The Irish Independent reports that the Government last night gave its 'bad bank' sweeping powers over developers and judges as it unleashed a €90bn plan to rescue banks and kickstart the economy.
But Finance Minister Brian Lenihan admitted it could take up to 30 years for the new National Asset Management Agency (NAMA) to sort out the toxic bank assets.
The State will effectively become one of the biggest property owners in the world as NAMA is granted extensive powers to take over land and development projects from borrowers who are not keeping up with their repayments.
Among the more controversial provisions in the proposed new legislation -- described by Fine Gael as a massive gamble -- is a radical series of rules and procedures to ward off legal attacks that could be disastrous for taxpayers.
But the plans, which include limited appeals to the Supreme Court and a clampdown on injunction proceedings, have alarmed lawyers. They claim that the proposals trample on judicial rights.
Under the new legislation:
- NAMA will take over up to €90bn in risky loans. As the current market value of these loans is far less, NAMA will pay well below this figure.
- The Government will take over 1,400 loans by the end of next June. The top 50 developers will be brought into NAMA before Christmas.
- NAMA will have the power to borrow up to €10bn to help complete projects it takes over -- but only if that development further enhances their value.
- Developers who are in default and whose property has been seized by NAMA will not be allowed to buy back their assets at a later stage.
- builders will not automatically lose their primary homes if they cannot repay their loans.
However, the proposed new legislation does not outline what the full cost of taking over the impaired loans will be.
It will not be possible to work out the full extent of the writedowns until all the €90bn loans have been transferred to NAMA.
The European Commission is expected to rubber-stamp the formula the Government hopes to use to value the loans ahead of the crucial Dail debate on the legislation in early September. Shortly after this, Mr Lenihan then hopes to be able to give an estimate of the discount that the banks will have to take on the loans.
Mr Lenihan unveiled the proposed legislation yesterday, and signalled that it could take 30 years for NAMA to sort out toxic bank assets.
Bulk
He said he expected the bulk of NAMA's work to be done in seven to 10 years, but admitted that some would go on a long time beyond this.
He claimed there was nothing in the proposed bill that would provide a "bail-out" for builders or developers. "Anyone who owes money before NAMA continues to owe it, and is expected to repay the full amount of that debt," he said.
However, the Government now faces a political dogfight to set up the agency as opposition parties highlighted the serious potential pitfalls facing NAMA.
Fine Gael deputy leader and finance spokesman Richard Bruton described NAMA as a "major gamble" that was effectively asking taxpayers to sign a blank cheque.
"The Government are saying 'trust me' on this. I think many people would feel that they don't deserve that." He said that the developers would be left in their "palatial homes", no matter what happened.
Labour's Ruairi Quinn said the Government was asking taxpayers to foot the bill and bear all the risk.
"Despite a figure of €90bn being bandied about, there is nothing in the bill to prevent it going even higher," he said.
The leader of the country's biggest union also declared his opposition to the new agency.
"The bill shows no evidence of new thinking, no willingness to learn from past mistakes and every intention of making ordinary people pay for the squandermania of the rich and powerful," SIPTU's Jack O'Connor said.
The Irish Independent also reports that Irish Nationwide, the embattled building society that has fallen foul of the collapse in the property market, is hoping bondholders will take hits on the face value of nearly €1.5bn of existing euro and sterling denominated debt that it wants to swap for new notes.
The move comes as the struggling lender, which has been hit hard by the property implosion, fights to prop up its balance sheet after it recorded massive losses and shouldered huge loan write-offs in the last financial year. In a statement yesterday, Irish Nationwide said that holders of its existing €900m of senior floating-rate notes due in 2012 can exchange them, almost at face value, for new euro-denominated government guaranteed floating rate notes that will mature next year.
Holders of £250m worth of existing senior notes carrying a rate of 6.25pc can opt to exchange them for new government-backed notes in sterling or euro. The new sterling notes will also mature in 2010, and will carry a reduced coupon of 3.625pc, while the euro tranche will also mature in 2010 and will pay a rate of 3.5pc.
A further £250m of existing lower tier 2 notes falling due in 2018 can be exchanged for new lower tier 2 notes that will mature in 2016. The new notes will be issued at par and pay a higher annual interest rate of 13pc.
"The rationale for the exchange offer is to create additional core tier 1 capital in the capital structure of the issuer [Irish Nationwide] to further strengthen the quality of its capital base," said the building society in a statement.
