More M2M

Today's WSJ has another article about M2M that is confusing, to say the least.  The journal says that FASB is considering widening M2M to include loans.  Per the journal, "FASB taking a more holistic view of accounting for loans, bonds, derivatives and stocks."

Meanwhile, the blog WebCPA noted:

FASB decided to loosen rules that kept banks from accounting for the cash flows they expected from mortgage-backed securities and other assets during impairment tests when they are categorized as available for sale, rather than just as held to maturity.

Note the major disconnect -- The Journal is implying that held to maturity loans might be marked to market. Meanwhile, the FASB is actually modifying rules related to assets held for sale. Huge difference.

The only modification I would propose is to revise the way that credit derivatives indices are used to value structured investments like CDO's. Plus a complete review of the use of credit derivatives as market proxies.  As far as the Journal's views regarding "fair value" -- it is safe to say that the world is converging on standards, and US GAAP can't let the IASB be the only body working on this issue.

AiG Issues Press Release -- No Headlines

AIG did a pretty good job of explaining the situation, but it already seems like a year ago, and there are more exciting items to blog. Now it is how AIG get zillions while the UAW gets shafted. A quickie to try to explain the AIG Bailout.  This is from an AIG slide as part of the Nov 20 presentation on the revised "deal."  

What is really going on is that AIG had already taken writedowns in the $30 billion range on these CDS's. They had also posted collateral in the $30's. The way it was designed to work is that the $70 billion in blue is the nominal amount (par) of the CDS's.  About 1/2 of that had already been booked as losses.  A similar amount had already been posted as collateral.  The problem is that every quarter, there was a lot of hand wringing about how much more should be written down to "market" that, of course, wasn't functioning.  A theoretical solution would be to write them down to zero, but AIG doesn't $30-$40 billion to take an immediate hit.  So each quarter, another 5%, 10%, or 15% would be written down.  AIG might have wanted to just settle up or buy their way out of this exposure, but there was no one with the capital, regardless of value.  AIG insisted things weren't that bad, but had and have little credibility on this issue.

The  credit facility I keep referring to as a SIV is known by the name Maiden Lane III.  Per the National Underwriter:

Maiden Lane III L.L.C., New York, a Delaware limited liability company controlled by the Federal Reserve Bank of New York, has started to buy “multi-sector collateralized debt obligations” that AIG’s AIG Financial Products Corp unit guaranteed with CDS arrangements back when the economy was stronger, according to AIG, New York.
The New York Fed and AIG announced the creation of the $35 billion Maiden Lane III CDS program shutdown entity in November, in connection with New York Fed efforts to replace a 2-year, $85 billion New York Fed credit facility.

Here is a table of the multi sector CDO's from the 3Q 10K:
Since there is no way you can read it as is, you can click on it to view it in full size. This lays out the numbers in a much more understandable way. However, column 3 shows the Net Notional Amount of $71,644,000,000. Column 4 is the "fair value" of the derivative of $30,207,000,000 as of September, 2008 financial statements. That means that AIG had already booked losses of $30.207 billion as of September -- that is, written that portion off.

Per AIG:

Included within that $71.6 billion portfolio (notional amount as of September 30) is approximately $9.8 billion of swaps that were sold as credit protection on "synthetic" securities. The swaps on these synthetic securities are also referred to as "cash settlement" or "Pay As You Go" (PAUG) swaps because they are settled in cash as and when losses are taken.

Here is what AIG says about it in September:

"Cash Settlement. Transactions requiring cash settlement (also known as “pay as you go”) are in respect of protected baskets of reference credits (which may also include single name CDSs in addition to securities and loans) rather than a single reference obligation as in the case of the physically-settled transactions described above. Under these credit default swaps:

• Each time a “triggering event” occurs a “loss amount” is calculated. A triggering event is generally a failure by the relevant obligor to pay principal of or, in some cases, interest on one of the reference credits in the underlying protected basket. Triggering events may also include bankruptcy of reference credits, write-downs or postponements with respect to interest or to the principal amount of a reference credit payable at maturity. The determination of the loss amount is specific to each triggering event. It can represent the amount of a shortfall in ordinary course interest payments on the reference credit, a write-down in the interest on or principal of such reference credit or any amount postponed in respect thereof. It can also represent the difference between the notional or par amount of such reference credit and its market value, as determined by reference to market quotations.

• Triggering events can occur multiple times, either as a result of continuing shortfalls in interest or write-downs or postponements on a single reference credit, or as a result of triggering events in respect of different reference credits included in a protected basket. In connection with each triggering event, AIGFP is required to make a cash payment to the buyer of protection under the related CDS only if the aggregate loss amounts calculated in respect of such triggering event and all prior triggering events exceed a specified threshold amount (reflecting AIGFP’s attachment point). In addition, AIGFP is typically entitled to receive amounts recovered, or deemed recovered, in respect of loss amounts resulting from triggering events caused by interest shortfalls, postponements or write-downs on reference credits."

They disclosed it.  However, I will say that I didn't see the $9.8 billion of PAUG CDS's specifically addressed.  This is inherently confusing because AIG has chosen to isolate $71.6 billion net notional CDS's on multi sector CDO's as the problem.  There are other CDS's that weren't considered a problem, and it wasn't always clear to me which set of CDS's were being referred to in this section of the 10-K.  However, the diagram below, from the 10-K, lays out how the credit facility or SIV works.  The AIG-FP obligation is for the "Super Senior" tranche - the box on the right.  For Multi Sector CDO's, thats the layer that AIG wrote the CDS on.  There is $38 billion in subordination -- relating to the dark section on the bottom that is someone else's problem.    

