S&P Blessing Cairn Left M&T Bank With a Crumbling Pile of Losses
In March 2007, Standard & Poor’s rated $773 million of the Cairn Mezzanine III collateralized debt obligation AAA. The deal crumbled after the rating company began cutting the rankings on bonds contained in the deal three months later.
The CDO, underwritten by Royal Bank of Scotland Group Plc and overseen by asset manager Cairn Capital Ltd., is one of dozens of transactions named in the U.S. Justice Department’s Feb. 4 lawsuit accusing the world’s largest credit-rating firm of deliberately misstating the risks of mortgage bonds as it sought to keep its share of the booming business of repackaging home loans for sale as securities.
M&T Bank (MTB), established in 1856 as Manufacturers and Traders Bank, lost $50 million investing in the most creditworthy portion of the Cairn CDO, according to the Justice Department’s complaint filed in federal court in Los Angeles. The Buffalo, New York-based lender was one of the financial institutions misled as S&P “devised, participated in, and executed a scheme to defraud investors,” according to the complaint.
The U.S. is seeking penalties against S&P and its New York- based parent, McGraw-Hill Cos., that may amount to more than $5 billion, based on losses suffered by federally insured firms.
M&T, with $83 billion in assets, had deposits of $65.6 billion as of Dec. 31, according to a regulatory filing. The Federal Deposit Insurance Co. oversees the fund that protects accounts of as much as $250,000 against bank failures.
In addition to the Cairn deal, M&T lost $80 million on a CDO called Gemstone VII issued in February 2007, according to the government’s lawsuit. M&T sued Deutsche Bank AG, the underwriter of the Gemstone deal, after the transaction defaulted in April 2008. The bank said last year it settled the case and received $55 million.
“On the one hand, it’s gratifying to see the government take action against one of the key enablers of the transactions that sparked the financial crisis,” Bob Wilmers, the chairman and chief executive of M&T, said in a Feb. 8 e-mail to Bloomberg View columnist Jonathan Weil. “Rather than sounding a timely alarm, the credit rating agencies were part of the problem, and we cannot allow organizations that got so many important things so wrong for so long to continue unchallenged.”
Wilmers was responding to a question about the banks that underwrote CDOs being listed among defrauded investors on deals they arranged.
Citigroup Inc. and Bank of America Corp. are included as defrauded investors in the government’s lawsuit.
“When you consider all the investors that ended up with worthless CDOs because they relied on AAA ratings, it’s hard for me to figure out why the Wall Street banks show up on this list so frequently,” Wilmers wrote. “I guess you have to be a lawyer to fully understand their case.”
Subprime-bond issuance peaked at $465 billion in 2005, rising from less than $54 billion in 2000, while bonds tied to so-called Alt-A loans granted to borrowers who often provided no documentation of their incomes, financed investment properties or accepted risky loan features, reached as high as $365 billion in 2006.
CDOs pool assets such as mortgage bonds and package them into new securities with varying risks in which revenue from the underlying bonds or loans are used to pay investors.
While CDOs backed by mortgage bonds haven’t returned, the U.S. market for collateralized loan obligations, which are CDOs composed of speculative-grade company loans, more than quadrupled to $55.4 billion in 2012.
Cairn Capital, a London-based asset manager overseeing $22.8 billion, this week sold the first European collateralized loan obligation since 2011, where issuance of the deals remains stunted. Sales of U.S. CLOs peaked at $91.1 billion in 2007 before credit markets froze in 2008.
The Cairn Mezzanine offering mentioned in the federal lawsuit was composed primarily of subprime securities issued during 2005 and 2006, when issuance of home-loan bonds without government backing surged to records, according to the complaint. About $1.2 trillion of the debt was sold each of those years, up from $136 billion in 2000, according to data compiled by newsletter Inside Mortgage Finance. Sales slumped to $707 billion in 2007, before freezing completely in 2008.
About 41 percent of the $1.78 billion Cairn CDO was composed of subprime home loans bonds rated BBB or lower, according to the Justice Department lawsuit. BBB is the lowest tier of investment grade on the rater’s scale.
On June 28, 2007, S&P “authorized immediate large-scale negative rating actions on non-prime RMBS,” according to the government complaint.
The transaction’s completion was contingent upon receiving top-rankings from S&P and Moody’s Investors Service (MCO), according to a prospectus dated March 28 2007. S&P said in a Feb. 4 statement that all of its CDOs cited by the Justice Department received the same ratings from a competitor.
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