Bond investors are supposed to have a quiet life, unlike share investors. But this year, there have been more than a few heart-aching moments for Singapore corporate bond investors as more bond issuers got into financial trouble and/or defaulted on their bond obligations, e.g. Pacific Andes Resources Development Ltd, Trikomsel and the latest, Swiber Holdings Limited.
In the past month, there have been some suggestions in social media of activism by bond investors against DBS, with reminders of DBS’ role in the Lehman minibond saga. There was also a news report of burnt investors in Swiber bonds claiming that they had not been given sound or appropriate investment advice by their private banker or relationship manager (“RM”) from DBS.
WHAT ABOUT SUING THE BANK FOR MY BOND LOSSES?
Investors who find themselves in such an unfortunate position may wish to be aware of the Singapore court’s approach towards cases of alleged mis-selling or breach of duty of care by the bank to customers whom they sold financial products to. The Court of Appeal had the opportunity to consider the liability of a bank when selling financial products (so-called ‘accumulators’) to its customer who later suffered investment losses in the case of Deutsche Bank AG vs. Chang Tse Wen  SGCA 49. In this seminal case, the plaintiff Dr. Chang claimed that Deutsche Bank AG had, among other things, misrepresented the nature of the services they would render him and was negligent in failing to advise him properly on managing his new wealth. The Singapore court’s approach is that they will take into account all facts relating to the parties’ relationship, especially any contracts or agreements entered into between the bank and the customer, to determine whether the bank had assumed any responsibility to provide investment advice. Solicitations or sales pitches in the form of the introduction and recommendation of financial products does not give rise to an advisory relationship. Unless the bank had voluntarily taken on a duty to advise the client (which is not the case in an execution-only role), the Singapore court is unlikely to find that the bank owes the customer an additional advisory duty of care where the bank’s role is contractually defined. This decision does not augur well for the bank’s customers, especially given how typically a bank will be well-advised by its army of lawyers who drafted those bank-customer agreements, the vagaries and costs of litigation and the challenges of evidence and fact-finding. For facts of the case and its detailed discussion, you may wish to refer to this helpful case explanation note from the law firm RHTLaw Taylor Wessing, which also compared the Singapore landscape for such cases to that in Hong Kong.
WHEN CONVENTIONAL WISDOM IS NOT SO WISE
There are some horrendous conventional wisdom and embellishments being promulgated by financial websites, books, TV and other media. These statements make me cringe (even till this day) and as a former investment banker, I’m in a unique position to comment on it professionally. Here are a few of my choice picks that I have come across from the abovementioned channels and my neighbourhood kopi-tiam uncle. However, please note that I am NOT saying that the following is a representation of how financial institutions in Singapore market bonds to their customers.
(i) “Bonds are safer than stocks which are more volatile.“
That’s what my CFA (Chartered Financial Analyst) textbooks said too, and the main reason why retirees are typically recommended to have a greater proportion of bonds than stocks in their portfolio. Well, as with most things in life, there are always “ifs” and “buts” to what the textbook says. In this case, bonds are not safer than stocks if the corporate bonds are not secured by valuable assets that can be easily sold for close to their reported book values; and not if the corporate bonds are issued by corporates whose management are not particularly adept at capital allocation and balance sheet structuring — not every CFO is born equal. In times of bond default leading to liquidation, holders of unsecured bonds rank higher than the poor ordinary shareholders, but are just as likely to get nothing back on their investment.
(ii) “Short-term bonds are safer than long-term bonds because you will get your money back sooner, hence the bondholder is less exposed to future fluctuations in market conditions.”
As I had explained in my article on Swiber published on 29 July 2016, due to the relatively short tenure of any medium-term note (“MTN”) (typically 3 to 5 years), the borrower must be sure it can quickly produce enough cash and some more from its capex and operating activities in order to repay the principal when it matures in 3 or 5 years’ time — this is no mean feat. The issuer is either counting on (i) strong operational performance with rising revenue and bill collection to generate operating cash flow; (ii) assets divestment; and/or (iii) the banks or the bond market being conducive enough to refinance the earlier MTN issue when this matures. When the general market conditions turn south unexpectedly, (i) becomes difficult to generate while (ii) and (iii) become the CFO’s Christmas wish to Santa Claus. Timed wrongly, the MTN can become a ticking time bomb and you’re not sure if you should cut the blue, red or yellow wire!
