January 20, 2022

DealBook: Seeking Relief, Banks Shift Risk to Murkier Corners

Banks have been shedding risky assets to show regulators that they are not as vulnerable as they were during the financial crisis. In some cases, however, the assets don’t actually move — the bank just shifts the risk to another institution.

This trading sleight of hand has been around Wall Street for a while. But as regulators press for banks to be safer, demand for these maneuvers — known as capital relief trades or regulatory capital trades — has been growing, especially in Europe.

Citigroup, Credit Suisse and UBS have recently completed such trades. Rather than selling the assets, potentially at a loss, the banks transfer a slice of the risk associated with the assets, usually loans. The buyers are typically hedge funds, whose investors are often pensions that manage the life savings of schoolteachers and city workers. The buyers agree to cover a percentage of losses on these assets for a fee, sometimes 15 percent a year or more.

The loans then look less worrisome — at least to the bank and its regulator. As a result, the bank does not need to hold as much capital, potentially improving profitability.

“I think we are going to see more of these type of trades in the U.S. given the demands by regulators to hold more capital,” said Kevin White, a former executive at Lehman Brothers who founded Spring Hill Capital Partners, which is working with banks to structure regulatory capital trades.

Citigroup, Credit Suisse and UBS declined to comment on their trades. Privately, however, bankers acknowledge that while these trades may be pushing risk into a less regulated corner of Wall Street, they also point out that the risk is being moved into a less systemic part of the financial industry than the big banks.

The rule-writing going on as part of the Dodd-Frank financial regulatory overhaul may prevent some of these trades, but bankers say this will simply force them to structure the trades differently.

Some regulators say they are concerned that in some instances these transactions are not actually taking risk off bank balance sheets. For instance, a financial institution may end up lending money to clients so they can invest in one of these trades, a move that could leave a bank with even more risk on its books.

Critics point to other reasons to worry. Most of these trades are structured as credit-default swaps, a derivative that resembles insurance. These kinds of swaps pushed the insurance giant American International Group to the brink of collapse in September 2008. Another red flag is that banks often use special-purpose vehicles located abroad, frequently in the Cayman Islands, to structure these trades.

“These trades allow the banks to go to regulators and say the risk is gone,” said Anat R. Admati, a professor of finance at Stanford University. “But it’s not gone at all; it’s just been pushed into a murky corner of the market.”

The trades can take many forms, but typically a bank will buy a credit-default swap on some of its loans from a special-purpose vehicle, which is financed by outside investors. If all goes well, the investors receive an annual fee for taking on this risk. But in the worst case, where the loans in the portfolio default, the insurance that the bank has bought kicks in and covers its losses. The investors on the other side are wiped out.

A number of American investment firms like Spring Hill Capital Partners have been trying to find investors for these deals. Glenn Blasius, another Lehman alumni, said he was raising money for the Ovid Regulatory Capital Relief Fund, which will invest in these trades.

The Orchard Global Capital Group has raised a fund to invest in regulatory capital trades, and the New Mexico Educational Retirement Board is among its investors.

In December 2011, Allan Martin, a representative with an investment consultant firm that advises pension funds, met with the New Mexican pension fund over investing through Orchard in a regulatory capital trade, according to the minutes of a board meeting.

Mr. Martin explained to the retirement board that these transactions had been created to allow the banks “to continue to hold the assets on their balance sheet” while selling some of the risk.

At the meeting, Jan Goodwin, executive director of the New Mexico Educational Retirement Board, asked about the use of credit-default swaps, which got A.I.G. into trouble. Mr. Martin admitted that the Orchard deal “has a little flavor of that” but said Orchard had done “a great deal” of due diligence on the underlying collateral, something he said A.I.G. often didn’t do.

In an interview, Mr. Martin said that “a lot of clients ask how this is different than A.I.G.,” and he said it was because Orchard had a better understanding of the risks involved in the assets it was dealing with.

An executive with Orchard did not respond to requests for comment.

Many major banks have structured these trades. In March, Credit Suisse completed a transaction named Lucerne, after the Swiss lake, in which it bought insurance on a 5 billion Swiss franc portfolio of small and medium-size Swiss business loans, according to people who were briefed on the matter but not authorized to speak on the record because they had signed confidentiality agreements.

Credit Suisse agreed to take a small percentage of the losses, and it lined up American and European investors willing, for an annual fee of roughly 10 percent, to assume the rest of the risk, these people say.