The debt holders have until next Wednesday to agree to the new offers, which are being arranged by Goldman Sachs and BNP Paribas.
Impairments
A stronger tier 1 capital base puts financial institutions in a position to be able to incur additional loan impairments and shoulder losses.
Irish Nationwide posted a pre-tax loss of €280m last year after it was forced to write off a staggering €464m of its loan book. Investment bank JP Morgan has previously estimated that Irish Nationwide will need to write off €1.3bn in loans over the next two years, which will represent a sizeable chunk of its total loan book.
The Irish Times reports that extensive powers to acquire development loans from banks at a significant discount have been given to National Asset Management Agency (Nama) under the terms of a draft Bill published yesterday.
Minister for Finance Brian Lenihan said the agency would not be paying “bubble property prices” to the banks for the loans and expressed confidence that in the long term the agency would be able to operate on a break-even basis.
However, the Opposition parties insisted that the Bill represented an enormous gamble for the Irish taxpayer that could have devastating consequences for years to come.
Speaking after the publication of the Bill, Mr Lenihan said it was necessary to address the health and stability of the Irish banking system, to get credit flowing and ensure that people’s savings were protected.
“There is nothing in the proposed Bill that will provide a ‘bail-out’ for borrowers, whether builders, developers or otherwise.
“Anyone who owes money before Nama continues to owe it, and is expected to repay the full amount of the debt,” he said.
Mr Lenihan emphasised that the agency would acquire development loans from the banks at a significant discount. The banks will be paid Government securities in return for the loans.
The Minister said he would be in a position to announce on September 16th, when the Bill comes before the Dáil, what the overall figure to be paid will be.
The price would depend on valuations carried out by experts in accordance with pre-defined valuation methodology, but he insisted it would not be based on the “bubble property prices” of recent times.
The Minister said the replacement of property-related loans with Government bonds would strengthen the balance sheets of the banks and that would increase their capacity to access liquidity in the financial markets.
The price Nama will pay will take account of the current market value of the collateral “adjusted to reflect a longer-term economic value which the underlying asset could reasonably be expected to attain”.
Detailed regulations on how the long-term economic value is to be calculated will be published in September.
Banks will be entitled to appeal the prices paid for loans by the agency to a valuation panel which will report to the Minister.
Mr Lenihan said that he was prepared to look at any constructive amendments to the draft Bill put forward by the Opposition during the Dáil debate in September.
Fine Gael deputy leader and finance spokesman Richard Bruton said the Bill involved asking the taxpayers for an enormous blank cheque.
“The central concern with Nama has been the worry that taxpayers will be asked to pay too much for these toxic loans,” said Mr Bruton who added that it provided a very elastic concept of “long-term value” for valuing the impaired bank loans and gave the Minister very substantial powers as to how this will be estimated.
“Perhaps the biggest gap of all is the remarkable silence of the Bill on how Nama will deal with the developers who created these enormous debts in the first place.”
Mr Bruton said there was a very real prospect that in a few years’ time, these same individuals would pop up again to buy the assets at an enormous discount, funded by the same banks whose liquidity problems were now being eased.
“This legislation represents an enormous gamble by the Fianna Fáil Government on bankers, developers and the future of the Irish property market,” he said.
Labour Party front bencher and former minister for finance Ruairí Quinn said that Fianna Fáil was proposing to establish the biggest property company in the world and asking taxpayers to foot the bill and bear all the risk.
Mr Quinn said his party would give the hugely complex Bill careful study and respond in a responsible way, but he added that Labour had never accepted that Nama on its own was the best way in which to deal with the crisis.
“We believe that temporary nationalisation of the institutions covered by the bank guarantee would be the quickest, most effective and least costly means of dealing with the appalling situation in which the country now finds itself.”
Sinn Féin finance spokesman Arthur Morgan accused the Government and the banks of perpetrating “the crime of the century”, saying they had burdened generations with unprecedented debt and crippled the public finances “for who knows how long”.
The Irish Times also says the Government has finally published the draft legislation for the National Asset Management Agency (Nama), but it is no clearer whether this “bad bank” plan aimed at unblocking the banks of their toxic assets and kick-starting new lending will work.
The main difficulty is that the key make-or- break detail still remains unknown – how much will the State pay for property-development and associated loans with a face value of €90 billion that are sitting on the books of the banks?
