Friday, April 10, 2009

Tears For Tiers

(I promised this explanation…here goes).

As has been reported in the SEC complaints, Stanford International Bank (SIBL), classified its investment portfolio into Three categories or “Tiers”.

Tier 1 was for cash and cash-like instruments (short dated paper, etc.). Very important Tier. It’s a well-known banking fact that you can run an insolvent bank for years, as long as you have liquidity. Knowing that, SIB maintained around 10% of its deposits in cash (Tier 1). This was an important pitch point for salesmen and officers, as in “The bank has never failed to pay in XX amount of years”. There was never a problem...until there WAS a problem.

In late 2008, as the bank faced an onslaught of redemptions, this cash balance was reported as low as $28 million, prompting management to seek funds from Tier 2.

Tier 2 was the actual portfolio. According to testimonies given to the SEC, it was worth a bit over $1 billion as of December 31, 2007 (instead of the $6.3 billion in the “books”) and had dwindled to $850 million as of June 2008 and only $350 million at year end 2008.
This portfolio was “overseen” (not actually managed) by Laura Pendergest-Holt and her team in Memphis.

Tier 3 was “everything else” and at the same time “very little”. Allen Stanford’s interview with ABC news gives a few clues about what exactly was and wasn't Tier 3 and how it was created. Here the interview again:

LINK

There are some great hints in his declarations. Forget about flying commercial or the Forbes list. He also said:

“Our returns in the “Boom Years” were lower than everyone else’s…No one is talking about that”

Ok. Let’s talk about it.

This goes straight to what was the Stanford “Business Model”. No Loans…just invest in securities. Back in the 90’s it was stocks and bonds (no hedge funds).
Here is what Stanford was talking about:



SIB’s average returns from 1992 through 1999 were 15% per year. That figure, believe it or not, is quite feasible for that period, since the S&P averaged 20% total return and the Nasdaq 30% in those years.
So SIB “underperformed”. That would also seem logical since SIB didn’t manage a straight equity or index portfolio. At the time they also invested in bonds.
Fifteen percent may sound like a lot, but in the late 90s, if that was all you were making…you were an “underperformer”.

AS has stated many times almost wistfully that the portfolio made “only” 14% in 1999, while others were making 30% and more…because his strategy was “conservative”.

Let’s assume, for the sake of the argument that the 15% is correct and it may well be. However, the “smoothness” of the numbers is very suspect, since as good as the market was, it was quite volatile also as returns on the indices reflect.

At some point, the portfolio made more…or more likely less than stated. Take 1994 for example, when the markets turned in a small loss and SIB stated a return of 13.9%. Perhaps it was only 5%.... but for the sake of continuing the business…they upped the number and created a “receivable” or something. Basically, they’d give it back when the market returned to normal.

AND THE MARKET COMPLIED. It was up almost 40% in 1995 and fresh money continued to come into the bank, so possibly they paid that “receivable” back with ACTUAL gains in excess of what was booked in subsequent years.
(As a side note…1995 and 1996 are the years with identical returns.).

So the numbers WERE being “managed” or smoothed out…if you will. Heck, even GE was “smoothing” its results, right? (GE was accused of doing JUST THAT back in those years).
And money was always coming in (deposits), so if the market bounced back, there was more “raw material” with which to recoup any “temporary” losses.

But then 2000 came around and it was bad. Especially bad for equity and incredibly bad for those high-flying internet and tech stocks that everyone was playing around with.
The Nasdaq lost 40% that year, but if you were in the wrong place you could easily have lost 80-90%. It wasn’t only the Nasdaq. The GE’s and IBM’s of the world were down sharply also.

SIBL claimed to have made 14.2% that year. That’s highly unlikely. Let’s assume that instead of that, SIB took a 20% loss. On a $600 million portfolio, you’re looking at about a $200 million difference and bankruptcy. But the common wisdom was “ the market always bounces back” and that had been the experience in the past. So a profit was booked where a loss should have been.

The problem with accounting for “fake” profits is that even fake accounting still has to do a double entry. So when you book that “fake” profit, you also book a “fake” asset. And this most likely how the TIER 3 investment category was born. "NOTHING was booked as an asset".

(Side note: Early this year, Satyam announced that $1 billion was missing from its cash accounts. No one “stole” this money, it was the result of booking false profits).

We know the story of course. The markets didn’t rebound until late 2002 and in the meantime more money entered into SIB, it was invested and lost. More “fake profits”…more TIER 3 Assets.



(Side note: I ran a simulation with a portfolio that was 30% S&P, 30% Nasdaq and 40% a bond composite. An “index” or average portfolio if you will. I used SIB’s deposit/expense flow. That portfolio racked up a $4 billion “shortfall” by the end of 2008. So most of Tier 3 was/is probably “NOTHING”, despite all the money that has entered the bank).