Citigroup cut a deal at the end of last year with the private equity firm Blackstone Group, which insured the big bank against a portion of the losses on a roughly $1 billion pool of shipping loans. The bank used a special-purpose vehicle in Ireland called Cloverie to facilitate the trade, according to people briefed on the matter but not authorized to speak on the record.

For its part, Blackstone put up about $100 million, or 12 percent of the value of the shipping portfolio, to cover any possible losses. If things go well, Blackstone will receive a return of about 15 percent, these people say. If the shipping loans go sour, Citigroup gets Blackstone’s money and the private equity firm loses its cash.

Credit Suisse received capital relief on the Lucerne deal, although the exact amount is not known. Citigroup was able to reduce by roughly 90 percent the amount of capital it needed to set aside to cover losses on the shipping portfolio.

One Citigroup executive with knowledge of this trade but not authorized to speak on the record said it was structured to reduce Citigroup’s exposure to shipping loans. The fact that it reduced the amount of capital the bank had to hold was “an added bonus.”

UBS also recently completed a regulatory capital trade, selling a piece of the risk on a portfolio of roughly 100 corporate loans, according to people who reviewed the transaction but who declined to speak publicly because they had signed confidentiality agreements.

And Citigroup is marketing a second risk capital trade involving shipping loans, according to people briefed on the matter.

“These trades are a good thing,” said Richard Robb, a New York money manager whose firm, Christofferson, Robb Company, has been structuring regulatory capital trades for more than a decade. “The best way to protect the banks against this risk is to move it outside the banking system to wealthy institutions. No one will be coming to bail out our company or our investors if these trades backfire.”

Article source: http://dealbook.nytimes.com/2013/04/10/seeking-relief-banks-shift-risk-to-murkier-corners/?partner=rss&emc=rss

Italian Senate Approves Austerity Measures

In Athens, leaders of both main parties said they were finalizing details of a national unity government, part of European political efforts to step back from the brink of chaos.

The Italian Senate voted with unusual speed to approve the austerity measures, thus enabling the lower house to complete parliamentary approval of the package on Saturday. Opposition senators did not vote, allowing the legislation to pass by a margin of 156 to 12.

Mr. Berlusconi promised this week to step down once the measures were approved, permitting a new leader to be appointed as the head of a technocrat government.

Mario Monti, a former European commissioner, has been widely mentioned as a likely front-runner, and he could take over as early as Monday.

In Greece, following similar maneuvers to replace elected leaders with respected, veteran officials known for expertise rather than popularity at the polls, Lucas Papademos, the prime minister-designate chosen by the two main political parties, was set to announce his cabinet by early afternoon, although, throughout the process of replacing the former prime minister, George A. Papandreou, such deadlines have frequently slipped.

Initially expected at 2 p.m. local time, the announcement was put back for two hours and Greek media speculated that there was disagreement over the composition of a new cabinet. The delay was not officially explained.

Days of political turmoil roiled bond markets this week, pushing the cost of borrowing in Italy to levels that economists regard as unsustainable and adding to the pressures on politicians.

By one measure, though, the promised changes in Greece and Italy seemed to have calmed investors: the leading stock market indexes in Britain, France and Germany all posted modest gains in Friday trading.

At the same time, the White House seemed to be showing growing impatience with Europe’s efforts to prevent their debt crisis from plunging the entire global economy into retreat.

Late Thursday, President Obama called Chancellor Angela Merkel of Germany and Presidents Nicolas Sarkozy of France and Giorgio Napolitano of Italy.

Speaking at a meeting of Asia and Pacific Economic Cooperation countries in Hawaii, Timothy F. Geithner, the United States treasury secretary, said Thursday: “The crisis in Europe remains the central challenge to global growth.  It is crucial that Europe move quickly to put in place a strong plan to restore financial stability.”

He also urged Asian and Pacific economies to take up the slack as Europe confronts slowing economic growth. “We are all directly affected by the crisis in Europe,” he said, “but the economies gathered here are in a better position than most to take steps to strengthen growth in the face of these pressures from Europe.” 

In Rome, to prolonged applause from other lawmakers, Mr. Monti took a seat in the upper house for the first time on Friday after he was appointed a senator for life. Mr. Monti has already held talks with President Napolitano and the speaker of the Senate, strengthening speculation that he is the leading candidate to succeed Mr. Berlusconi.

