I contacted Floyd Norris, the Chief Financial Correspondent for the NYT, about the GJN situation, and he published today a column about it. NYTimes.com
Please note that WFC is claiming that the swap termination fee was for its damages to unwind another swap, some kind of a swap (hedge) for the GJN swap counterparty, as I understand their claim? Who knew about that one?
WFC/Wachovia (WFC) sold the mop and pop investors, the widows and orphans crowd, a beneficial interest in $27.7 million of a JPM Trust Preferred security. WFC then took over $12 million of that amount from the redemption proceeds of that bond, so that WFC could "substantially" settle some kind of swap/hedge transaction. I seriously doubt any investor even contemplated such a possibility. I am not sure what substantially means in this context? Was the remaining portion used for caviar and cocktails?
Without any doubt, reasonable or otherwise, it is clear from the price action of GJN from the time of JPM's redemption announcement in mid-June until trading was suspended on 7/12/12 at $24.88 that investors did not even have an inkling of this possibility, as the security traded near its $25 par value until it was delisted. Investors were contemplating the full $27.7 million in proceeds plus accrued interest.
If there had been adequate warning in the prospectus, short interest in the security would have spiked after JPM's announcement and the GJN price would have plummeted. Instead, GJN rose in price after JPM made its redemption announcement on extremely heavy volume for that security, and small short interest declined in the weeks prior to redemption as noted by Norris. I noted in a June 13, 2012 Post, near the bottom, that GJN had risen on June 12th by over 13% on very heavy volume to close at $24.4, but I did not know the reason for that action. I did not own GJN in mid-June, and I certainly was not going to buy it near its par value.
Efficient market theory?
If WFC had made an adequate disclosure of the risk, GJN would have been the leading loser that day on the NYSE!
The gory details are summarized in some other posts.
Item # 1 When Does a Capital Treatment Event Occur?
More On JPM Potential Liability for a Make Whole-Redemption 2035 TP
More On JPM Potential Liability for a Make Whole-Redemption 2035 TP
Item # 3 GJN Redemption
Wells Fargo-GJN
Subsequent Posts:
On JPM's Potential Liability-Make Whole Payment: GJN-JPM-Make Whole Payment
Legal Claims: GJN-Wells Fargo/More on When Does A Capital Treatment Event Occur
Added 8/3/2012: In the comment section below, I refer to the lack of a call warrant attached to the GJN Trust Certificate. New readers may not understand what I am talking about. I took a snapshot of the call warrant provision in the synthetic floater GYB to make my comment clear:
Prospectus
The fixed coupon trust certificates would have the call warrant exercisable for any reason soon after the original IPO data. Trust Certificates: New Gateway Post. For anyone interested in learning more about call warrants and trust certificates, I would recommend the following posts dealing with fixed coupon TCs: Call Warrant Exercised on JZE and JZJ; Call Warrants and Trust Certificates; More on the Call Warrant in TCs; Call Warrant Exercise for TC XKK; Call Warrants and Trust Certificate: XFL CALLED; Notice Filed for Redemption of Trust Certificate DKF; Call Warrant Exercise for XFJ.
So in context, I would argue that the overall structure of the GJN, and the status of the GJN owners as third party beneficiaries of a trust created by WFC/Wachovia, is important in its construction. With that thought in mind, the argument would be that the swap termination fee could only be taken out of any make whole payment. The construction of the prospectus, in proper context including the facts of who sold it to investors, is a separate issue from any liability for securities act violations or other arguments presented by me to date. This argument was actually my first one formulated to use against WFC.
Subsequent Posts: Legal Claims-GJN-Wells Fargo
District Court Decision in Turkle Trust v. Wells Fargo (N.D. Cal)/Summary of Argument: JPM Potential Obligation to Pay Make Whole for its Recent 2035 TP Redemption/Other JPM Capital Trust Preferred Securities: Language on Make Whole Payment and Capital Treatment Event (8/13/12)
GJN-JPM-Make Whole Payment
Subsequent Posts:
On JPM's Potential Liability-Make Whole Payment: GJN-JPM-Make Whole Payment
Legal Claims: GJN-Wells Fargo/More on When Does A Capital Treatment Event Occur
Added 8/3/2012: In the comment section below, I refer to the lack of a call warrant attached to the GJN Trust Certificate. New readers may not understand what I am talking about. I took a snapshot of the call warrant provision in the synthetic floater GYB to make my comment clear:
 |
| GYB Prospectus at page S-3 |
The fixed coupon trust certificates would have the call warrant exercisable for any reason soon after the original IPO data. Trust Certificates: New Gateway Post. For anyone interested in learning more about call warrants and trust certificates, I would recommend the following posts dealing with fixed coupon TCs: Call Warrant Exercised on JZE and JZJ; Call Warrants and Trust Certificates; More on the Call Warrant in TCs; Call Warrant Exercise for TC XKK; Call Warrants and Trust Certificate: XFL CALLED; Notice Filed for Redemption of Trust Certificate DKF; Call Warrant Exercise for XFJ.
So in context, I would argue that the overall structure of the GJN, and the status of the GJN owners as third party beneficiaries of a trust created by WFC/Wachovia, is important in its construction. With that thought in mind, the argument would be that the swap termination fee could only be taken out of any make whole payment. The construction of the prospectus, in proper context including the facts of who sold it to investors, is a separate issue from any liability for securities act violations or other arguments presented by me to date. This argument was actually my first one formulated to use against WFC.
