Mortgages and annuities

(Sep 20, 2008)

Another week, another giant financial institution comes crashing down.  This time it is the turn of HBOS, a large UK mortgage provider.  The problem was not one of leverage as such, since all banks are highly leveraged.  The problem was one of funding: HBOS's mortgage liabilities were long-term, whereas its funding was short-term.  When HBOS came to renew its short-term funding, nobody was willing to lend.

In an earlier post we showed why the annuities business is also leveraged. However, a crucial distinction between annuities and banking is that the money "borrowed" from the policyholder cannot be recalled at short notice like ordinary loans.  This is one huge appeal of the annuities…

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Tags: leverage, mortgages, annuities

Leverage in the annuity business

(Sep 15, 2008)

The recent bankruptcy filing for Lehman Brothers follows hard on the heels of the forced takeover of Bear Stearns earlier this year. Debt played a role in the demise of both: as with many banks and other businesses, they used borrowed money to enhance shareholder returns, a phenomenon known as leverage. Leverage works well when profits are made: the shareholders reap all the rewards of the total deployed capital, both their own and the borrowed funds. Of course, leverage also increases the downside risk: since debt has to be repaid no matter what, shareholder funds are first in line to be wiped out if things don't go according to plan.

The use of borrowed money is not restricted to banks and corporate borrowers. Indeed,…

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Tags: leverage, annuities

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