The following post is by a hedge fund manager friend of DB who shall remain nameless. He runs the emerging markets desk at his firm.
Emerging Markets and derivatives are like alcohol and barbiturates: each on its own has attractions but create a recipe for choking on one’s own vomit when combined. And despite all warnings, rock stars (or in the case of finance “rock stars”), real and aspiring, continue to do just that. The latest set of investors to get the Jimi Hendrix experience: writers of CDS on the Kazakh financial institution BTA Bank. The bank, by some measures Kazakhstan’s largest, declared its intent to restructure its debt back in late April, after the authorities alleged its loan book to be riddled with undisclosed related-party deals and its controlling shareholder, Mr. Mukhtar Ablyazov, fled the country. On a loan book of KZT 2.4 trillion, it has now provisioned nearly KZT 1.5 trillion, the sort of write-down that makes Merrill Lynch look like a bunch of pikers. Sadly for creditors, it didn’t occur to Mr. Ablyazov to try to pitch the bank to Ken Lewis.
The chicanery at BTA Bank itself is another story, though. ISDA’s Determinations Committee declared a credit event on April 29th. The baleful interaction of EM and derivatives relates to the CDS credit event auction. BTA Bank had issued a fairly full curve of eurobonds, most of which traded in the wake of the default in the mid-20s. The spirit of creativity was strong with the Kazakhs, though, and the bank was understood to have done a fair number of private deals. Less well-understood was the magnitude of off-balance sheet borrowing. A few “shell” borrowers – reputedly related to BTAS’s controlling shareholder — had taken out loans from western banks, which in turn got guarantees on these loans from BTA. The “shell” borrowers in turn onlent to Ablyazov-related entities (as Borat would say, “Naughty, naughty!”). Credit Suisse was the most active lender; at the time of making the loans – which yielded a premium to other BTAS obligations – it had gone and hedged itself by buying CDS from the market.
The NYT Magazine printed a piece over the weekend called “Too Much Credit,” penned by hedge funder Ben Heller, who runs the emerging markets desk at his firm. Heller wrote about the frustration he would inspire in salesmen trying to pitch him to make loans and investments in developing countries, by asking “pointed questions,” and sometimes– OMFG– passing on deals. One guy was particularly pissed off that Heller turned down a gas project in Indonesia after it came out that it was “controlled by a shady family that defaulted on lenders a few years before, sticking them with losses of 90 cents on the dollar.”
As the credit bubble grew, and more bankers started taking Heller’s rejections personally, he stopped saying no fucking way from the get-go, listened to every ridic pitch, and actually said yes to a few he later regretted the morning after (“Anybody out there care for a small Argentine oil field? I’ve been assured that the angry gang of Mapuche activists blockading it will be gone soon.”)
Then, last year, when things got really bad, Heller’s firm decided it had to take off the beer goggles (kidding: it is a serious, prudent firm that never drinks on the job) and drastically cut back on EM loans (much like…a lot of places). And passing on the deals they might’ve in better times given a drunken bang (ultimately leading to PCD– post-coital depression) felt good! Sayeth BH:
The constraint on new investment paradoxically restored my freedom. “No!” I declared.
“Just … no?”
“Should I elaborate?” I asked. I told him that it was the dumbest idea I’d heard in a long while, and that I’d sooner pile up hundred-dollar bills to make a bonfire than invest.
I hung up abruptly, and I began to feel a long-forgotten rush. The rush of calling foolishness by its true name. The pleasure of meting out chastisement to presumption. The satisfaction of knowing that my no meant a death blow for this bad idea, because there wasn’t an uncritical yes waiting next door. I am capital’s gatekeeper, and you shall not pass!
Nice! Standards and whatnot. Obviously, though, we wanted more horror stories, so we emailed Ben and asked him to tell us about some other deals that had been de-nied (as recently as…yesterday).