Subsequent Posts: Legal Claims-GJN-Wells Fargo
District Court Decision in Turkle Trust v. Wells Fargo (N.D. Cal)/Summary of Argument: JPM Potential Obligation to Pay Make Whole for its Recent 2035 TP Redemption/Other JPM Capital Trust Preferred Securities: Language on Make Whole Payment and Capital Treatment Event (8/13/12)
GJN-JPM-Make Whole Payment
Hi, I found your website through NY Times story. Judging by the price action, you are likely correct that the issues were delivered to the wrong investor group, but the prospectus is not as opaque as you, or the NY Times writer, portray.
ReplyDeleteThe prospectus discusses Wachovia's seniority in the "Early Termination of the Swap
Agreement" section of page S-9. From the article, I thought that the first mentions would have been in page S-50, after a deluge of structural minutae. S-9 is a very normal place for such discussion. Most of the prior pages are typically devoted to codifying the related parties.
Then the prospectus further elaborates on the FIRST page of the "Risk Factors" section. How is this a buried feature? Any investor will look at the risk factor section.
I am truly apologetic if my tone is rude. My umbrage raised while reading the NY Times article, only to be disappointed by a standard, and frankly concise--read the prospectus for TARP warrants to see legalistic mumbo jumbo--prospectus.
I appreciate your sense of responsibility and fairness, but I think that you risk encouraging investor laziness by focusing on the (totally normal) prospectus. The real focus should be upon the Wachovia/WFC agents who apparently marketed these products to an unsophisticated group. There should also be a check for similar abuses on a systemic scale.
It's a completely normal, readable prospectus! First page of the "risk factor" section! Risks 2 through 5!
I was so busy complaining earlier that I forgot to say that your site is great.
ReplyDeleteAlex: Thanks for your comment. It may have been a normal prospectus for a sophisticated swap counterparty who routinely deals with these instruments. Retail investors could never have even contemplated the risk unless the prospectus clearly explained the circumstances and risks with examples. The security would have been shorted after the JPM if the risk had been understood by professional investors.
ReplyDeleteThe price action before the delisting and after the the JPM announcement proves beyond any doubt in my mind that the GJN owners never understood the risks. I would be confident to learn that professionals were duped also.
Do you think that the mom and pop investor would understand what was being said in the FIRST page of risk factor section.
An intelligent retail investor might just link that risk factor statement to the make whole provision. If there was an early redemption by JPM under the make whole provision, this would have resulted in a premium payment to the GJN Trust. How would WFC capture that payment? Bear with me.
In many trust preferred prospectuses, there is a call warrant feature. I have lost over 10 fixed coupon trust certificates due to that feature.
What is it? When the brokerage forms the Grantor Trust, it will attach a warrant that it could buy, at its option, the trust certificates back at their par value (usually $25 plus accrued interest), take possession of the bonds owned by the trust and then sell them in the bond market for a guaranteed risk free profit.
How? The brokerage firm would choose only bonds with make whole provisions, making a call by the issuer unlikely. In a bond bull market, the underlying security owned by the trust would rise to well over par value in many cases. (example I owned JZE that was called and the underlying bond is now selling for over 150)
Where there is a call warrant attached to the TC, the brokerage company could call the TC and capture the make whole payment for itself! THE OWNERS OF THE TRUST CERTIFICATE WERE THE BENEFICIAL OWNERS OF THAT JPM TP AND WOULD NORMALLY CAPTURE THAT MAKE WHOLE PAYMENT UNLESS SOMETHING ELSE TOOK IT AWAY FROM THEM
This is the kicker. GJN is one of the few trust certificates with no call warrant.
The only way for WFC to take away that premium payment would be to deduct possibly a "substantial" amount from that premium payment for its swap termination fee.
Hi, I sort of agree with Alex and disagree with your claim that "The security would have been shorted after the JPM if the risk had been understood by professional investors". For those professional investors who understand the risk factors but failed to act by shorting the security, it was most likely due to the fact the they were not aware of the existence of this opportunity rather than the risk factors was not well explained in the Prospectus.
ReplyDeleteAny investor – be it mom pop or professional, should do homework before investing and take responsibility for the consequences of their decisions. Even the most plain-form security, say a corporate fixed-coupon cash bond, has risk of value going to zero. If the company defaults and the cash bond becomes worthless, should the mom pop investor cry out and complain that the Prospect of the cash bond did not quantify the possible loss he would face?
Mr. Anonymous: There is no need to click the send button three times. I have to approve comments before they are posted to keep the spam off the site. I will publish comments from those who wish to defend Wells Fargo including those who are employed by the firm and are apologists for it.
ReplyDeleteI will post anonymous comments including those who disagree with me. I would appreciate a statement regarding your location and interests in this matter.
I would give short sellers more credit. There are a number of synthetic floaters available for purchase. While they are somewhat off the beaten path, both sophisticated individual and professional investors are aware of their existence.
The lack of short selling needs to be coupled with the other relevant trades after JPM's redempiton announcement. As I have pointed out, the GJN shares popped on heavy volume on the first trading day after that announcement and continued to trade near their par value of $25 until delisting.
While I do not know the identity of those purchasers shortly after JPM's announcement, they were most likely professionals who were the only ones likely to be aware of JPM's announcement at that time, and who believed that the owners of GJN would receive their $25 upon redemption, just like every other trust certificate which had been redeemed up to that point in time. GJN was the first TC redeemed at less than trust certificate's par value. A large number had been redeemed prior to GJN at no less than par value.
