The bankruptcy of Canadian real estate company Urbancorp, which issued bonds on the Tel Aviv Stock Exchange less than five months ago, has presented the Israeli public once again with a simple and depressing message: The Israeli capital markets and the people who manage our money have learned nothing and not fixed anything since the failures of Nochi Dankner, Eliezer Fishman, Moti Zisser, Lev Leviev, the disasters by Israeli firms in the Eastern European real estate markets — and dozens of other cases of misuse of the money that anonymous citizens without faces have abandoned in their hands.
In essence, the scandalous Urbancorp bond issue is no different than that of the securities issued by the big Israeli tycoons. Just like then, the collapse exposed an across-the-board systematic failure in which almost everyone involved was negligent: the underwriters, advisers, lawyers, mutual fund directors who bought the dubious goods, the Midroog rating agency, and the government regulators too, such as the Israel Securities Authority and the Finance Ministry’s Supervisor of Capital Markets and Savings.
To a great extent, the present affair is even more infuriating than the fall of the tycoons. In this case, no external event occurred, not even a minor one, as happened in many of the other cases. Even worse, the real estate industry in Canada has never seen better times, every day new record high prices are being set and we have no reason to believe the Urbancorp case is a “sting” by a Canadian businessman at the expense of Israeli investors.
Here in a nutshell are the institutions that failed:
In return for issuing the Urbancorp bonds on the TASE, 180 million shekels ($47.6 million) worth, the underwriters — led by Apex Issuances — received the very tidy sum of 5.2 million shekels (nearly $1.4 million). By law, the leading underwriter is responsible for vouching for the “truthfulness” of the prospectus: The underwriter is the one who must ensure that what is written is accurate, and no major details are missing or hidden.
The ratings agency Midroog, which is partially owned by Moody’s and is run by CEO Eran Heimer, gave the Urbancorp bonds an A3 rating just before the issue. This is a relatively high grade investment rating, which should calm potential investors.
But a large number of investors in Israel nonetheless had suspicions something did not smell quite right in the Urbancorp story, so the bonds were issued at a relatively high interest rate (and relatively low price) of 8.15%. The institutional investors who manage the Israeli pensions of the Israeli public did not participate in the issue at all.
This number by itself should have raised the suspicions of any reasonable investor: If Midroog gives the bonds an A3 rating, how is it possible that the capital markets price the same bond at the level of a much worse off firm? It is possible to provide an answer to this question: Midroog, just like the underwriters, received a nice sum of money for the grade they gave, money they would not have received if the issue did not take place in the end.
Advisers, trustees and lawyers
The same as with the underwriters, these professionals have a responsibility to examine the details and dive into the numbers to ascertain the public is not being sold a heap of manure.
Mutual fund managers
Some of those in the Israeli financial industry, we must admit, did not touch this issue. Not a single provident funds, pension fund or insurance company bought Urbancorp bonds. But the over 8% yields melted the hearts of a few of the managers of the largest mutual funds in Israel, including Psagot, Yelin Lapidot, Ayalon, Analyst, Excellence, Migdal, Meitav Dash, Menorah and Tamir Fishman.
It would have been interesting to have been the fly on the wall listening in to the meeting in a fund such as Psagot when they decided that Urbancorp was not fit for feeding to its provident fund investors, but was attractive and tasty for those invested in its mutual funds. We could imagine such a conversation:
Mutual fund investment manager: Say, bro, are you going to order Urbancorp bonds? They’re rated A3 but came out with a yield of eight and something percent. It will drive our yields on the portfolio sky high.
Provident fund investment manager: Urbancorp? I wouldn’t touch it. I made a few phone calls, it turns out no Israeli institutional investor is buying. Doesn’t smell good, I’m out.
Mutual fund investment manager: But why? They have a great rating. They checked. So you know better than they do? What a waste.
Provident fund investment manager: I don’t know, it doesn’t look right to me. All the papers wrote too that these bond issues for North American real estate are all a bit dodgy. They wrote that these firms can’t sell bonds at home even with double-digit interest rates, so it’s a bit strange they are issuing here at half the price. Even on the radio they talked about it. And after they all wrote and talked about it, it would be really embarrassing if there was a problem with it. After all, who still believes the ratings agencies? Or the underwriters? After all that happened in 2008, the tycoons and so many other cases? We’ve been there, done that.