The draft legislation, which runs to 136 pages and 200 sections, outlines the biggest financial exposure assumed by the Government in the history of this State.
The scale of the task is gargantuan. Nama will hold more assets than any publicly quoted property company in the world, dwarfing giants such as GE Capital Real Estate and Morgan Stanley Real Estate, which own assets of $85 billion (€60 billion) and $70 billion (€48 billion) respectively.
The difficulty for taxpayers is that the Government is seeking approval to buy up to €90 billion in loans at an as-yet-undecided discount to be determined by as-yet-unknown valuation methods from now until June 2010.
On the cost of the scheme, all that is known so far is that the Government will pay “significantly” less than the loans’ book value.
The draft proposals primarily outline the mechanics of how Nama will operate. The toxic assets will be valued loan by loan through an assessment of when the loan was made and the percentage of the property’s value represented by the loan. Nama will then consider the asset’s current value based on the value of the property backing the loan.
Minister for Finance Brian Lenihan says some assets will be valued at their current market value or over this value, at “a long-term economic value”. This will be based on factors such as demographics, demand and supply, and future economic growth.
Lenihan says the value of some land backing loans will increase over time because there is no current market for certain property and these will be valued on the “long-term economic basis”.
This is essentially a hope value and follows EU guidelines on the valuation of toxic assets, giving the Government flexibility. It also avoids assigning a depressed, firesale price, which could lead to heavy capital injections into the banks to make up the shortfall caused by severe losses on loans.
Lenihan also says that other land will not move beyond current values due to “gross oversupply” in the market. The price paid for these loans will be valued accordingly. For example, loans on landbanks that have little or no prospect of development, even in the long term, will be priced at agricultural value.
In some cases, as a result of the dramatic collapse in the property market, these lands may have fallen in value by up to 90 per cent. However, that is not to say this will involve a 90 per cent writedown on the loan as a bank may have only originally provided a loan worth 60 per cent of the land’s value.
Lenihan says the banks provided on average loans worth 75 per cent of the value of the development land, so in many cases of development land, the borrower’s 25 per cent equity will be wiped out and the bank will also have to take a loss on its borrowing share.
The Minister has given a breakdown of the type of loans that the State will be buying. Some €30 billion of the €90 billion loans are backed by “pure land”. A further €30 billion relates to loans on work-in-progress projects, which could be everything from building sites where just the foundations have been laid, to developments that are almost complete.
The remaining €30 billion relates to loans provided on commercial investments such as office blocks and shopping centres that were provided as collateral to the banks for the development loans. More than half of all loans being acquired by Nama are performing, which means they are generating some interest payments; the remainder are bad.
The State will through Nama buy 10,000 loans in all across the banking sector.
All of the above figures relate to the face value of the loans on the books of the banks. Again, they don’t reflect the knock-down price that the State will pay for them.
Lenihan says each loan will be valued “separately and individually”.
The Minister will reveal on September 16th how much in Government-backed bonds will be issued to pay for the toxic bank loans – this will give an “indicative” estimate of the cost of the scheme. The thinking is that the Government could not seek the approval of formal legislation establishing a State enterprise of such a scale as Nama without revealing an estimate of the cost of the scheme.
At the same time, he will also publish the formula to determine how much Nama will pay for the loans. However, it will be June 2010, when all loans are moved to Nama, before the size of the discount will be known.
Once the “haircut” has been applied, Nama’s next challenge is to recover its money and make a profit over and above the purchase price paid. The difficulty for the taxpayer is that the State is taking all of the risk upfront on the Nama plan. The success of the plan depends on the lifespan of State agency and the working out and sale of bad property assets over a long period.
The draft legislation fails to outline the expected lifespan of the agency, though the proposals say that it will be reviewed after five years. Officials say it will take 10 years as values will not recover until life returns to the market. That seems some time away.
The first assets to be transferred to Nama will include the most toxic as they will relate to the top 50 biggest developers whose loans currently have an estimated book value of €30 billion. Such borrowers are the most exposed.
Clearly, if a long-term economic or “hope” value is being assigned to certain loans where properties are held by Nama, developed over time and then sold, it may take longer to make a profit on these assets.
In these circumstances, the State is likely to pay over the odds for some assets in the short term, leading to Nama incurring losses on the first assets it acquires, develops and sells in the agency’s early stages of operation.