I noted on the day after that JPM redemption announcement (mid-June) that I could not explain why the security had popped on heavy volume. I did a google search and came up empty on explaining why. I did not know why until someone contacted me about the redemption proceeds in mid-July 2012.
Both the lack of short selling and the price action of GJN are consistent with an important point. Neither are consistent with a proper and adequate disclosure in the prospectus. The comment that I made prior to receiving yours illustrates how even an intelligent investor reading the GJN prospectus in its entirety could have been duped by it.
I would also point out, again, that the GJN owners were the beneficial owners of the JPM bond that was redeemed, an investment grade obligation. That bond did not lose any value. It was redeemed by its issuer at par value plus accrued interest. That security did not cause the loss to the GJN owners. The loss was caused by the creator of the Grantor Trust, WFC/Wachovia, who also sold the GJN TCs to the public at $25 without adequate disclosure of the risks, and who had no ownership interest in the JPM bond directly or indirectly.
If WFC had told the public in clear terms what it was doing to hedge its risk, and that the moms and pops would have to pay WFC in case something went awry, with specific examples, no one would have bought this security.
As noted previously, the statement made by a WFC spokesperson to Floyd Norris suggest to me that WFC was aiming for a risk free return to itself of around .7% on $27.7 while passing the risk of loss onto the moms and pops in ways no individual investor could even comprehend, let alone figure out, based on the obtuse statements made by WFC deep into a very long and complicated single spaced page prospectus.
Maybe a Court will rule on who is right about it.
Anyone who feels a need to defend Wells Fargo in this matter need to address the following factual point directly:
ReplyDelete1. Does the trading action in GJN from the time of J P Morgan's redemption notice on June 11, 2012 until July 12, 2012, when the trading was suspended, prove by the preponderance of the evidence that the warning contained in the prospectus was materially deficient in conveying the risks?
That trading activity includes the following:
A. The spike in volume and rise in GJN's price on the first trading day after the announcement. I noted in the June 13, 2012 a 13% rise of GJN on heavy volume but did not have an explanation for it. My explanation now is that professional investors knew about the JPM announcement and bid up the price in anticipation of receiving par value in less than 4 weeks.
B. Continuous trading near par value until the security was delisted.
C. The absence of any short sales during the foregoing period. As noted by Norris in his column, the small short position declined before delisting.
I think that a WFC defender further needs to address why WFC did not fully explain the risks in clear language in the context of the hedges it had allegedly put in place. Could any investor have foreseen the 12 million dollar swap termination fee without an express statement on what WFC was doing, possibly to earn itself a risk free rate of return while passing the risk of loss onto the moms and pops, widows and orphans.
Sorry I posted three times as this was first time ever for me to post on internet and I did not understand well how to do it.
ReplyDeleteI had no interest in defending WFC, I don’t work for them. My location is non-japan Asia. I did not follow this certificate until I came across this topic on dealbreaker.com and was directed here. I did not spend enough time to study the situation as well as you and the definitions of “professional investor” or “well explained in Prospectus” were too ambiguous, I am in no position to carry on more arguments.
I was urged to speak up because I do feel the buyer of the certificate should look inward first before going into attack mode. I totally agree with what you said in your profile “Every individual investor needs to accept full and sole responsibility for their decisions, and to prepare accordingly”. This certificate stands to gain big time if we were in the high interest rate environment now and the value of the certificate could be much more than $25. the certificate was made in 2005, it’s quite easy to see the merits of this certificate at that point in time when people were foreseeing interest hikes and wanted to have floating interest rates incomes to benefit from that. The unfortunate turns of events in 2008 up to now led to historical low interest rates made the certificate worth much less than original investments, it’s not the security’s fault, it is simply the market has gone against investor’s bet.
As to the accusation of WFC “possibly to earn itself a risk free rate of return while passing the risk of loss onto the moms and pops, widows and orphans”, I have to say something. This certificate is actually possibly to pass tremendous gain onto the moms and pops, widows and orphans if high interest rates were here. if market did go that way, will somebody come out and singing praises for WFC?
Second, do you call a car manufacturer’s margin between selling price and material/labor cost a “risk free rate of return”? the manufacturing of the certificate is no different than the ensemble of a car. You purchase components at cost, put them together, sell it at a higher price to make profit. If a new model in 2005 was bought for 100000 but due to price drop of the engine over years, in 2012, while never used still a brand new car, a dealer only quotes 50000 to buy it back from you. Would you insist the dealer shoulder the drop in value? The manufacturer of this note, like any other business, was to make money for their service, it is not free money.
I apologize for my inability to understand your analogy to a car manufacturer. Maybe I would understand it better with a few changes in the analogy that would actually make it more consistent with the GJN facts rather than some reality creation about car manufacturers that does not exist in the real world. I would change the analogy to add some facts more consistent with GJN.
ReplyDelete(1) my car manufacturer knows of a material risk in the car that could cause substantial injury to the buyer and refuses to disclose that risk in an understandable manner, and nonetheless goes ahead and sells the car anyway;
(2) a professional mechanic inspecting the car can not with due diligence discover the defect known to the manufacture;
(3) my car manufacturer (WFC) has no risk of loss (and real car manufacturers apparently have guaranteed profits with no risk of loss to themselves as you assume in your hypothetical ?)
(4) my manufacturer has transferred the risk of a substantial loss to the buyer without disclosing the risks known to it in an adequate manner, and its purpose is to make a guaranteed return without having to take any risks.
Things most really be different for capitalists in Asia.