(iii) “This bond is rated [insert credit rating] by [insert name of famous credit rating agency].”
Lehman Brothers was not the only name on Wall Street to become sullied when the investment bank filed for bankruptcy protection in 2008. The big three credit-rating agencies — Standard & Poor’s, Moody’s Investors Service and Fitch Ratings — are still trying to repair their reputations as being an objective, level-headed group of credit analysts following the collapse of Lehman Brothers. These agencies were criticized for not only failing to warn investors of the dangers of investing in mortgage-backed securities (“MBS”) that were at the core of the financial crisis, but also for earning fat rating fees from assigning credit ratings that helped banks to push those MBS to customers. In any case, even if they were unbiased, credit ratings are typically rear-view mirrors because credit-rating agencies make the classic mistake of thinking recent financial performance is likely to repeat. The biggest case in point was that Lehman Brothers’ own debt still had an investment-grade rating when it filed for bankruptcy protection!
(iv) “This bond is recommended by a big bank, so it should be safe.”
According to a Straits Times report dated 6 August 2016 on Swiber’s bond sales by DBS Bank, a self-employed man, who wanted to be known only as Mr. Jin, said he had invested $500,000 in two Swiber bond issues through DBS Bank. “I was simply following the advice of my relationship manager, who never told me much about the company. I just thought, a bank in Singapore, with this much regulation, would not recommend risky investments,” this Mr. Jin said. Well, Mr. Jin’s story should teach us that the name of the arranger or distributing bank and its being highly regulated are totally irrelevant in assessing the future financial strength and credit-worthiness of the underlying bond issuer.
(v) “This bond issue is selling like hotcakes, it’s already [insert big number] times over-subscribed.”
The same aforementioned Straits Times report also reported that S$160 million 7.125% Swiber bonds met orders for S$240 million when it was issued in 2013. Similarly, another S$240 million 5.55% Swiber bonds met orders for over S$500 million when it was issued in 2014. This experience has now shown us that the level of over-subscription during issuance — an indicator of strength of demand from investors — is no indicator of future (or even current) financial strength of the bond issuer. If this was not already common sense, then it should be clear by now that hunting for good investments is far different from hunting for good food (many Singaporeans’ favourite pastime): the length of the queue is no indicator of the underlying quality. In investing, being in the same boat as many others is not always a source for warmth and comfort.
Another Straits Times report dated 8 August 2016 also suggested to readers that the level of over-subscription may not reflect actual underlying demand, because investors might have been led by the RMs to exaggerate their real demand in hope of getting a greater allotment of the bonds — the typical Singaporean ‘kiasu-ism’ manifesting itself again. This way, according to this aforesaid news report, the RM also looks good to his superiors in the bank, which in turn looks good to their issuer-client for garnering such strong investors’ interest. Such strong interest can then allow the issuer to perhaps reduce the offered yield payable on the bond, which ironically works against the interest of the bond investor. If this Straits Times report is factually true, then it appears that the practice of exaggerating one’s orders to get a decent-sized allotment is not restricted to institutional fund managers when they were placing their orders for hot China H-share IPOs in the mid-2000s.
(vi) “The issuer is owned by the government.”
According to a Business Times report dated 8 January 2016, even bonds issued by Temasek Holdings-owned Neptune Orient Lines (“NOL”) could give investors sleepless nights, as prices fell following the decision by Temasek Holdings to sell its majority stake in the shipping company to junk-rated French company CMA CGM SA. The obvious reason for concern is the change of ownership. A check on the website of Bond Supermart showed that since Temasek Holdings’ sale decision in December 2015, the 4.40% NOL bonds due 22 June 2021 had fallen in price by approximately 33 % by March 2016, while the yield in the same period had surged from 6% to approximately 15% — see price chart below.