Mutual fund investment manager: [Angry] I understand, for you and the pension fund managers the money keeps on flowing in from savers every month like a Swiss watch — so what do you care about returns? So you can play “conservative investor.” But me? I need to beat Yelin Lapidot every day, beat Altshuler, Dash, everyone. Otherwise I drop in the rankings and all the money will flee to other firms, they’ll fire me and no one will hire me. So I need to take risks. A real investment manager is someone who knows how to take risks and exploit opportunities.
Provident fund investment manager: Risks, risks, but the money is people’s pensions. It’s not like in your mutual funds, where its extra cash from all sorts of upper middle class people who will soon withdraw the money and buy a new car or build a swimming pool in the back yard with it.
Mutual fund investment manager: Yalla, don’t talk down to me. All this money, mine and yours, it’s other people’s money. Widows and orphans. Abandoned property. We saw you in the IDB, Fishman and Leviev issues. You’re talking to me now, not to the newspaper.
Israel Securities Authority
The Israel Securities Authority chose to protect the public only through the requirement for the companies to provide a detailed prospectus for the offering, and not through using its discretion concerning the quality of the bonds.
The ISA entered the picture only after the problem was exposed — in other words, only after the train had left the station. This is a convenient approach for the authority, but in doing so it abandoned investors because whoever really wants to will always find a way to present a distorted or partial picture of the true financial situation of a company. This was how it was for the bond issues for the Eastern European real estate projects a decade ago, this is how it was for the issues by the tycoons, and how it was 20 years ago during the wave of bubble companies lacking any real business operations.
There is another problem too: The chairman of the ISA, Prof. Shmuel Hauser, took upon himself the role of being responsible for the stock market, and he is determined to increase the number of companies traded on the TASE and the daily turnover. In doing so, he has placed himself in a potential conflict of interest as opposed to the good of the Israeli investing public. On one hand, he wants more companies and more “action” in trading,; but at the same time his job is to make sure poor companies that hide their true situation do not enter the stock market.
Treasury’s Supervisor of Capital Markets
The Finance Ministry’s Supervisor of Capital Markets and Savings likes to complain they do not have the budget, manpower and investigative authority that the Securities Authority and the Bank of Israel’s Supervisor of Banks do. They are right, but this fact does not exempt the Finance Ministry from responsibility.
Even in Jerusalem they know how to read newspapers, they read the warnings about the wave of bond issues of the North American real estate companies, and they too did nothing.
Those who understood - knew the truth
Those with experience in the markets and the American real estate industry knew months ago of the many strange and disturbing phenomena in the recent wave of bond issues in Tel Aviv by American real estate firms. For example, they could have told stories about developers who were willing to sell senior debt at double-digit yields - and managed to sell subordinate debt on the TASE, at single-digit interest rates - backed by the very same real estate. That does not make any sense. It just proves that something improper about the way the institutional investors in Israel make decisions, that they do not know how to price these American goods and they are willing to pay too high a price for them.
From the beginning, the decision by those who manage “someone else’s money” in Israel to buy into this recent wave of issues was hard to understand: After all they bought the goods because someone knocked on their door and sold it to them; and not because they made a rational and planned decision to invest part of their portfolio in North American real estate. If that had been their original decision, the logical way to carry it out would have been through buying up diversified property portfolios on the New York Stock Exchange, where, at the very least, it is possible to assume the American market knows how to price the goods.
So why does this happen? We have told and written the answer thousands of times, but it seems we have no choice but to remind and explain the answer once again: Because this is other people’s money; because the public’s “agents” in the capital markets first think about their own salaries, bonuses and bank accounts; because they do not have professional capabilities for making detailed and individual investment decisions outside of Israel; because in some cases they took a fat cut of the fees for themselves; and because they lack one fundamental thing: Internalization of the fact that they serve the public, that they are truly trustees for the public’s money.
Until this changes, we will continue to see the failure of issues, companies and financial instruments every few years. Today these are the junior bond issues of over-leveraged companies from North America. Tomorrow it will be something else, even if this newspaper and all the media warn about it.
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