You did not even try to address the material point that I requested for those defending WFC. The trading activity proves that no one understood the risks, including professional and institutional investors. So, in this case, you can not look inward and blame yourself. Individuals are not responsible for bad outcomes that are caused by others with superior and undisclosed knowledge that have a duty to disclose those known risks in an intelligible manner .
If the risks had been adequately disclosed by WFC, the trading activity would have been precisely the opposite after June 11, 2012.
So you want to blame individuals, rather than WFC, for not being able to figure out what would happen to them. The mere fact that no one apparently figured it out, as shown in the trading activity, is not material?
Even an intelligent and informed investor would have found it extremely difficult, after much study and knowledge, to figure out that WFC was going to take any, let alone a substantial portion, of the proceeds paid by JPM into the trust as a "swap termination" fee that "substantially" was for the unwinding of its own hedges.
Without any hedges, it would have been cleaning up for the past four years and would not be losing anything at all until the 3 month T Bill exceeded 4.85% and then the very maximum out of pocket loss would be 2.15%, while the maximum possible gain was 2.85% (difference between 3% minimum coupon and the 5.85% fixed rate of the JPM TP)
The loss experienced by the investors in GJN has nothing to do with the basic provision of the agreement, an exchange by the trustee of 5.85% annualized for the greater of 3% or 1% over the three month treasury bill rate up to a maximum 8% on a $25 par value. It was caused by WFC taking almost $11 for every $25 par value certificate that it had sold to individual investors, when JPM redeemed the security sold by WFC to the trust created by it for $25 per TC.
Disagree with "The trading activity proves that no one understood the risks, including professional and institutional investors". for every buyer there is a seller. what you say about those sellers? also, when a small group of people who claim to be professional or institutional investors don't understand something, does it mean the something is absolutely not undertandable to any one?
ReplyDeleteI took a look at the prospectus. it says clearly the value of swap needs to be deducted from JPM bond proceeds if the swap loses money AND the value of swap will be ADDED to the JPM bond proceeds if the swap ends up profitable upon early termination. it's two way outcomes available to investors. no luck for them that market has gone against them. don't blame the security. do the homework.
I guess the capitalists in Asia are much smarter than the institutional and professional investors who bought (not those who sold) the cerfiticate after JPM announcement.
Also, it was very ethical and professionally appropriate for WFC Trust to do the swap hedge on day 1. if they did not do it as sugggested by you, it would be a gambling against certificate holder by taking the other side of the bet. That is a crime. WFC Trust is earnest in doing the hedge and passing all possible GAINS/losses through itself without taking side, without benefiting from market move in either direction.
ReplyDeleteI agree with Alex, risk factors were clearly laid out in the Prosepctus.
Perhaps, I need to modify that statement with no "purchaser" understood the risk when buying near par value between 6/11/12 and 7/12/12.
ReplyDeleteAs to the sellers, I doubt that many, if any, were selling due to an understanding of the risk. If I had owned GYC on 7/12/12, I would have sold it at $24, without a doubt. I would have done a google search to discover an explanation. And, failing to find one, I would have sold the position to realize a significant profit.
As noted in my April post, I viewed the certificate to be overpriced based on its current interest coupon, and likely coupon for the next two years at $23. For a security that had been trading under 22, and even under $20, a sudden 20% pop will produce mostly sellers who are not reacting to anything other than harvesting a quick profit.
It would be interesting,however, to find that person who understood that WFC was about to take a $11 swap termination fee, or any significant amount, and then neglected to short the stock. Maybe that would be hard to explain if your point had any merit whatsoever.
As Norris pointed out in his article, the short interest was negligible and went down rather than up.
For that smart seller who figured it all out and sold the stock for a quick profit, that person must have become dumb really fast, incredibly stupid would not be an understatement, for failing to short the security for even more risk free money, a gift of $11 bucks a share by simply selling the long position for a quick profit and going short for another quick $11 per certificate. But, no one did. And what does that say about your argument.
I have another question for you.
Did WFC lose money on the swap with the trustee, as you apparently maintain ?
Or did WFC lose money on something extraneous to the swap agreement with the trustee that is not explained within the four corners of the prospectus?
I assume you are referring to pages S-12 and S-13 of this single spaced agreement. You have now studied that statement and can provide me with your understanding of it without any delay.
Correct a typo in my last comment. If I had owned GJN on 6/12/12, not 7/12/2012. As previously noted, I noticed the pop on 6/12 and did not own the stock. If I had owned it then, I would have sold it after doing a a search and finding no reason for the pop.
ReplyDeletePlease explain why a seller, who knew of the risk and appreciated, would not have backed up the truck and sold GJN short?
I will give you the last word. Your last comment was nonsensical to me about a "crime" if they did not hedge. There is no legal reason for them to hedge or not to hedge in my opinion. The only reason for them to hedge is to try to guarantee a profit for themselves.
ReplyDeleteI will publish one more comment from you that explains why those sellers who understood the risk did not short the stock for a guaranteed profit and explains the WFC loss in terms of the prospectus language. You can quote the language in the prospectus about passing on the loss from any hedge to the owners of GJN once you found it. Just refer to the page number. If you have anything else to say, I will not respond since I view it as a waste of time .
OK. Since you absolutely don't see it: paragraph wrapping the word "S-9",right above "calculation agent" says: In the event the Underlying Securities are redeemed or liquidated and the Swap Agreement is then in effect, an early termination payment will be payable under the Swap Agreement. Any such early termination payment under the Swap Agreement that is payable by the Trust to the Swap Counterparty will be deducted from the redemption or liquidation proceeds payable to the Certificateholders. If any early termination payment under the Swap Agreement is payable by the Swap Counterparty to the Trust, the amount of such payment will be added to the proceeds payable to the Certificateholders. See "Description of the Swap Agreement--Events of Default and Termination Events" and "--Payments Upon Early Termination" herein.