There was no easy way out of this “death spiral”, particularly because of the high cost of SIB’s deposits. Because of high rates and commissions, expenses were running at over 12% of deposits per year (very consistently from 2000 on). So, to make an example, if you had $100 worth of liabilities (deposits) and only $50 worth of productive assets, you’d need to make those assets yield 24% JUST TO BREAK EVEN. Practically impossible. Ah…but those halcyon days of the ‘90s gave them hope.

At some point, these guys figured that this wasn’t working and they needed a new plan. It was important to keep deposits coming in, to move the real portfolio/deposit ratio up and they needed something to provide better returns than the market was delivering.

Two strategies appear to have emerged. The first was “private equity”. A company by the name of Stanford Venture Capital Holdings was set up. Some of the investments were made through that vehicle. Others directly by SIBL.
Stanford’s website still has its “portfolio” of ptivate equity deals on it. These are all relatively small and almost without exception, terrible investments. As an example SIB sank $127 million dollars into eLandia alone during 2007 and 2008. Their remaining stake is TODAY worth less than $10 million. American Leisure Group is bankrupt. Health Solutions Systems seems to be heading to bankruptcy…and so on.

Where did the money for these investments come from? Book it to Tier 3. How much was it? It would be a matter of adding up, but $500 million, perhaps? How much is left? Not much. ($50 mm is my estimate).
But there is always the “Majestic Grille” in Memphis. Enjoy a “Majestic Mimosa” with Brunch on Sundays.

The other strategy was to build up financial businesses along what it considered its ‘area of influence.” Here we have the development of Stanford Group Company (US) and the franchises in Venezuela, Panama, Ecuador, Colombia, Mexico and elsewhere.
The important difference with the “other” strategy is that these banks and financial institutions were (are) NOT owned by SIBL and are NOT on SIBL’s books (any version).

These were (are) the property of Allen Stanford. That is why they are called “affiliated” companies. That of course begs the question; Where did the money to acquire these banks come from? SIBL NEVER paid a dividend. Allen Stanford did not have any other significant businesses. So the most likely answer has to be TIER 3. This could very well be the reason that there is supposedly a loan on the books to AS for $1.6 billion or so (although that could very well be something else).

Now in the cleanup of this mess, the liquidation of these institutions would provide money to Allen Stanford’s estate (which could then be theoretically used to satisfy SIBLs creditors). But they are also not worth much. We analyzed SGC in “Stanford vs. Stanford”. Probably worthless. Stanford Bank de Venezuela couldn’t be given away. Equity was declared “lost” and the bidder only had to put in capital (to the bank itself) and pay the government it's deposits. AS's estate will get nothing from that sale.
The situation was probably similar elsewhere. The problem was, that although they were “affiliated” these institutions lived off Antigua. SGC took in a large part of its revenues from sales commissions of Antigua CDs. And AS provided capital when needed ($7 million in early 2008 to SGC, for example). The Venezuelan bank gave out domestic loans with Antiguan CDs as collateral. Good luck collecting on those. Without the support of the "mothership" in Antigua, these outposts were unviable.

The other question would be why was AS the owner and not SIBL? The logical answer would be to avoid scrutiny. If SIBL were to buy or set up a bank in Panama, for example, the local regulators might want to look at the books from Antigua. That could lead to some embarrassing questions.

Just so some of the non-financial professionals understand. Nowhere on Earth is a bank owner allowed to take out a loan from his own bank. It’s fraud…defined.
What’s more, it’s common policy that bank officers get their personal loans elsewhere precisely in order to avoid such conflicts.

Once you’re on that slippery slope, anything goes. Personal expenses become “Image investments”. Cricket tournaments with $20 million prizes become “advertising investments”...etc. The WSJ in a 2002 article mentions a loan to the Antiguan government. Tier 3? Why not?

So if you kept up with all this, you should understand what Tier 3 contained: a few little somethings that were awful investments, some “anythings” that were definitely ill-advised, but mainly…a whole lot of “nothing”. But definitely NOT what was advertised in the financial statements.

You may also understand what AS was referring to when he mentioned “restatement” on the ABC interview. That will probably be his trial defense: “we messed up the accounting and should have “restated” our profits”. A seven billion dollar "OOPS"

You may also understand why he says “it wasn’t a ponzi”… because ponzis have no assets”. It didn't start as a ponzi. It was probably never really meant to be a ponzi, but it became one for all practical purposes.

Millennium bank was certainly more of a ponzi than Stanford and probably was never anything else. But SIBL was liquidating all its Tier 2 assets as it faced redemptions and was trying to pull cash out of its Tier 3 investments also. Had it been successful, it would have been left with NO assets. Then what would it have been?
Call it a PONZ if you like, or perhaps Ponzi without the dot on the i.

2 comments:

  1. I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.


    Sarah

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    ReplyDelete
  2. Great explanation! Let's see how this mess unfolds...

    Almost like the Omega Corp scam :-) Surreal

    http://www.quatloos.com/cm-omega/cm-omega.htm

    ReplyDelete