Sunday, June 8, 2008

More CDO problems for AIG?

After writing off $20 billion on their swaps, it now looks like some of the CDO's that AIG aren't quite what they thought. In the WSJ:

"Next on Crunch's Hit Parade: Corporate Synthetic CDOs?

Banks and insurance companies, such as American International Group and French insurance giant Axa, snapped up highly rated pieces, which typically offered a better return than similarly rated corporate bonds. Hedge funds often bought the riskier pieces, attracted by even higher returns.

Now, though, the CDOs aren't looking as good as they once did. That is in part because the banks that created them, in order to achieve more attractive returns, often filled them with companies that had among the lowest of investment-grade ratings, meaning they were among the riskiest of high-quality borrowers...

To be sure, whatever troubles synthetic CDOs face in the months ahead probably won't be as bad as those seen with CDOs linked to mortgage debt, analysts and investors say. Most companies' finances remain relatively healthy. Also, corporate CDOs are simpler beasts with a longer track record, having survived a downturn early this decade.

To some extent, the current prices of synthetic CDOs already account for significant difficulties to come. One index that tracks the cost of default insurance, the Markit CDX index, suggests investors are expecting about one in 13 investment-grade companies to default over the next five years, according to Ashish Shah, global head of credit strategy at Lehman Brothers in New York. That is more than has been seen over a five-year period since the 1980s, he says.

Still, analysts see ample reason for concern. For one, many economists are expecting the current downturn in the U.S. to be worse than the relatively mild recessions of the past couple decades. Beyond that, says Brian Yelvington, a strategist at independent research firm CreditSights in New York, the original credit ratings on many deals were far too rosy. So even if defaults don't break records, many CDOs could still face downgrades."

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