ReplyDeletepls pay attention to the word "added", not only "deducted".
as to the short selling. first i did not know the full info about the short selling situation. I don't dare to make speculation about what's going on. is it possible that the certficate is no where to borrow from or too costly to borrow?
Please don't get mad. i appreciated your insight and thorugh work. i did not know about these certificates are traded actively on exchange. There might be some real gems awaitng to tbe discovered. you are definitly putting the hard work in and are well ahead of everybody else. thank you.
That was your last comment. You have no idea what your are talking about
ReplyDeleteI added an insert to a post published on 8/8/12 which was originally published before reading the last comment from Anonymous:
ReplyDelete(his reply on this issue, read after the publication of this post, was that it may have been too difficult or costly to short. Costly? For a brief holding period and a $11 per share potential gain. As WFC pointed out to Norris, there was $2 million of GJN held in accounts at that firm and that would seem like one of many places where shares could be used for short selling. Please also note how Norris responded correctly to the argument that GJN owners could receive a bonus if interest rates were high and the swap agreement had value to them and could be added to the redemption proceeds This is a really obvious point that Norris is making. Why would JPM redeem the 5.85% long term debt when it would cost it more to refinance with interest rates being high. NO WAY! The structure of that provision (+ or - from proceeds received by an early redemption by JPM) would come into play when the swap agreement had value to WFC, not a plus value to the third party beneficiaries, who clearly did not even contemplate how they would be hosed under it)
I inserted the following in my 8/8/12 Post:
ReplyDelete(added: it had to be marginal, at best, for JPM to redeem a 5.85% junior bond with liberal rights to defer interest payments, maturing in 2035, even in today's abnormally low interest rate environment.)
(added: what about those purchasers at near par value after 6/11, did they understand the risks as disclosed by WFC? Did the owners of GJN as of 6/12, who kept their shares, did they understand the risks as disclosed by WFC? Did those experts at Wells Fargo Advisors who had their clients in GJN at the time of redemption understand the risks? Did other professionals who had their clients in GJN at the redemption date understand the risks? )
I didn't know which of your many GJN posts to respond to, so I just picked the most recent one. I am in the apparently awkward position of being one of the few people on the planet that bothers to read the prospectus of securities like this. It is awkward because I was fully aware of the risk and do not feel that GJN investors were ripped off, however I know that few investors read prospectuses and they get themselves in all sorts of trouble because of this.
ReplyDeleteMore important than all of this after-the-fact analysis, I actually identified this risk in advance of the GJN redemption and did attempt to let at least a few people know what was going to happen by posting on the Yahoo message board. The board was deleted after redemption, but I found the cache here with the title of my post "Price is too high for redemption" on June 14: http://tinyurl.com/8jm27ad
I could not find a direct link to the cached message, but I found that the majority of my post can be found in my posting history on Yahoo here: http://tinyurl.com/9h5ymn4
Scroll down to see my post (currently #28, but that will change over time as I make new messages) with the same title above on June 14, which reads: "JPM will redeem the underlying bond of GJN next month, but the trust will owe the swap counterparty some money due to early termination of the swap. I don't know how much it will be, but I think it will be much larger than..."
It gets cut off there, but pretty much ended with something like "...investors are currently pricing in."
So in my view, if someone had actually read the prospectus, it is clear that it was understandable and that an investor was not guaranteed payment of $25. One interesting thing about this is that the security was, as far as I know, never actually called for redemption with a press release. Some investors just made the assumption that they were going to get $25 and ran with it.
As to any legal issues, I really don't think there is much of a case. The prospectus is quite clear on all of the details; any investor who bought this as a new issue should have signed a document from their broker stating that they received and reviewed the prospectus. Anyone who bought it in the secondary market is responsible for their own due diligence. On the matter of the swap value, it was higher than I would have guessed, but it was not determined by Wells Fargo or US Bank or whomever you might want to sue; it was an average calculation by no less than three swap dealers. As you noted in one of your posts, the reason the value is so high is that the discount rate is so low.
Ultimately, what the investors got is the fair market value of the security upon redemption. The reason it was so much less than $25 is that the fair market value of pretty much any long-term floating rate security issued in 2005 is worth materially less today than it was back then. Simply put, GJN was not worth anything close to $25 in today’s market. Financial theory argues that an investor can take the proceeds and reinvest in something that will have comparable returns to what would have been achieved in GJN over time.
It is unfortunate that so many people were surprised by the results on this security, but it is unsurprising that so many failed to exercise one of the basic rules of investing: know what you own.
I was about to leave for dinner when I received your post and will have a response later this evening.
ReplyDeleteDid you try to short GJN?
Have you received information from WFC that they secured three quotes from swap dealers, rather than calculate their own damages when unable to secure the requisite number?
Were you aware that JPM would not pay a make whole payment prior to the redemption date?
It is okay that you reject my argument limiting the swap termination fee to the make whole payment. A court may or may not be asked to decide that issue along with many more. I have no financial interest in any of this.
Did you ever own GJN and if so, why did you sell it ?
I include snapshots of my trades. I sold 150 GJN shares at slightly over $23 last April based on price and better alternatives for yield. So I would agree that it was not worth $25 unless the thousands who bought it believed that $25 in redemption proceeds would soon be paid plus a small monthly accrued interest payment that might have been a couple bucks.
