Financial Times says creditors take the reins at Tokyo Star Bank.

Their analysis, here (free registration), or here (Bloomberg – no hassle), is exactly what I was saying in January.

This story shouldn’t surprise me, as I had gotten some Advantage Partners and Tokyo Star Bank web search hits. I believe that my analysis was spot on, that Advantage Partners was using the “special purpose vehicle” to fund Tokyo Star Bank. Once the people who lent to the special purpose vehicle wanted their money back, it effectively was a run on Tokyo Star Bank. Tokyo Star Bank didn’t have a sufficient depositor base, or a large enough friendly creditor, to unwind the transaction.

Remember, the asset side of a bank’s balance sheet is mostly the loans that the bank made.

The liability consists of things like:

1) deposits
2) bond borrowing, where the bank takes money from investors on extended terms, like 5 or 10 years.
3) the bank owner’s own capital.

Let me try to put this visually:

On the left, the large orange rectangle with the “4%” in it represents a little bit of cash, and a big amount of loans. So big, that it might as well all be loans. These can be loans to the government, to consumers, to businesses—you get the idea.

Down at the bottom of the asset side, are smaller rectangles representing loans that have some question marks about them. In one, these are loans that look like they might be trouble. The red one on the bottom is for loans that are definitely not paying back the whole thing.

On the right side are liabilities. For a normal bank, the big liability is the deposits that the bank took in from customers. This is the whole idea of a bank. The bank offers you liquidity, and in turn they get to take your money and put it out for loans at interest. This is why there are banks. You would not want to live in a system without banks, even though they are not very popular as business institutions right now.

The liabilities side–and this is what confuses non-accountants–are the things that a company owes. But it also “owes” back to the original investor, who has an equity stake. The equity stake is not guaranteed its money back, so all the “owing” is, is the right to the profits, and to get whatever would be left if the whole thing were sold or unwound.

From around 1983 to 2007 or so, [in America, excepting the ’90 recession,] the equity share in a bank was a fantastic thing. You paid the creditors and depositors their fixed interest to borrow their money, and you kept all the difference.

When the global recession got underway in 2007, and then Lehman was shown to be bankrupt in September 2008, those equity rectangles took some hard hits. Because whatever wasn’t there in good loans was chopped off the asset side, and chopped off the equity part of the liability side.

(Note: I say “Lehman was shown to be bankrupt in September 2008”, because some people think, and I agree, that it was insolvent in August 2008; and maybe several months before. This was due to a maneuver they did with bonds, which is shorthanded as “Repo 105”. I wrote about it extensively in early 2010. One of my posts is here, using bank geometry like above.)

Back to Advantage Partners. The depositor rectangle for Advantage was this “special purpose vehicle” mentioned in the article. The special purpose vehicle, in turn, had borrowed from other investors. These investors wanted their money back, because the special purpose vehicle couldn’t come up with cash to make payments the right way. We call this default.

So it was like small-d dominos. Only there were just two to knock down.

Whatever Advantage Partners had put up as equity was wiped out. Apparently, also, what was lent by the ultimate creditors is subject to some haircut, (meaning: they might not get back 100% of their money.) When this happens with a bank, it’s really bad.

The Japanese regulator quoted in the piece had some words of wisdom. These are, that it’s basically hard to be a bank in Japan, because there aren’t a lot of highly profitable lending opportunities in the country. These venture capital guys want to come in and make 12% or more. But you can only really do this, if your depositors accept 0% interest, and your borrowers maybe pay 4% or 5%. The regular Japanese banks already have that market sewn up. When every bank branch has people who will bow to you and make you feel like oh-sama (not the villain in Pakistan), what is the Western “hot money” investor going to offer to beat that?

I don’t know if Advantage itself lost the equity, or some investor using Advantage to invest lost it, but somebody really blew it with that purchase. Notice how there’s been nothing about that in the Japan-side expat online media . . .

[Update: The question is: how can Advantage Partners lose anything if it isn’t the actual investor? Beats me. As far as I can tell, Advantage Partners sets up what amounts to a holding pen for a particular investment, usually referred to with an alphanumeric, like AP 18, AP 19, etc.

The actual owners of AP number number may be other investors. Or, it might be Advantage Partners, LLP. It sounds like with the bank, it is actually other investment partnerships that put the money in, and lost it.

Remember the Financial Crisis? How could you forget, right? Part of the problem was this very sort of thing. There were these “structures” and “vehicles” out there, and no one could quite make sense of which was which. The main lesson learned was that this sort of thing did NOT “spread the risk”. It increased the risk–because nobody knew what was what.

It sounds like the best description of Advantage Partners LLP is that it is like a mutual fund company. You may invest in a mutual fund, and it goes bust. Well, that was your money–not the mutual funds’.

(But this company might hold an investment outright, too.)

The only information you get from the Advantage website is cryptic and lawyer-ese. It’s not even clear where the actual LLP partnership is formed. I think I understand what it’s doing. Maybe.]

[Update #2: According to the Financial Times article, there are conflicts of interest within these various financing structures. Shinsei Bank, the former Long-Term Capital Management Bank which was recapitalized in 2000 by Ripplewood Holdings and J. Christopher Flowers, is one of the creditors that would not renegotiate terms with Tokyo Star. Rightly or wrongly? It makes you feel like the banking industry is rife with this sort of thing. Governments have been shellacking (liquidating) the shareholders of banks since the Financial Crisis began. It’s no surprise that creditor banks would be equally as tough.]

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