Terra – feet firmly planted?

Yesterday Terra Securities got an indication from Kredittilsynet, the agency in charge of supervising the Norwegian financial markets, it would loose its license to trade in securities, and subsequently filed for bankruptcy. A motion that was granted by a judge later the same day. With assets of 219M NOK and claims reaching in excess of 600M NOK the fight for what is left of the company will be fierce.

The Terra Group, with Terra Securities as a major part of its operation, is not a small player in the norwegian financial markets. Owned by some 70 local savings banks scattered around the country, Terra was founded to provide financial services to and through the banks that the banks themselves were to small to offer. While the Terra Group, and its other subdivisions should not be directly affected by the bankruptcy, there is no hiding that Terra as a brand is not very strong these days (and a few commentators have suggested that a renaming will occur in a not too distant future).

What happened that made the company loose its license and file for bankruptcy?

For the most part, the reason lies with four municipalities and their investments through Terra Securities. All four have a relatively high income through hydroelectric energy production, and loans were granted with a security in the future income from this industry which were then put into alternative investments. There is a law prohibiting municipalities from investing borrowed capital in products such as stocks and options, but there is a loophole when the loans are anchored in future income such as in this case.

Borrowed capital were then put into a very complex product trading in the american bond market – so complicated was the structure of these investments that the CEO of Terra Securities declined to comment on both if he could explain the model and if he himself understood it. Can you?

In the original english version of the prospect risk assessment had gotten a prominent place, but in presenting the product and translating the prospect to Norwegian the risk got systematically downplayed and in some cases omitted entirely. Downplaying the risk was a key element in the reasoning for retracting of the licence.

Here is an excerpt from the original prospect from Citigroup:

Investing in alternative investments is speculative, not suitable for all clients, and intended for sophisticated and experienced investors who are willing to bear the high economics risks of the investment, which can include:
- Loss of all or substantial portion of the investment due to leveraging, short selling or other speculative investment practices;
- Lack of liquidity in that there may be no secondary market for the investements and none expected to develop;
- Volatility of returns;
- Restrictions on transferring interests in the investments;
Potential lack of diversification and resulting higher risk due to concentration of trading authorothy with a single advisor;
[...].

Into this product, and apparently with absolute trust in the sales pitch from the Terra representatives (no external advisors were hired to evaluate the product), and without reading the original prospect, the municipalities put a combined sum of 451M NOK

There is a clause in the contract where if the value of bonds dip below 55% of original value the holders would need to come up with additional security to keep the investment afloat. Which in the real world translates to a two day deadline to come up with 100M. (Yes, this is what happened)

Did I mention that the investment got geared up by as much as a factor of between 8 and 10, meaning the municipalities had the responsibility of investments as high as 4-5 billion NOK? Or that the product originally got classified as a hedge fund, a product class that is illegal to market in Norway?

Terra Securities is bankrupt; the four municipalities have a goal of getting out of the agreement without significant losses; the previous owners of Terra Securities as well as the Norwegian government have made it clear that they have no intention of bailing out the municipalities. The municipalities on their end have refused to throw good money after bad, and the investments will most likely be sold off by Citigroup. What the outcome of such a sale will be is unclear, but there have been speculations that all the money could be lost and that additional losses could be at least as high as the initial investment.

So far the 70 employees in Terra Securities as well as some people in the executive branch of the Terra Group have lost their jobs. As for the politicians and administration in the municipalities, they are still banking on someone (and at this point I have a feeling they will settle for just about anyone) to bail them out of the the sticky position. When they come to realize that the man on the door is not a savior but a claims collector, then heads will start to roll.

The moral of the story? If you do not understand the product you are investing in: don’t. If someone is promising something that seems too good to be true: it is too good to be true. If you cannot bother to read the documentation, then you deserve what you have coming. The tragic part is that ‘you’ in this case are the innocent inhabitants of four, in essence, bankrupt municipalities. They are the ones who will suffer from a rotten investment that should never have happened.