{"id":41414,"date":"2013-08-28T05:51:34","date_gmt":"2013-08-28T09:51:34","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=41414"},"modified":"2013-08-28T05:51:34","modified_gmt":"2013-08-28T09:51:34","slug":"beware-of-this-dead-money-investment","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2013\/08\/28\/beware-of-this-dead-money-investment\/","title":{"rendered":"Beware of This \u201cDead Money\u201d Investment"},"content":{"rendered":"

By WallStreetDaily.com<\/u><\/a> <\/p>\n

Talk about the past coming back to haunt you\u2026<\/p>\n

Way back in the 1990s, banks uncovered a novel way to save money on taxes and employee benefits by – get this – betting on their employees dying<\/i>.<\/p>\n

I\u2019m not joking.<\/p>\n

An obscure investment known as bank-owned life insurance (BOLI) made it all possible. The banks simply purchased life insurance on their employees in bulk, and named themselves as the beneficiaries.<\/p>\n

So if an employee dies, the bank profits.<\/p>\n

I know. Nothing could possibly<\/i> go wrong with such an arrangement, right?<\/p>\n

Of course, it did.<\/p>\n

And now, some 20 years later, the involvement of one of the world\u2019s largest financial institutions in these \u201cdead money\u201d investments is making its stock\u2026 well, a \u201cdead money\u201d investment, too.<\/p>\n

Few investors realize it, however. Most people are being lured into thinking that the bank\u2019s mega market cap of $192 billion – and respectable 3% yield – makes it a safe, blue-chip investment.<\/a><\/p>\n

As you\u2019ll find out in a moment, though, it\u2019s anything but.<\/p>\n

Better Off Dead<\/b><\/p>\n

The way BOLIs work is pretty straightforward\u2026<\/p>\n

A bank purchases life insurance on employees. However, they don\u2019t actually pay the premiums to an insurance company. Instead, they keep the money in a designated fund and invest it on their own. Hence, the bank-owned part.<\/p>\n

If you know anything about how insurance companies invest premiums, you\u2019ll immediately recognize what a coup the banks pulled off.<\/p>\n

Instead of premiums being socked away in stodgy, low-return, low-yield investments – like cash and U.S. Treasuries – banks can be more risky with the capital to generate higher returns.<\/p>\n

They get to keep all the profits, too. Not to mention, they pocket a payout upon an employee\u2019s death.<\/p>\n

Now, the banks can\u2019t spend this money any way they want. It must ultimately be used to cover expenses for employee benefits. However, all the premiums invested, as well as any capital appreciation, aren\u2019t taxed.<\/p>\n

So BOLIs are essentially a tax shelter and<\/i> cheap funding source for banks. No wonder they\u2019re so popular, even today. (It\u2019s estimated that almost 4,000 banks own $140 billion in BOLIs.)<\/p>\n

There is a downside to BOLIs, however: If banks invest the premiums poorly, they\u2019re on the hook for the losses.<\/p>\n

In our world of never-ending financial innovation, though, it shouldn\u2019t surprise you that banks found a way to eliminate that risk, too. And therein lies the problem\u2026<\/p>\n

No Such Thing As \u201cNo Risk\u201d<\/b><\/p>\n

The financial wizards over at JP Morgan <\/b>(JPM<\/a>) devised a way to assume much of the downside risk on BOLIs – for a fee, of course – using a derivative product known as a \u201cstable-value wrap.\u201d<\/p>\n

Don’t worry about learning the ins and outs of another esoteric investment. All you need to know is this\u2026<\/p>\n

Other major banks followed JP Morgan\u2019s lead into this market. And now, thanks to recent changes in regulations (Basel III), they\u2019re required to set aside more capital to cover the liabilities created by these long-term derivatives.<\/p>\n

As Martin Zorn, Chief Operating Officer at the risk management firm, Kamakura Corp., says, \u201cTimes have changed: There are a lot of long-term derivatives on financial institutions\u2019 balance sheets that have become very costly today, and will stay that way.\u201d<\/p>\n

Granted, these derivatives only account for a small percentage of the megabanks\u2019 investment portfolios. But the point is, the increased capital they have to set aside comes with an opportunity cost.<\/p>\n