The challenge in a market like Singapore is that many investors may be cash-rich but not all have the necessary technical know-how or experience to understand the implications of events like takeovers, distressed businesses and the response of parent companies on the pricing of their securities. Many investors, including so-called “accredited investors” (which is defined in Singapore as having S$2 million in net assets or at least S$300,000 in income in the preceding 12 months), may also not have read or understood for themselves the fine print within the bond issue information memorandum — particularly the paragraphs on security or guarantee — which again means that they could misprice credit risk. Put simply, being an “accredited investor” is not synonymous with being a “sophisticated investor” although our securities law seems to define it as so. “What about asking my young, pretty RM to study that 500-page information memorandum and explain the details to me over dinner and a bottle of wine?”, I hear you asking……
(vii) “My RM told me it’s a solid company…can fill my boots. Why leave your money in fixed deposit and earn that low interest rate?”
Before a customer takes any RM’s investment recommendation too seriously, one may wish to question how the typical RM’s personal compensation is aligned with the financial returns to the customer. There is a great explanation of this RM-customer relationship in the 1940 classic book “Where Are The Customers’ Yachts” written by Fred Schwed Jr. According to former financial columnist for Time and Fortune magazine John Rothchild’s comments on this humorous and entertaining book, “The investor’s need to believe somebody is matched by the financial adviser’s need to make a nice living. If one of them has to be disappointed, it’s bound to be the former.” It is also for the same reasoning that Warren Buffett once proposed a Newton’s Fourth Law of Motion: For investors as a whole, returns decrease as motion increase.
SO WHO CAN I REALLY RELY ON FOR MY BOND INVESTMENTS?
Well, self-reliance and independent thinking is the best reliance — I know this does not sound too helpful. As a prospective investor, you should be prepared to do (or learn to do) your own research on the bond issuer, part of which means understanding the issuer’s business and reading the 500-page information memorandum in sufficient detail so as to understand the risks yourself.
A proper credit analysis before investing in a corporate bond will involve the following steps:- (i) scrutinize the bond issuer’s past few years of financial statements to understand what makes the issuer tick; (ii) read the terms of the issue as found in the information memorandum — particularly those on covenant protections, payment terms, call provisions, security, debt maturity profile, contingent liabilities, etc; and (iii) perform a line-by-line cash flow projection (using Excel spreadsheet) based on very conservative assumptions on the issuer from now till the date of maturity of the bond, in order to gauge for ourselves its repayment ability or default risk. All these work will take up at least a day or two for just one bond issue. The commonly seen computations on debt-to-equity, current ratio or interest coverage ratio do not convey enough details to make us sleep like babies at night. In investment, we shouldn’t like excitement or sweaty palms. We agree with what George Soros once said, “If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.”
We accept that not everyone is trained to perform such detailed credit analysis. As such, you can either learn how to DIY over time, engage some real independent professional help (which may not be cheap), or stay away from that enticing high single-digit bond yield altogether — yes, that 0.35% 12-month fixed deposit rate isn’t too bad compared to negative rates in Europe and Japan! Warren Buffett once expressed amazement at how people would spend much more time checking around and shopping for the best deal on something like a dress, a handphone or a dinner which cost only a few hundred dollars, but would never ask at least 30 times the number of questions before eagerly plonking down $250,000 or more on their investments.
BOND DEFAULT RISK IS REAL, AND RISING.
The above chart shows the historical default rate for US speculative-grade bonds. The default rate for high-yield bonds has risen to the highest level in six years, but is still relatively low compared to the last 25 years, i.e. there’s room for higher default rates based on historical pattern. It’s probably no great surprise that plunging commodity, metals and energy prices have to do with roughly 50% of the rising defaults in recent times. Although the above chart depicts the default rate in the US, it can still be a good proxy for understanding the general situation in the corporate bond market in other parts of the world, since markets like metals, energy and shipping are global in nature. For those of you sitting on bond investments, you may wish to re-visit your portfolio. I certainly hope you have not thrown that bond issue information memorandum away already.