make roughly $37 million. Colin Fan, the former co-head of the bank’s invest arm, will make the most. His $1 million investment will make him about $9 million. Greengate and AXA have also made money on the deal, all at the expense of Deutsche Bank. The bank’s losses are estimated to be near $60 million. I don’t how the bank feels about its clients making money on the investments they sell them but they are not happy about the employees making money on the investments they purchase from the bank. Internal auditors are reviewing the trade, previous audits, and the structure of the deal from a compliance standpoint to investigate if the employees structured the deal to pay inflated profits to themselves and Greengate while locking the bank into high fixed costs. It’s interesting to me as a former bank employee. I never worked on anything like this but every year when bonuses were due I would have the inevitable conversation with a senior manager about how my bonus was going to be larger than the bank expected and they would be restructure my end of year payout to a lower figure. The reason that the gain is so high on this investment is because there was a considerable amount of risk involved. You can easily imagine the Deutsche Bank employees investing in the deal as a sign of good faith. A large institution like AXA SA would not buy the senior tranche if the junior tranche wasn’t picked up and another large company would not have any interest in the junior trance…it’s too risky. The bankers did find a small hedge fund to buy the junior and to reassure the hedge fund the bankers also invested. It worked out well for them but they also put a significant amount of money on the line. Then again, you could argue that they were willing to take what looked like the least appealing investment because they know it would “pay an inflated share of profits and fees to themselves and the hedge fund, while locking the bank into high fixed costs.” 


Last week I wrote about the strange activity over at LendingClub and the controversy around the CEO’s resignation. Bloomberg published a comprehensive narrative of the rise and fall of LendingClub and the account reads like a typical Wall Street story, “from innovation to wild exuberance to disillusionment.” The article itself is interesting if you are following the story but I wanted to at least point out the where the wheels came off given my confusion a week ago. Ultimately, the CEO’s fall from grace started 2 years ago when he invested his own money in a company called Cirrix. He then presented the investment to the board and risk committee at LendingClub but failed to disclose his own stake. That is against the rules. Most recently, the board lost confidence in Laplanche during interviews surrounding a loan deal that went bad with investment bank Jeffries. $3 million of a $22 million deal came from loan applications that had been altered to meet the investor’s criteria. The loans were repurchased by LendingCLub and sold to another buyer but Laplanche’s lack of candor and disregard for policy lead the board to seek his resignation. 

Regis – “Minor detail with major implications!”

The Department of Labor recently announced that salaried employees earning income below a certain threshold would be eligible for overtime pay. The analyst at Piper Jaffray, who covers the hair solon Regis, estimated that the change would cost Regis $81 million.  This adjustment was based on the premise that store managers were not currently being paid for overtime. Well, it turns out that they do, and the change will only cost Regis about $5 million. By the time the analyst adjusted her estimates the stock was already down 19%. In an email to Bloomberg, the analyst wrote that the mistake was related to a “minor detail with major implications!” Major implications indeed.  At least they now know what it’s like to get a bad “haircut.” Sorry, I couldn’t help myself. 


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