In other words, since the money is just providing collateral, it can\u2019t be allocated elsewhere to generate actual profits.<\/p>\n

The situation can\u2019t simply be unwound, either. Most of these derivatives are unique, so they\u2019re not easily priced. They don\u2019t trade regularly on exchanges. And there\u2019s a limited pool of potential buyers.<\/p>\n

Think about it\u2026 Banks aren\u2019t exactly going to rush out to buy other banks\u2019 long-term derivatives if they’re looking to unload their own.<\/p>\n

Add it all up, and since the liabilities extend out for decades, banks are stuck with them. Or as Morgan Stanley<\/b> (MS<\/a>) Chief Executive, James Gorman, declared at the company\u2019s annual meeting, these positions are \u201cdead money.\u201d Indeed!<\/p>\n

Three More Risks Facing JP Morgan<\/b><\/p>\n

JP Morgan is the biggest issuer of these derivatives, accounting for upwards of 30% of the market. In turn, it\u2019s the most capital constrained. And if you\u2019re in charge at JP Morgan, that\u2019s not an ideal situation.<\/p>\n

Not with the economy on the mend and interest rates rising.<\/p>\n

We\u2019re essentially on the cusp of entering the sweet spot of the economic cycle for banks and financial institutions. Yet the company can\u2019t take full advantage of it.<\/p>\n

That\u2019s not the only reason the stock is a \u201cdead money\u201d investment, though.<\/p>\n

Richard Bove, a well-known banking analyst at Rafferty Capital, sees \u201cthree clear risks\u201d to JP Morgan\u2019s earnings potential: lower investment-banking fees, slower payment systems profits and rising litigation costs.<\/p>\n

Accordingly, he lowered his rating on the stock to a \u201cHold.\u201d<\/p>\n

My response? When will Wall Street analysts ever get a pair?<\/p>\n

We all know their \u201cHold\u201d is merely a euphemism for \u201cSell.\u201d And that\u2019s exactly what I think you should do if you own JP Morgan. There\u2019s too much downside risk and too little upside potential.<\/p>\n

If you need a suitable alternative, consider Bank of America<\/b> (BAC<\/a>). As I shared earlier in the year<\/a>, it boasts strong fundamentals and a compelling valuation. But the tale of the tape pretty much says it all.<\/p>\n

In the last year, JP Morgan is up about 40%, whereas Bank of America is up 80%. In more recent weeks, the divergence appears to be intensifying.<\/p>\n

\"\"<\/p>\n

Since July 10, JP Morgan is down almost 6%, compared to an 8% rally for Bank of America.<\/p>\n

Bottom line: If you\u2019re looking for the lowest-risk, highest-return trade in mega-cap banking stocks, dump JP Morgan and buy Bank of America.<\/p>\n

If you want to mitigate the market risk altogether, consider putting on a pairs trade: Divide the capital you plan to invest in two. Then use half to sell short JP Morgan, and use the other half to buy Bank of America.<\/p>\n

Rest assured, regardless of which option you choose, it promises to be a much better alternative than sticking with a \u201cdead money\u201d investment.<\/p>\n

Ahead of the tape,<\/p>\n

Louis Basenese<\/p>\n

The post Beware of This “Dead Money” Investment<\/a> appeared first on Wall Street Daily<\/a>.<\/p>\n

Article By WallStreetDaily.com<\/u><\/a><\/p>\n

Original Article: Beware of This \u201cDead Money\u201d Investment<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

By WallStreetDaily.com Talk about the past coming back to haunt you\u2026 Way back in the 1990s, banks uncovered a novel way to save money on taxes and employee benefits by – get this – betting on their employees dying. I\u2019m not joking. An obscure investment known as bank-owned life insurance (BOLI) made it all possible. … <\/p>\n

Continue reading “Beware of This \u201cDead Money\u201d Investment”<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-41414","post","type-post","status-publish","format-standard","hentry"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/posts\/41414","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/comments?post=41414"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/posts\/41414\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/media?parent=41414"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/categories?post=41414"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex-news\/wp-json\/wp\/v2\/tags?post=41414"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}