Friday, January 4, 2013

Credit Suisse plans new asset-backed bonus scheme to transfer more shareholder funds to bankers

Reuters reports that Credit Suisse is planning a third asset-backed bonus scheme.  The stated idea is to offload risk onto the bankers by having the bankers' bonuses fund the risky assets.

The reality is the scheme is another way for the bankers to profit at the shareholders' expense.

Let's look at the first deal that Credit Suisse did in 2008 involving asset-backed securities.  Under the terms of the deal, Credit Suisse was first in line to absorb $500 million of losses.  Meanwhile, the bankers received interest payments of 5-6%.  Since its inception, the value of the assets involved has increased by 80%.

To an outsider, the structure appears fundamentally flawed.

First, the bonuses should be thought of as "equity" and there to take the first loss on the assets.  As a result, the bankers should not receive any payments until all the assets mature or are sold.

Second, there is a problem when it comes to pricing the assets put into the scheme.  There is a limited market for these securities, so they are difficult to price.  Naturally, the bankers whose bonus is exposed to these securities will want to put as low a value on them as possible (which might imply that Credit Suisse shareholders absorb a loss).  Of course, the shareholders would want to put as high a value on them as possible (say cost).

As a result, Credit Suisse's shareholders should have received the lion's share of any increase in price of the assets in the scheme.  Say an 80/20 split for simplicity.

With these two minor changes in structure, the banker bonuses become truly at risk and the shareholders are protected from conflicts in asset pricing.

Credit Suisse is preparing to offload more risk exposure to staff in its 2012 bonus giveaway but significantly fewer managers will be allowed to join the latest version of a scheme that has yielded stellar rewards in previous years. 
Pioneered in 2008, Credit Suisse's ground-breaking asset-backed bonus schemes pay managers a portion of their bonuses in financial instruments whose value depends on the performance of risky assets that the bank is exposed to. 
The creation of a new Credit Suisse scheme comes as banks bow to the demands of shareholders and regulators to move away from cash bonuses in favor of alternatives that are more aligned with the risks bankers are taking.
Please recall that bankers receive salary and stock options in addition to their bonuses.  
Two earlier schemes have helped the bank to transfer $17 billion of troubled loans and derivatives off its balance sheet, improving its capital position since capital demands are directly related to the size of a bank's balance sheet. 
The schemes have also allowed the bank to save about $1.4 billion on cash or share-based bonus payments. 
Staff, who are not given a choice about how they receive their bonuses, can reap sizable rewards if the underlying assets do well and have already enjoyed massive paper profits on one of the schemes, though they can't get their money until 2016....
True transferring of risk would suggest that the bankers should not be eligible for sizable rewards if the underlying assets do well.

The reward for the bankers should be getting their bonuses at the end of the day.
Further details of the Plus Bond, which will have a "similar" structure and composition to the 2011 scheme, will be announced to staff later in January, according to the spokesman.
For the 2011 scheme, a $12 billion pool of derivatives was taken out of Credit Suisse and put into a specially created vehicle. 
Staff were given bonds that entitled them to regular interest payments of 5 to 6.5 percent, and would get a payout at the end of the scheme in lieu of their original bonus amount. 
The value of their final payout depends on how the underlying assets perform; the first $500 million loss is borne by Credit Suisse and any further losses reduce the lump sum staff ultimately get. 
Reports last summer claimed the value of the original PAF 1 notes had shot up by 80 percent. PAF 1 included troubled assets that were thinly traded in 2008 and hard to value. The surge in its value came as the price of other similar assets recovered from the lows of 2008 when PAF 1 was created....
The asset-backed schemes, which Credit Suisse chief executive Brady Dougan described in an email as "a risk transfer from the firm to employees", are part of a Credit Suisse bonus pool that also includes deferred shares in the bank and cash.

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