I read this article written by Sam Jones on the Financial Times website this afternoon, ft.com. I have avoided covering too much about the financial ups and downs of GB’s finest as it all tends to be very well covered everywhere else – but a major bank losing a quarter of its value in a single afternoon, that’s a story.
BARC down 24.85 per cent. RBS down 13.03 per cent.
– On an afternoon when the market is up, and the next nearest faller is Lloyds, down 5 per cent.
A flurry of rumours abound. Talk that Barc won’t be included in the putative UK government bad bank scheme; talk of monoline exposure; and talk of the impact from the downgrades on credit card companies to which Barc is exposed.
None of which, as rumours, seem to have the mettle to force Barc to lose a quarter of its value on a Friday afternoon – by our judgment at least.
Mayfair’s finest must certainly be enjoying this. It certainly seems like there’s been a raid on the day the short selling ban on UK financials expired. (Though on the other hand, Barc’s performance has been dismal all week.)
But we would draw readers’ attention to one other set of facts – presumably not the proximate cause of this afternoon’s panic, but certainly worth bearing in mind.
Last week, Sir Nigel Rudd resigned as deputy chairman of Barclays amid rumours of a spat with chairman John Varley over the valuation of certain assets on the bank’s balance sheet (a notion which has been dismissed by friends of both Rudd himself and Barclays).
Barclays is an industry leader in synthetics – corporate CDOs, structured credit products, et cetera. Before Christmas, there were a number of warnings circulating about the potential for disaster in this market – on almost the same scale as that seen in ABS CDOs.
Yesterday, rating agency Moody’s issued this notice (emphasis ours):
New York, January 15, 2009 — Moody’s Investors Service announced today that it has revised and updated certain key assumptions that it uses to rate and monitor corporate synthetic CDOs, a type of collateralized debt obligation backed by a pool of credit default swaps referencing corporate credits.
Moody’s is revising its assumptions to reflect the expected stress of the global recession and tightened credit conditions on corporate default rates, which are likely to be more variable and extreme than those in other recent historical downturns. Specifically, the changes announced today include: (1) a 30% increase in the assumed likelihood of default for all corporate credits in synthetic CDOs, and (2) an increase in the degree to which ratings are adjusted according to other credit indicators such as rating Reviews and Outlooks. Moody’s also announced an increase in the default correlation it applies to corporate portfolios as generated through a combination of higher default rates and an increase in investment grade and financial sector asset correlations.
Based on initial assessment, Moody’s expects to lower the ratings of a large majority of corporate synthetic CDO tranches by three to seven notches on average. The actual magnitude of the downgrades will depend on transaction specific characteristics such as tranche subordination, vintage and portfolio composition.
Those kind of cuts could have disastrous implications for banks’ asset risk weightings under the Basel II regime. Although many banks use their own internal methods to calculate risk weightings, rather than relying on an external rating-based approach, it will be very hard for banks to justify to auditors the use of models that are out of line with the kind of assumptions the rating agencies are now adopting.
Conclusion: any bank with large holdings of synthetic CDOs may be forced to make large writedowns and more seriously, stump up huge extra amounts of regulatory capital.
And which UK banks are big with synthetics? Barc and RBS, by our memory. More info to follow.