By Aline van Duyn and Michael Mackenzie in New York and Paul J Davies in London
February 5 2008 (Last updated: February 6 2008)
SourceStandard & Poor’s, the credit rating agency that is considering downgrading the top triple-A credit ratings of bond insurers, warned that the move could be damaging for banks with direct exposure to the insurers.
The forecast came as bond insurers including Ambac, FGIC, MBIA and SCA continue frantic efforts to raise capital to avoid downgrades.
Banks with exposure to the insurers are in talks about providing capital. One group is discussing a deal related to Ambac, and another group of banks is believed to be considering raising funds for FGIC, partly owned by Blackstone Group, the private equity firm.
Leading private equity firms, which at one stage were considered to be potential sources of fresh capital for bond insurers, are unlikely to participate in any recapitalisation efforts.
S&P said most potential losses for banks in the event of downgrades for the “monolines” would be through hedging arrangements that the bond insurers had provided on the least risky tranches of collateralised debt obligations. Bond insurers had hedged $125bn (£64bn) of subprime-related CDOs, S&P said.
Although it did not specify which banks were most exposed, S&P noted that Citibank, Merrill Lynch and CIBC had all reported hedges on the so-called super- senior tranches of high-grade CDOs and had recently taken reserves for counterparty risk.
“The value of those hedges has increased as the value of the underlying CDOs has fallen and can be presumed to be 40 per cent to 60 per cent of the notional amounts,” said Tanya Azarchs, analyst at S&P. “More reserving may be necessary to reflect the increase in counterparty risk, if the ratings on guarantors are lowered.”
Losses could also be triggered because some of the CDOs were hedged in “negative basis trades”.
These take advantage of pricing differences in the bond and credit derivatives markets. A gain can be reported if a position is hedged, but not if the hedge is “ineffective”.
The potential for further counterparty risks for banks was highlighted yesterday as Primus, a Bermuda based-company that takes on credit risk for banks and others solely through derivative contracts, reported its largest loss yet
Copyright The Financial Times Limited 2008