HEARD ON THE STREET
AUGUST 22, 2009
Bankers Play Dress Up With Old Deals
By LIZ RAPPAPORT
Irresponsible securitization helped bring the financial system to its knees. Yet, as banks start to heal, little seems to have changed. Wall Street has quickly fallen back on old habits.
Banks are building investment products to fit ratings firms' triple-A standards, in the process taking advantage of capital rules still tied to ratings.
Several banks have resecuritized chunks of triple-A rated commercial-mortgage-backed securities -- effectively making mini-CDOs out of parts of deals already in the marketplace. The result: A strengthened triple-A tranche and a more speculative triple-A security with less call on cash flows. That means the stronger portion is likely to retain its top-notch rating even in the face of downgrades and won't require extra capital put against it. The weaker tranche can be sold to a more speculative investor.
Banks are building investment products to fit ratings firms' triple-A standards, in the process taking advantage of capital rules still tied to ratings.
Several banks have resecuritized chunks of triple-A rated commercial-mortgage-backed securities -- effectively making mini-CDOs out of parts of deals already in the marketplace. The result: A strengthened triple-A tranche and a more speculative triple-A security with less call on cash flows. That means the stronger portion is likely to retain its top-notch rating even in the face of downgrades and won't require extra capital put against it. The weaker tranche can be sold to a more speculative investor.
But, regulators are watching, aware Wall Street is operating in a gray area -- before new, more onerous capital requirements for banks on resecuritizations are scheduled to come in. These would require banks hold more capital against repackaged securitized products. But they don't take effect for at least 18 months. And they don't yet include more straightforward structured products like those that have seen significant downgrades in this cycle.
Wall Street's latest alchemy raises the question of whether resecuritizations are a mirage based on gaming the ratings process. It also should focus a spotlight on the capital that banks need to hold against structured products on their balance sheets.
For example, the credit crisis has thrown up one seeming anomaly: Triple-A rated structured securities carry much lower risk weightings than similarly-rated corporate bonds. That means banks have to hold less capital against them. But thousands of triple-A tranches of securities backed by residential mortgages have been downgraded in the past two years and the volatility can be gut-wrenching.
Standard & Poor's recently downgraded several commercial-mortgage-backed securities to nearly "junk" from triple-A. About a week later S&P restored some to triple-A after "updating its criteria" for estimating losses.
The theory is that a bond backed by many diverse loans is less risky than a single corporate bond. What has emerged instead is that structured products are a type of straitjacket that has little flexibility in an economic dislocation. The rules for restructuring individual mortgages in a pool are strict. The highest-rated corporate bonds, in contrast, are issued by companies that have the flexibility to sell assets, cut costs or raise equity to make sure they can continue to pay debts.
Regulators should worry less about being too harsh on banks and accelerate proposed changes to strengthen rating methodologies and capital requirements. These should take account of the inherent rigidity of all structured products, not just resecuritizations, and the risk that poses to investors.
Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved
Wall Street's latest alchemy raises the question of whether resecuritizations are a mirage based on gaming the ratings process. It also should focus a spotlight on the capital that banks need to hold against structured products on their balance sheets.
For example, the credit crisis has thrown up one seeming anomaly: Triple-A rated structured securities carry much lower risk weightings than similarly-rated corporate bonds. That means banks have to hold less capital against them. But thousands of triple-A tranches of securities backed by residential mortgages have been downgraded in the past two years and the volatility can be gut-wrenching.
Standard & Poor's recently downgraded several commercial-mortgage-backed securities to nearly "junk" from triple-A. About a week later S&P restored some to triple-A after "updating its criteria" for estimating losses.
The theory is that a bond backed by many diverse loans is less risky than a single corporate bond. What has emerged instead is that structured products are a type of straitjacket that has little flexibility in an economic dislocation. The rules for restructuring individual mortgages in a pool are strict. The highest-rated corporate bonds, in contrast, are issued by companies that have the flexibility to sell assets, cut costs or raise equity to make sure they can continue to pay debts.
Regulators should worry less about being too harsh on banks and accelerate proposed changes to strengthen rating methodologies and capital requirements. These should take account of the inherent rigidity of all structured products, not just resecuritizations, and the risk that poses to investors.
Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved
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