The Terra Securities scandal was a scandal that became public in November 2007. It involved highly speculative investments by eight municipalities of Norway in various hedge funds in the United States bond market. The funds were sold by Terra Securities to the municipalities, while the products were delivered by Citigroup. The municipalities involved were Narvik, Rana, Hattfjelldal and Hemnes in Nordland, Vik and Bremanger in Sogn og Fjordane, Haugesund in Rogaland, and Kvinesdal in Vest-Agder, all large producers of hydroelectricity.
The investments were very complicated. They were geared, and they involved high risk through a small upside but a very large downside. Terra Securities, now bankrupt, was a subsidiary of Terra Markets, which is owned 66.73% by Terra-Gruppen, an alliance and co-branding company owned by 78 local savings banks in Norway. The remaining 33.27% was owned by the management of the company. Citigroup is the third largest bank in the United States.
Background
In 2001, Vik municipality found a loophole in the Municipality Act and invested borrowed money in the stock market, by first investing and then seeking permission later. This utilization of the loophole was confirmed by the Norwegian Ministry of Local Government and Regional Development in 2002, because the money borrowed was secured in future income. Vik had borrowed through DnB Markets based on annual payments of NOK 10M, secured through income from hydroelectric power production. This money was then invested in bonds through Terra Securities in 2001 and 2002.
In the same year, in 2001, the four Nordland municipalities Narvik, Rana, Hemnes and Hattfjelldal borrowed money to invest in complicated bonds issued by Citigroup and sold through Terra Securities. The municipalities also signed a confidentiality clause with Terra, which ensured that no independent third party could evaluate the quality of the investments. It has been questioned if such a clause, under the circumstances, was legal.
In Narvik's case, part of the capital came from the municipal sale of 50% of Narvik Energi, the municipal power company, in 2002 to DONG Energy and HelgelandsKraft. The other three municipalities had ownership in HelgelandsKraft (Rana 26.8%, Hemnes 7.0% and Hattfjelldal 2.5%) as well as property tax income from power stations owned by Statkraft. These municipalities were investing future income from these sources.
The main advisors in Terra were Knut Anders Opstad and Harald Norberg. They had tried to sell the investments to all municipalities with income from power production by contacting the Association of Norwegian Power Municipalities, but had been rejected by the organization.
Nature of the investments
After the reinvestment in 2007, the municipalities gained a potential upside on their investments of between 0.5% and 3.0% above risk-free placements, but instead risked losing not only their entire investment, but in a worst-case scenario twice what they invested. A total of NOK 451 million was invested, but was 'geared' by borrowing an additional amount corresponding to ten times the investment, so that – in reality – the municipalities were actually investing between NOK 4 and 5 billion. In a worst-case scenario the municipalities could lose NOK 900 million.
The investment model was so complex that the CEO of Terra Securities could not confirm that even he actually understood how it worked. The deficit from the investment came in late 2007 caused by a credit bubble in the United States.
The investments made by Haugesund involved a placement of NOK 227.5M as a security for Citigroup, in case loans to United States municipalities were defaulted beyond 3.32%; Haugesund would have to pay this to Citigroup. The mayor of Haugesund, Petter Steen jr. claims that he thought the municipality was buying a bond in Statkraft. Instead they were selling such a bond as security for the hedging they were performing for Citigroup.
Total investments in Terra/Citigroup scheme: Bremanger: NOK 170 million Hattfjelldal: 103M Haugesund: 220M Hemnes: 84M Kvinesdal 32M Narvik: 52M Rana: 297M Vik: 38.5M