Archive for the “Off-Balance Sheet Entities” Category

Things are getting ugly for OppenheimerFunds these days. Not only has Tremont Capital Management, which Oppenheimer owns, lost hundreds of millions of dollars in the Bernie Madoff scandal, but bad bets on toxic mortgage-backed securities and credit-default swaps have decimated bond funds like the Oppenheimer Core Bond Fund and the Oppenheimer Champion Income Fund.

The Oppenheimer Champion Income is down more than 80%, making its performance one of the worst among bond funds for 2008. As for the Oppenheimer Core Bond Fund, it is down by more than 42%.

As reported Dec. 18 in a story by Eric Jacobson on Morningstar.com, the Core portfolio carried approximately $400 million in mortgage-backed securities as of the end of March 2008, “exceeding its (then) $2.2 billion in net assets via transactions that were effectively akin to margin borrowing.”

The fund also had approximately $800 million in exposure to credit via default swaps, including American International Group (AIG), Lehman Brothers, Wachovia, Washington Mutual, and Bear Stearns, as well as around $600 million in total return swaps. These facts, critical to investors, were never included on the fund’s balance sheet, according to the article, and therefore did not appear in its net assets.

By the end of September, the Core Bond’s credit exposure to those various markets “totaled more than 180% of net assets on a dollar basis,” says the Morningstar article. To put it another way, for every shareholder dollar in the fund, it was exposed to the credit-driven movement of more than $1.80 worth of toxic securities.

Making matter worse: Most of the additional market exposure came from off-balance-sheet derivatives, giving the appearance to investors that the funds’ portfolios were not highly leveraged and therefore more fiscally sound than what was reality. And despite the fact that both the Core Bond fund and the Champion Fund were highly exposed to commercial mortgage-backed securities, detailed information regarding the extent of that over-concentration was and is no where to be found in any of Oppenheimer’s marketing materials or on Web site.

The ramifications of Oppenheimer’s behind-the-scenes gamble with derivative bets gone bad have been painful for investors. In particular, parents who invested in several state-run college savings plan are facing major financial losses because of portfolios containing the sinking Oppenheimer funds. To top it off, the losses hit the most conservative plans the hardest.

In Oregon, the 529 College Savings Plan includes more than 70,000 investors who are saving college money for 100,000 children, grandchildren and others. The plans in the network are worth about $750 million. One year ago, the value was $1 billion. About $89 million was invested in the Oppenheimer Core Bond Fund in September 2008.

In October 2008, the board that oversees the Oregon College Savings Plan questioned Oppenheimer about the fund’s poor performance. At the time, Oppenheimer managers said they bought the mortgage-backed securities when they believed the price had bottomed out. However, the securities continued to lose value, yet Oppenheimer just kept buying them.

In Oregon’s case, an investigation with the attorney general’s office is underway regarding Oppenheimer’s actions. But the bottom line is clear: The returns on the funds simply don’t add up to what Oppenheimer represented.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

The past 12 months may well be remembered as the year in which losses connected to hard-to-value securities reached unheard-of levels, as investment firms and financial institutions disclosed nearly $700 billion in write-downs for mortgage-backed securities, leveraged loans and other assets that plunged in value. Still, the coming new year could give 2008 a run for its money. That’s because of something called off-balance sheet financing.

For some time now, financial institutions have made profits hand over fist by financing business deals with off-balance sheet entities. In simple terms, off-balance sheet refers to when companies transfer certain projects, investments or underperforming assets such as collateral debt obligations (CDOs), subprime-mortgage securities or credit default swaps from the parent company to an off-balance-sheet subsidiary.

Once the assets have been removed from a company’s primary balance sheet, it gives the appearance that the parent is carrying less debt - and thereby less risk. And, because off-balance sheet entities are largely unregulated, there is no one to question otherwise.

As the concept of off-balance sheet financing gained favor with Wall Street, so too did massive leveraging. Collateral debt obligations, subprime securities, credit default swap contracts - all have increased exponentially in recent years. What Wall Street failed to consider as it took on these added risks was the possibility of failure, not to mention the systemic damage that the failure potentially could unleash on the nation’s financial system as a whole.

Case in point: Credit default swaps. Credit default swaps are privately negotiated contracts between two parties - a buyer and a seller. The buyer of a credit default swap pays a fee to the seller. In exchange for that fee, the seller agrees to cover the buyer’s losses in the event that the underlying financial instrument defaults. The problem is the credit-default swap market itself. It is a $60 trillion unregulated market where contracts are traded without any federal oversight to ensure buyers actually are capable of covering losses.

When credit markets began to freeze up this year, that’s exactly what happened to institutions like Bear Stearns, Lehman Brothers, American Insurance Group and Citigroup. At the time, all of the firms were holding high concentrations of mortgage-backed securities - the same assets they once used as collateral to get credit and had to now significantly mark down in value.

A domino effect ultimately took hold, as creditor institutions turned up the heat via margin calls on the institutions that wrote the credit default swap contracts. Unable to meet those calls, Bear Stearns, Lehman, AIG, Citigroup and others quickly found themselves in trouble. Some of the companies like Lehman filed for bankruptcy protection; others were forced into a firesale; and some turned to the federal government for a bail-out to the tune of billions of dollars.

Now, countless other financial institutions are holding their breath, hoping they won’t meet a similar fate. Unfortunately, off-balance-sheet excesses already may have put them on a path to failure. There are literally trillions upon trillions of dollars of outstanding debt obligations residing “off-balance sheet” today for nearly every Wall Street institution around. When reality finally sets in, and the off-balance-sheet assets come back on balance sheet, watch out. It could make the nation’s current fiscal crisis look like child’s play.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.