risky assets

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

Stock market indexes in the United States and Europe dropped more than 4 percent as Japan intervened to weaken its currency and the European Central Bank began buying bonds to try to calm markets.

At the close, the Standard Poor’s 500-stock index was down 60.27 points, or 4.78 percent, to 1,200.07. The Dow Jones industrial average was off 512.76 points, or 4.31 percent, to 11,383.68, and the Nasdaq was down 136.68, or 5.08 percent, to 2,556.39.

It was the biggest percentage drop since February 2009.

Following accelerating falls over the last two weeks, the stock market is now officially in “correction” territory, defined as a drop of 10 percent to 20 percent since the latest peak.

The S.P. 500 has fallen 12 percent since its recent high of 1,363.61 on April 29, underlining the new negative investment sentiment about the economy and Europe.

“We are now in correction mode,” said Sam Stovall, chief investment strategist at Standard Poor’s. “We could have another couple of weeks to go before it bottoms.”

The last time the market was in a correction was last summer, when it fell 16 percent before recovering.

A fear haunting markets is that the United States economy may be heading for a double-dip recession. And even after a second major rescue package for Greece and the agreement to raise the debt ceiling in the United States, investors are concerned that world leaders have not done enough to address fragile underlying economic growth, while Europe’s debt problems have moved on to the much bigger economies of Italy and Spain.

Mohamed El-Erian, chief executive of the bond giant Pimco, said investors were selling risky assets like stocks “globally prompted by concerns about the weakening economic outlook, spreading contagion in Europe and insufficient policy responses.”

With Thursday’s dive, the three major American indexes had erased all of the gains made so far in 2011, with the S.P. and Nasdaq markedly below the start of the year.

The Dow, an index of 30 blue-chip stocks, was about 11.1 percent off of its most recent closing high of 12,810.54, reached on April 29. But it was 19.6 percent below its all-time high of 14,164.53, on Oct. 9, 2007.

Since the beginning of 2008, there have been 17 days with drops of 4 percent or more — 13 in 2008 and 4 in 2009.

Unnerved by policy makers’ apparent inability to get ahead of Europe’s festering debt crisis, European stock markets turned sharply negative across the board.

In Britain, stocks closed down 3.43 percent. In Germany, the DAX index dropped 3.4 percent. In France, the CAC 40 closed down 3.9 percent.

“This is the worst it has been in Europe,” said Jens Nordvig, currency economist at Nomura Securities in New York. “The current rescue package was not enough to cope with the size of the problems posed by Italy and Spain. We need a new framework that can cope with those two countries, and without it markets are on their own and are falling.”

Major indexes in Italy, Spain, France and Switzerland all closed Thursday more than 20 percent below their 2011 highs, while Germany was off nearly 15 percent and Britain’s decline was more than 11 percent.

The selling has extended to many other markets. Mexican stocks are off almost 14 percent from their highs earlier this year, and Brazil’s major index has lost more than a quarter of its value.

Yields on Italian government bonds, already above 6 percent, rose sharply, adding to concerns that the nation’s current debt position is unsustainable. Yields on Spanish debt also increased. This was despite large-scale intervention by the European Central Bank, which for the first time since March began buying bonds in an apparent attempt to prevent the region’s sovereign debt crisis from engulfing Italy.

The markets had expected some concrete action from Prime Minister Silvio Berlusconi on Italian’s worsening debt situation in public remarks late Wednesday. But they were disappointed when he defended the country’s fundamentals and said current packages were enough to foster economic growth. The Italian stock market opened up but then slipped sharply.

Since many of Europe’s banks hold the bonds of countries like Italy and Spain, concern is turning to the health of the banking system as these bonds drop in value. With warning signs flashing that some European banks are struggling to fund themselves in increasingly expensive credit markets, the E.C.B. also moved to help weaker banks by expanding its lending to institutions in the euro area at the benchmark interest rate. Bank stocks nevertheless fell sharply in Europe.

Jean-Claude Trichet, the president of the E.C.B., said the bank had acted in response to “renewed tensions in some financial markets in the euro area.”

He said that uncertainty created by the debate in the United States to raise the debt ceiling had unnerved European markets as United States investors had become increasingly reluctant to lend to European banks. “It’s clear the entire world is intertwined,” he said. “What happens in the U.S. influences the rest of the world.”

But the E.C.B.’s steps were not enough to help Europe’s bond markets.

Laurent Bilke, an analyst at Nomura in London, said the E.C.B. had been buying government debt of Portugal and Ireland in order to calm these markets. But it had not been buying Italian and Spanish government debt, and that had unnerved investors.

He said the E.C.B. council had also not been united in its decision to take extraordinary measures to intervene in the markets, and that fact had spooked markets.

Article source: http://www.nytimes.com/2011/08/05/business/markets.html?partner=rss&emc=rss

DealBook: Seeking Relief, Banks Shift Risk to Murkier Corners

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