Banks burned by minibonds get good news
It has been sweet and sour news recently for banks that were burned in the Lehman Brothers minibond saga and forced to make large provisions.
The bad news is that the provisions made by the lenders is 20 to 30 times the commissions they earned from selling the products. These painful lessons have led many lenders to stop selling investment products for other banks to prevent the same problem occurring again.
The good news is that banks are making lower provisions than expected - HK$5.2 billion, down from the HK$6.3 billion originally expected in the minibond settlement. It is still likely the largest settlement involving retail investors and underscored the need for banks to take greater care in marketing complex financial products to small investors.
Despite their name, minibonds are not actually bonds but risky credit-linked notes that became almost worthless when Lehman slid into bankruptcy in September 2008. As a result, regulators received more than 20,000 investor complaints alleging that bank staff misled them about the riskiness of the products.
In July last year, 16 banks that sold the minibonds issued or guaranteed by Lehman reached a settlement agreement with the Securities and Futures Commission and the Hong Kong Monetary Authority. Customers younger than 65 years old were repaid 60 per cent of their initial investment while those aged 65 and above got 70 per cent.
According to the SFC, more than HK$5.2 billion was repaid to about 24,400 bank customers and about HK$109 million to 366 brokerage clients.
The HKMA said 98.9 per cent of customers who responded to the offer accepted the settlement.
Although the total payout is lower than expected, the total provision is still costly. In addition, banks must pay about the same amount as they earned in commissions in legal fees to get back the collateral from Lehman's liquidators.
In acting as a middleman in the sale of the minibonds, each of the 16 lenders received a commission ranging from a few million dollars to HK$160 million. The payout represents more than 20 times the commission they earned from the sale of the products.
Bank of China (Hong Kong), for example, was the largest minibond seller. It earned HK$160 million from the sales but ended up paying HK$3.28 billion to customers.
While BOCHK was hit the hardest in absolute terms, Bank of East Asia suffered more when comparing commission income and payout. BEA earned HK$3.9 million in commissions but paid HK$115 million back to customers - almost 30 times what it earned.
ICBC (Asia) paid 23 times its commission to customers. The lender made HK$3.8 million in commissions from selling Lehman-related products since 2003 but it paid HK$89 million in compensation to customers.
Fubon Bank received HK$12 million in commissions but paid HK$140 million in compensation - 11.67 times its commission income.
Learning from the painful lesson, BEA has shifted its focus to developing or selling simpler and more conservative products. Instead of selling third-party products such as the minibond, the bank now relies more on its own trading platform in order to mitigate credit default risk exposure to counterparties.
'These have been well accepted by customers and we experienced a strong rebound in business starting the second half of 2009,' a BEA spokeswoman said.
Fubon has shifted from product sales to focusing more on portfolio management, while ICBC also has shifted to selling more of its own brand of fund products.
The minibond fiasco also has led the Hong Kong Monetary Authority to add tougher restrictions on banks selling investment products.
All sales proceedings must be audiotaped, while the branches must also have separate areas to handle traditional banking business and investment product sales.
Stanley Wong Yuen-fai, an executive director at ICBC, said the authority's new requirements on banks selling investment products has added cost to banks.
In addition, the new procedures for selling investment products have reduced customer interest.
Fubon has also enhanced its systems and control processes to meet the HKMA requirement.
'To minimise risks and cope with the new regulatory requirements, the bank reviewed and enhanced its internal processes, from due diligence checking of business partners, to product selection, to the selling process,' a spokeswoman said.
Overall, Wong said investors still had not yet fully recovered from the minibond fiasco.
'We have had a mix of investor reaction after the Lehman problem,' he said. 'Some customers, particularly those not eligible for settlement, refrained from making further investments at ICBC.
'On the other hand, some customers continue to make investments, although they take a more conservative approach than before.
'I believe it will take time to fully restore customers' confidence.'
A BEA spokesman said the HKMA's new requirements had made sales a lengthy process, although it sped up after customers and bank staff got used to them.
'More importantly, we find that some customers think they are being protected under the new measures recommended by the HKMA, and some of them are more receptive to buying investment products,' the spokesman said.
The good news for banks is their total provisions are less than expected. BOCHK, the biggest seller of minibonds, last week said it had paid HK$3.28 billion for the minibond repurchase scheme, which is lower than the HK$3.63 billion it originally estimated.
Fubon made a HK$140 million provision, much lower than its expected HK$321 million.
The minibond saga will cost lenders up to 30 times fee income
BOCHK earned HK$160 million in fees but ended up paying customers, in HK$: $3.28b