The legislation approved by the Senate is aimed at reducing Italy’s 1.9 trillion euro, or $2.6 trillion, public debt and boosting growth, but the European Union has already said that Italy will need to take further measures.

The proposed legislation includes selling 15 billion euros of state assets and increasing the retirement age to 67 from 65 by 2026. The new law also foresees a liberalization of closed professions and labor laws, a gradual reduction in government ownership of local services and tax breaks for companies that hire young workers.

Gaia Pianigiani reported from Rome, and Alan Cowell from London. Niki Kitsantonis contributed reporting from Athens.

Article source: http://feeds.nytimes.com/click.phdo?i=35981640685d8db46f779cfa720496b1

California Lawmakers Close Budget Gap

But the plan relied on the same sort of accounting maneuvers that Gov. Jerry Brown has decried since he campaigned for office last year, and it remained uncertain whether he would sign it.

Democratic leaders made it clear that their budget was not ideal and that they favored a plan Mr. Brown had put forward, which they said would address fundamental shortfalls in the state budget, in large part by extending three expiring taxes. But such extensions require a two-thirds’ approval in the Legislature, and Democrats were unable to rally enough Republican support.

But a new state law requires only a simple majority to pass the budget, so Democratic leaders said they felt obligated to do so to meet Wednesday’s budget deadline.

That new law, which voters approved last year in a ballot initiative, also permanently docks legislators’ pay for every day the budget is late.

To approve Mr. Brown’s plan, Democrats need the support of two Republicans in each house. While Republicans have said they could agree on a plan that would put the governor’s tax extensions on the fall ballot, they oppose a plan that would extend those taxes for several months before such a vote took place.

Darrell Steinberg, a Democrat who is the Senate president pro tem, said: “This budget is not our preference. We have told the Republicans, We prefer to work with you, but with you or without you, we will continue to govern California.”

Mr. Steinberg added, “I would love nothing more than coming back to the floor and fighting to pass Plan A, but if the Republican votes are not forthcoming, this is a solid and credible Plan B.”

The agreement reached by Democratic leaders in the Legislature relies on optimistic revenue forecasts, deferral of payments to schools and some parts that could be challenged in court, like a sell-leaseback on several buildings.

It also deepens some cuts, including taking another $300 million out of the state’s higher-education budget and $150 million from the state court system. In addition, it raises car-registration fees and subjects online retailers to the state sales tax, even if they are not based in California.

Mr. Brown has 12 days to sign or veto the plan. He has said he will continue to try to secure the four Republican votes he needs to pass his own plan.

Senator Robert Huff, the ranking Republican on the budget committee, said he thought Democrats were “taking a club to the head” of Republicans by trying to get them to negotiate again.

“There are some things in there that are really odious to Republicans,” Mr. Huff said of the Democrats’ budget. “They are trying to scare people with cuts to education and law enforcement. Calling it a place holder is the best way I could put it.”

Mr. Huff also said the budget could make it harder for Democrats to push for tax extensions.

“Ironically, what is happening is what we’ve been saying could happen for months: they could balance a budget without raising taxes or making an all-cuts budget,” Mr. Huff said.

Even if voters are given a chance to vote on the new taxes, their approval is hardly a given. Poll numbers have shown support from voters declining over the last several weeks as state revenue collections have improved, and a similar plan pushed in 2009 by Gov. Arnold Schwarzenegger, a Republican, failed.

If the courts blocked parts of the budget, the Legislature would have to step in again to make up the difference.

“This is the classic California get-out-of-town budget,” said Joe Mathews, a co-author of “California Crackup: How Reform Broke the Golden State and How We Can Fix It” (University of California Press, 2010). “It has all kinds of things that are phantoms, money that doesn’t exist or might not exist. But the problem here is that the only thing you can really get agreement on are fictions.”

Several lawmakers and observers said that while the budget relied on many “one-time” fixes that would do little to address future deficits, it was no worse than budgets that were approved in the last two decades.

“Even though the bond markets don’t like us, they will like us much less if we can’t have a balanced budget on time,” Mr. Mathews said. “In their defense, I don’t see a lot of ways you can make it a lot better right now.”

California lawmakers have passed a budget on time only once in the last two decades, in 2009, and within months of that, a $7 billion gap emerged.

Article source: http://feeds.nytimes.com/click.phdo?i=3c483570774fa1060edfdb7df62db8a5