Why were you aware so early that JPM was redeeming the underlying TP in GJN. I did not own GJN when JPM made that announcement, nor any other JPM TP, so I was not paying any attention to what that bank was doing. You most have been monitoring its activity for some reason.
I would agree with TennIndpendent on this one. It is not a question of whether one or two, or even twenty people could have put it all together and realized the danger prior to the redemption date. The trading history proves that a large number of investors did not appreciate the risk which means the disclosure was inadequate and needed to more plain and upfront at the start of the prospectus, rather than several pages into it, with clear examples of how investors could lose part of the $25 par value to Wells Fargo who created the trust, appointed itself swap counterparty, and sold individuals the certificates.
ReplyDeleteBefore you ask, I am in the financial services industry but have never been associated with any of the firms involved. I have also never sold securities to an investor in any brokerage capacity; i.e., I’ve never earned a commission selling products and thus am not here to defend myself or anyone else for this product. I’m just trying to add perspective on how this didn’t have to be a disaster for investors.
ReplyDeleteAll of my investments are in tax deferred accounts. I have no margin accounts and therefore have never shorted anything. With GJN, I saw the potential but didn't know what the swap was worth and didn't know if there were shares available to short, so I didn't contemplate opening an account solely to attempt to short it. In hindsight, maybe I should have tried :)
No, I have not seen the quotes that WFC received from the swap dealer. The swap value came in higher than I would have guessed, but I'm not completely shocked. GJN's payment terms are reasonably similar to GYB and PYT and those have traded at what I think are reasonable prices (if somewhat overvalued) in the $16-$18 range lately; GJN had been trading over $20 even before the redemption and I considered it significantly overvalued. So my hunch was that GJN might be redeemed for under $20, but since I made no attempt to calculate the swap value, I really wasn’t sure.
JPM was not the issuer or guarantor of GJN, so I wouldn’t expect it to make GJN investors whole. JPM’s only role here was to honor the obligations on the Trust Preferred, which they did. JPM is not responsible for someone else repackaging their security.
I don’t think I’ve ever owned GJN, but I have traded dozens of other exchange-traded bonds and preferreds and I have hundreds of them on my watchlist, which I review at least twice a day. I have owned some of the other third-party trust preferred floaters at times in the past, but issues such as GYB, PYT, GJS, GJT, etc. always seemed more attractive than GJN.
The reason I became aware that JPM was going to redeem its Trust Preferreds was that I actually saw GJN’s price jump from approx. $21 to $24 on high volume (on June 12th, right?) and was curious as to why. I checked to see if there was a press release from GJN about redemption and I didn’t see one. I noted that the underlying bond had a name that sounded like it could be a Trust Preferred and it is well known that the capital rules are changing and banks have been redeeming these, so I looked up JPM and saw that they had announced in an 8-K (http://tinyurl.com/cksd3bq) that they would be redeeming all of their Trust Preferreds on July 12. Since GJN’s price was still a little under $25, my initial thought was that there might be an arbitrage opportunity to buy it and make a small gain (but high IRR) in the next month. However, I always review the prospectuses on these floaters before buying as I know that the rules on what happens to the swap are different for different securities. So I looked up GJN’s prospectus and concluded that the swap would require a settlement payment, so I obviously wasn’t going to buy.
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ReplyDeleteSince I don’t have a margin account, I obviously wasn’t going to sell, either. On the 14th, I decided to post my thoughts on the Yahoo GJN board, although I knew it wasn’t closely followed but I figured someone might be looking given the big price jump. No one ever did respond to my post, so I have no idea if anyone ever read it.
The interesting thing about it is that the day of the big move up for GJN, it was clearly sophisticated investors doing the buying. They saw the news from JPM that the Trust Preferreds would be redeemed and they figured out that GJN would thus also be redeemed. Alas, they failed to do sufficient homework on what would happen to the swap. As for that swap, there is absolutely nothing wrong with the swap being settled upon early termination. If you wanted to make the case that the settlement payment was too high, perhaps there is data you could use to make that case (my guess is that you would not find that data; the swap dealers don’t seem to have any incentive to manipulate the quote). But even if you found that the payment was too high, the error probably wouldn’t be more than $2 or $3, not the $10 difference between redemption price and par value.
So that’s my story. I certainly feel bad for the investors who didn’t understand what they owned here, but as someone who does his own investment research and identified the risk, I cannot support the idea that the information on GJN was unknowable. I also don’t think there is much merit in a lawsuit, but obviously that is not for me to decide. I do think there is a significant problem for any plaintiff who bought shares in the final month based on the fact that they knew the JPM Trust Preferred would be redeemed because it is clear that they had done their own due diligence (there was no announcement of redemption by GJN, after all), but just didn’t do it very well. I think the due diligence assumption would also generally apply to anyone who bought in the secondary market at any time, wouldn't it? Perhaps, though, some of the original investors (assuming they have held their shares this whole time) could make a case that they were misled by their brokers for not disclosing the redemption risk, even though it is disclosed in the prospectus. I’m not a lawyer, so I have no idea how strong their case would be. I believe the prospectus is not misleading and all of those initial investors should have signed off that they received and understood it. Does the court consider that sufficient? I don’t know. I have no doubt that very few of the investors or even the brokers actually bothered to read the prospectus, but I don’t know the legal ramifications of that. The brokers, of course, will claim that they did read the prospectus and that they explained all of the risks, so doesn’t it become “he said, she said” unless there is direct evidence to the contrary such as an email from the broker that said it couldn’t be redeemed under $25? Again, I’m just throwing these ideas out there. My specialty is money, not law.