For the CDS's on the Super Senior, Multi Sector CDO's, the "Gross Notional" is $108.5 billion.  The result of the credit facility is that when it is completed, AIG will have no net exposure.  They will have written off the entire amount, sold the remaining assets to the credit facility.  Here is my diagram (typo: change the $25 to $30):

The take away from this. First, that Super Senior meant about 1/3 subordination. Secondly, AIG has been writing this stuff off for 4 quarters, and a big chunk of it is gone. Thirdly, the NYFRB has about 75% subordination from the original CDO's, which doesn't sound that bad. Sounds like they have a decent chance to fully recover their money. After all, some people pay off their mortgages, and if not, some of the assets are recoverable. Settling a PAUG CDS on a synthetic CDO may be difficult, but someone needs to drive a good bargain and with the FRBNY, I don't see why it couldn't happen Fifth, this stuff is too complex for normal people. Given the low level of confidence and trust -- people are going to assume the worst. However, one would hope that the WSJ would put a little more effort into it.

AIG Reporting in the WSJ - Atrocious

I never set out to defend AIG, but this WSJ story is hopelessly confusing.  It sounds like what they are trying to say is that there are an additional $10 billion in losses, based unidentified sources, that have not yet been disclosed.

Fine, I suppose.  However, then they repeat parts of last month's SIV/bailout.  This is not news in any respect, but gets announced as if it hasn't already been reported, booked in AIG financials, etc.  The multi sector CDO's that AIG guaranteed via CDS's are being settled in such a way there is no material uncertainty.  Just like they announced.  As I described in an earlier post regarding the AIG bailout, they are just settling up $65-70 billion in CDS's.  Per the Journal:

As of Nov. 25, Maiden Lane III had acquired CDOs with an original value of $46.1 billion from AIG's counterparties and had entered into agreements to purchase $7.4 billion more. It is still in talks over $11.2 billion.

So the SIV is buying $60.3 billion in multi sector CDO's. That's less then $70 billion. The SIV is using a $5 billion investment from AIG, Up to $30 billion in FRBNY loan, and the rest is being written off by AIG. They had already written off most of this, so the new bad news in November was relatively modest.

The problem is that the WSJ staff writers don't seem to understand anything about accounting.  The "news" last month was that AIG was going to honor its CDS promises.  Once that fact sunk in (if it ever did), the exact mechanism is irrelevant.  That is, the counter parties were made whole.  If you bought a CDS from AIG on a $10 million multi sector cdo, then you get the $10 million and AIG got the cdo, which it then sold to the SIV at a discount.  It doesn't matter if you send the collateral back, mail in the cdo, and then get your $10 million.  Or if you keep $5 million in collateral, mail in the cdo, and the remaining $5 million.  You had an insurance contract for $10 million, and you got your $10 million.  However, the WSJ writers seem to get caught up regarding when the collateral was posted as if that was news.

The only new news is that there may be additional losses.  AIG said:

...that exposure has been fully disclosed and amounts to less than $10 billion of AIG's $71.6 billion exposure to derivative contracts on debt pools known as collateralized debt obligations as of Sept. 30

The WSJ writers are also hung up on whether a CDS is a speculative bet or a credit protection instrument. It is obviously both. How many times does AIG need a beat down in print over the same dumb mistake?

There is also some confusion about what I think might be CDS swaps where the purchaser didn't own the underlying.  It is impossible to figure out what the journal writers are getting at, but they want it to sound dramatic. 

There may or may not be additional AIG losses that haven't been disclosed.  However it would not be surprising if AIG's trillion in assets have taken a few hits since the 3Q financials.  A coherent discussion by the Journal might have shed some light on it.  But breathlessly rehashing last month's news adds nothing.

 

The WSJ Does Some Reporting

After yesterday's critical article, it looks like the Wall Street Journal decided to actually hunt for some primary sources that know more then the fact that an industry analyst is supposed to have an opinion -- even if they haven't bothered to read the SEC Documents.

Here is probably a little more then "fair use" of a damn good WSJ piece.

PARIS (Dow Jones)--Electricite de France SA (1024251.FR) is confident that 20 of Constellation Energy Group Inc.'s (CEG) biggest investors share its view that the bid by Warren Buffett's MidAmerican Energy Holdings Co. for Constellation grossly undervalues the U.S. utility, a person close to the French company said Friday.

EDF is offering $4.5 billion for a 50% share of Constellation's nuclear assets whereas MidAmerican is offering $4.7 billion for the whole company. EDF has a 9.5% stake in Constellation, with which it has a joint venture to build nuclear plants in the U.S.

The person, speaking on condition of anonymity, said EDF and the investors that share its view hold around 50% of Constellation's equity. EDF's 9.5% stake cost the French state-controlled utility around $1 billion, the person said.

EDF and its bankers have had no contact with MidAmerican in recent weeks, the person also said. EDF expects the Constellation board to assess EDF's binding offer, which it says values the company at $52 a share, "objectively." The board has already accepted MidAmerican's offer of $26.50 a share when it was on the brink of collapse because of a liquidity crisis.

The person said EDF's offer is good value as it stands, based on conservative market benchmarks. That's before taking into account other factors such as extending the life of Constellation's relatively modern and efficient nuclear reactors, as well as the new nuclear plants it hopes to build, he said.

The person said that when MidAmerican made its bid in mid-September, EDF and its private-equity partners at the time weren't immediately able to come up with a competing, binding offer.

Regarding EDF's agreed GBP12.5 billion takeover of British Energy PLC (BGY.LN), the person said EDF is close to refinancing half of the GBP11 billion syndicated loan it has secured for the bid. EDF will launch a EUR2 billion bond, a CHF1 billion bond and a GBP400 million bond in December.

The refinancing will lower the cost of the British Energy transaction and relieve pressure on some of the banks in the syndicate.

-By Paris Bureau: Telephone: 33 1 4017 1740