When FT Alphaville’s Sam Jones recently attempted to get some more information from Legal & General on its £1bn CDO holdings, the insurer either wouldn’t or couldn’t answer his questions, which you can find here.
Goldman Sachs, however, has had a little bit more luck. It has learnt that instrument consists of 324 corporate debt securities, over 99 per cent of which are investment grade, and that L&G chose the securities that went into the CDO.
Furthermore, management has assured Goldman that an unnamed investment bank (we reckon Deutsche Bank) “dealt” with the lower tranches and therefore investors have nothing to worry about at all.
In fact, Goldman has upgraded its rating on L&G to “buy” and added the insurer to something called the “Conviction List” on Tuesday in part because fears over the CDO holding have been” overdone”.
CDO and ABS exposure sounds worse than it is Legal & General has £844 mn of super senior CDO tranches, which we understand to have caused some concern in the investor community. The instrument consists of 324 corporate debt securities, over 99% of which are investment grade (L&G chose the securities that went into the CDO). The subordination of the CDO is 40% and the term ten years, with 8.5 years still outstanding. Management has assured us that an investment bank dealt with the lower tranches and that they do not preside anywhere within L&G. Although holding a CDO reduces the visibility investors have on the underlying asset risk of the company, it is difficult to envisage 8.5 year cumulative losses on investment grade bonds in excess of 40%. To date, there has been no reason to impair this asset. The ABS portfolio is relatively diversified as shown in Exhibit 12.
Goldman has run also run an extreme stress test on the CDO, involving the following loss assumptions over the next five years:
• 4.5% impairment of IG corporate debt (-£916 mn);
• 100% impairment of HY corporate debt (-£183 mn);
• 100% impairment of Tier 1 bank hybrid debt (-£650 mn);
• 40% decline in equities (-£560 mn);
• 100% impairment in sub-prime ABS, 50% impairment of other ABS (-£658 mn).
And the conclusions are:
The 5-year cumulative pre-tax loss would be £2,967 mn, £2,136 mn post-tax. Such an extreme scenario could still be covered by the £650 mn special addition to the credit reserves (expected to cover 550bp of losses) and the existing IGD surplus of £1.8 bn. This is before considering any cash generated over the period or utilizing the levers available to L&G that could increase regulatory capital (eg financial reinsurance, private placement of hybrid debt).
Now that wasn’t too hard was it L&G? So what about revealing, for example, if there is a knock out trigger in any of these CDOs that may cause them to be unwound?
Related link:
L&G comes clean on CDOs – sort of – FT Alphaville