I have never worked in the financial services industry, and would never use a broker for any reason.
ReplyDeleteApparently, based on calls that I have received to date, there were brokers who bought this security for their clients and their clients owned it at the time of redemption.
I thought that I would start by explaining "make whole" The prospectus for GJN contains some clear information on that issue.
If JPM opts to redeem the underlying bond, it has to make a make whole payment to the owners of that bond, with certain exceptions which I will discuss shortly. A redemption in July 2012, so far in advance of the 2035 maturity date, would trigger a make whole payment to the bond owners of the entire principal amount of the bond ($1,000) plus all scheduled interest payments from July 2012 until August 1, 1935, discounted to present value using a treasury rate which be abnormally low. This would be a huge amount. In short, JPM would not redeem a 5.85% coupon bond and make that payment. I think that we can agree on at least that point that is made clear in the GJN prospectus.
That is what is meant by "make whole" in terms of bond investing. It is present in a number of long term bond prospectuses, primarily for senior bonds, but occasionally in more long term junior obligations such as the 2035 subordinated debenture issued by JPM and owned by J P Morgan Chase Capital, a Delaware Trust created and controlled by JPM.
This is a very important concept to understand for anyone investing in synthetic floaters now.
Do you not see the differences between GJN and GYB /PYT?
The problem with GJN started when JPM elected to redeem the subordinated debenture without paying the make whole payment which would have been huge and would must likely covered and than some the swap termination fee eventually received by Wells Fargo. JPM relied on the "capital treatment event" exception, which does allow it to avoid that huge payment when it redeems the TP within 90 days after it reasonably determines the existence of that event. And if someone asked me today when that event reasonably happened, I would say when President Obama signed the Dodd-Frank bill into law about 2 years ago. That is when it could have been determined by anyone that this TP would have to be phased out as Tier 1 equity capital. Well, JPM missed that deadline. So, instead, it relies as the trigger event a proposed rulemaking from the Federal Reserve issued shortly before its announcement.
So even a most diligent and extremely knowledgeable person who had memorized the prospectus and knew every detail in it by heart, would have to know that JPM was redeeming the TP without a make whole payment. That is a lot of knowledge for any individual investor to have. I will continue commenting on your comment later this evening. I am busy now.
I own over 400 positions, and am actively monitoring another 1000 or so worldwide in addition to writing this blog and other matters.
Response to the August 8, 2012 4:35 PM poster:
ReplyDeleteThe necessary facts are laid out in the prospectus, although perhaps not in the order (in hindsight) that some might have preferred. Legally, is an investor not responsible for reading the prospectus in full? If the required information was disclosed, but nobody read it, whose fault is that?
By the way, I've been down this road before. At 10pm the night before Lehman filed for bankruptcy, you know what I was doing? I was searching through the prospectuses of third party trust preferreds that Lehman was involved with to see what the repercussions might be. I only identified one that mattered: JBK. At the time, GYB, PYT, and JBK were all very similar securities with the same underlying bond and similar (but not identical) interest rate swaps. However, Lehman was the swap counterparty on JBK, but not the others. The prospectus clearly stated that in the event of default by Lehman, the swap would be cancelled with no settlement. So with the swap wiped out, JBK was thus transformed into a much higher paying fixed rate security. I did the logical thing and sold all of my PYT and GYB the next day to buy JBK and I kept buying JBK for months afterward. It literally took more than 3 months before enough investors figured out what had happened to cause the JBK price to separate from the other two. So it's a similar story to GJN. All of the information needed was right there in the prospectus, but most investors just don't bother to look into the details. I don't know how that is the fault of the issuer.
I believe the capital treatment event relieved JPM of any make whole payments. There has certainly been a lot of debate as to the timing of the Trups redemptions, but I'm guessing they're all safe. An event is triggered if a change in capital rules is proposed, signed into law, announced, takes effect, etc. That has provided quite a few opportunities to call the Trups.
ReplyDeleteIf that is your argument, however, Wells Fargo and GJN are not the source of the problem. If JPM underpaid Trups holders, then GJN's trustee would join with other Trups holders on behalf of GJN holders in a lawsuit against JPM. I find it highly unlikely that anything would come of such a lawsuit.
About that make whole payment...I just pulled up the prospectus again to see what it says. You are correct that under "Optional Redemption" it discusses the make whole payments. However, the very next section notes that if there is a capital treatment redemption, they may be redeemed at par, but only if the full issue is redeemed (which it was).
ReplyDeleteSo I don't understand the argument that someone was diligent enough to pull up the prospectus and identify that there could be a make whole payment, but then completely ignore the next paragraph about the capital treatment event. You can't possibly argue in your defense that you read part of the prospectus, but not all of it, and therefore were misled. It also should have been obvious to a competent investor that JPM would not have called that bond if they had to make an enormous make whole payment.
I would request that you not post a comment until I have an opportunity to more fully respond to what you have already said in the ones you have already made.
ReplyDeleteI wrote a post on JBK, and also noted that swap termination event which was not a trust termination event. This is really detailed knowledge not possessed by almost anyone. You are the third person, including myself, who figured that one out early. Did you know that the trustee had taken $100,000 of a distribution to cover legal expenses in the bankruptcy hearing since the Lehman estate was claiming a right to a swap payment and that has not been resolved yet. I too bought JBK once I figured out that it had been turned into a fixed coupon TC rather than a floater. It still has baggage however. Do you recall off hand what JBK says about a redemption of the underlying security and how that compares with GJN, GYB and PYT.
I have a lot of things to do, not the least of which is managing my own money, my father's trust, and other family member's money. And a few other matters in addition to writing what may be the most comprehensive blog on financial matters, all for free. I have something like 1500 positions in those accounts, and a monitor list of another 1000 or so securities worldwide throughout the capital structure. So I can not devote all my time on this issue, particularly when the same points are being raised over and over again.
Trust Certificates are now a meaningless part of my portfolio. I am down to a few positions in fixed coupon TCs,mostly bought during the Near Depression period that have not yet been redeemed. Synthetic floater positions are barely on my radar and include 150 GYB, 50 GJT and 50 GJR.
In case you missed my statement, I did not own GJN at the time of redemption. And as a retired attorney, I will not represent those aggrieved by what happened to them, so I am completely disinterested.
I have a gateway post that you may want to read called "Trust Certificates: New Gateway Post" that has snapshot of my trades, links to discussions about TC buys and sells. That is a September 23, 2011 post which you may find helpful
I would direct you attention to what I have previously said about the 90 day requirement and to section 171 of the Dodd-Frank bill that deals with the phase out of TPs as Tier 1 capital for banks like JPM. The pertinent part from the JPM TP prospectus is found at A5 or A6, somewhere around there, as an attachment to the GJN prospectus.
The owners of GJN do not need the trustee. They were beneficial owners of the JPM TP that was owned by the Grantor Trust set up by JPM. They should have standing to sue JPM for the make whole payment. I discuss that legal approach sufficiently in the blog and see no need to comment on it further. It is a matter that could be resolved fairly cheaply and as a matter of law by the judge.
If you are going to buy synthetic floaters like PYT and GYB, I would recommend reading those prospectuses again for similarities and dissimilarities with GJN. I have several recent posts where I discuss synthetic floaters in light of the GJN situation including GYB, PYT, JBK and GYC. You may want to see how I am analyzing that issue and comment if you have anything to add or if you disagree.
I would at least agree with you on just one point. Now that we know about the serious danger to the principal value of synthetic floaters due to the swap termination fee risk, every prospectus needs to be reviewed again with that specific issue in mind, the first time that any TC had been redeemed for less than its par value.
Please do not send me another comment until I respond to your position on GJN which is really the same as the gentlemen from Asia, but better stated.
Information about the Lehman Bankruptcy Estate making a claim for a swap termination fee in connection with JBK can be acquired by calling David Kolibachuk (212-361-2649) who is the person at U.S. Bank Trust who acts as the trustee.
ReplyDeleteIn February 2009, the trustee took $100,000 from funds otherwise payable to the owners of JBK, as shown in its distribution statement filed with the SEC. Those funds are being used to pay attorneys to resist that claim. The owners of JBK will not get back the funds actually spent in that matter.
It is not known by me at the present time whether more funds will be need to resist the Lehman estate's claim.
As stated repeatedly in several recent posts, anyone desiring to purchase a synthetic floater, or is attempting to make a judgment call on whether to keep those currently owned, needs to review each prospectus with the GJN debacle in mind. For those investors who dabble in this area, it is now a known risk that a swap termination fee could substantially eat into the owner's capital for long dated maturities, in the event the underlying bond issuer can somehow avoid a "make whole" payment. If you do not understand what "make whole" means, then you need to learn pretty fast if you currently own this type of security.
ReplyDeleteTo evaluate that risk, the investor must first learn about make whole payments and how they are calculated. Individual investors would most likely not have the software necessary to make that calculation. For a long dated maturity, such as GYC, GJR, GYB, PYT, GJP, etc., the make whole payment would have to be substantial, if made, since there are a large number of interest payments until maturity, and the discount of those coupons using the Treasury Rate would be low. So for most people, including myself, it will only be possible to guess at the amount of a "make whole"
My exposure to synthetics is almost non-existent. Each investor will need to make their own evaluations after reading a prospectus in light of what happened to the GJN owners and why it happened.
The following statement about comment moderation will appear in tomorrow's post:
ReplyDeleteThere are a few individuals who have started to come this blog for one limited purpose. To repeat over and over and over again how any fool could have understood what was about to happen to the GJN owners since the prospectus was so obvious and clear. Occasionally, while claiming to be proficient in the "clear" prospectuses, they demonstrate a startling lack of knowledge about them such as not having a clue about the meaning of a "make whole" provision. They insist on ignoring everything that I am saying about the matter and just repeat their contention in various forms, for reasons that are not clearly apparent to me. There is one possible explanation which makes sense to me. I am going to cut off those persons from further comments on this blog.
They have had their say and have I given them more than sufficient opportunity to blame the GJN owners, including all of the purchasers of GJN after 6/11/12, all of those owners who owed the security as of 6/11/12 and failed to sell before the redemption date including those with professional advisors at Wells Fargo and other brokerage firms; and all sellers of the security after 6/11/12 who failed to short the stock after realizing how much was about to be lost due to their reading of that "clear" warning in the prospectus. I have had enough. Those individuals can take their arguments to another blog. Of course, they would give both WFC and JPM a pass and would view any claim to the contrary to be barking up the wrong tree or having no possible merit worthy of judicial resolution.
Anyone interested in what these three WFC and JPM apologists have to say can review the extensive comments found at Stocks, Bonds & Politics: GJN-Wells Fargo-New York Time