Lenihan says if there is any shortfall at the end of the Nama’s life, then the Government will introduce a levy on the banks to make up the difference. However, he told reporters yesterday that he didn’t expect the State to lose any money on Nama.
The agency will also take on some of borrowings of its own. Nama will have powers to borrow up to €10 billion to complete developments in an effort to increase values.
Officials say the transfer of both good and bad assets to Nama will mean that the cost of the new government bonds used to buy the loans will be more than covered by interest payments on good loans. This will also cover the cost of running the agency.
Interest is currently being paid on more than 50 per cent of the loans being transferred to Nama, according to its interim managing director, Brendan McDonagh.
There is also a question mark over how much cash the banks will be able to draw from the European Central Bank by swapping the State bonds used to buy loans. It is not clear how much liquidity the bonds will inject into the system to generate funds for new lending.
One source close to the Nama plan says that determining whether the plan was a good or bad idea depends on a consideration at a particular point in time.
With the property market currently valuing assets at firesale prices, Nama now seems like a bad idea as the taxpayer is bearing all of the risk, he says, but as the market recovers over time, Nama may end up being a good idea.
This will be of little comfort to taxpayers on whose behalf the Government plans to assume a massive risk without yet being able to tell them either the cost of the gamble or how long they face such a risk.
It will be some time before one can say whether Nama will work. That is the difficulty with the option chosen by the Government to repair our broken-down banks.
The Irish Examiner reports that consumer markets remained very weak in quarter two of 2009 but pub sales fared better than most, a new report has found.
Despite a modest lift in consumer confidence from April to June, this has had little impact on sales.
The Consumer Market Monitor findings show consumer spending fell 14% from the final quarter of 2008 to the first three months of this year.
By comparison, personal savings have increased from 3% of disposable income in 2007 to 10% in 2009, reflecting a "precautionary response to the rapidly deteriorating prospects for employment and incomes," the monitor said.
Retail sales value, excluding the motor trade, decreased 43.9% for the year ending May 2009, while one of the hardest hit sectors has been the motor trade, down 42.5% for the year to the end of May.
Household equipment was down 27%, clothing and footwear 26.2%, department stores 17.6%, fuel 21.5% with newspapers and stationary falling 14.3%.
Bar sales held up better than expected with a fall of just 11.4% in volume and 9.8% in value according to the survey, jointly produced by UCD’s Michael Smurfit Graduate Business School and the Marketing Institute of Ireland.
According to the report, the sales decline was at record levels across all sectors. The figures were compounded by the collapse of the motor trade and the rise in cross-border shopping.
Personal sector credit declined for the fourth consecutive quarter in Q1 2009, with the pace of decline becoming more rapid.
Property lending accounted for 61% of all personal sector credit as the number of loans paid out for home purchases declined 39% in the first quarter of 2009 against the previous quarter.
When compared to the same period in the previous year, the fall was 52%.
The annual rate of increase in mortgage lending declined to 2.6% in May, the lowest level on record.
Credit card debt decreased slightly, by 0.8%, between April and May 2009, while payments on credit cards have exceeded indebtedness in every month of 2009 to date, resulting in a net reduction of €23 million in credit card debt.
As in past downturns, food has held up best with sales off 4.6% by volume and 6.5% in value, with some of that dip possibly due to price cuts, the report said.
The Financial Times reports that China has taken the unusual step of moving a $5bn refinery and petrochemical plant, one of the country’s biggest foreign investment projects, after a public outcry, a senior Communist party official said on Thursday.
The decision to relocate the plant is the highest-profile victory so far for China’s loosely organised but increasingly aggressive environmental and community activists.
Wang Yang, party secretary of Guangdong province and south China’s most powerful politician, attributed the decision to shift the joint venture project of Sinopec, the Chinese state owned refiner, and Kuwait Petroleum Corp, to “strong criticism from the community”.
“This reflects how Guangdong values environmental protection, the ecology and the opinions of our citizens,” said Mr Wang, who sits on the party’s 25-member Politburo, in a rare interview with foreign reporters. “It was a very difficult decision to make because [the project] has been approved by the state council and signed by the partners.
“We only have one planet to live on and whatever we do at this end affects people at the other end,” he said.
The plant was to be built in southern Guangzhou, the provincial capital, 60km upwind of Hong Kong, where the project has also come under criticism.
Last year, 14 delegates to the provincial people’s congress filed a motion opposing the refinery on the grounds that it could worsen regional air pollution. That opposition emboldened environmental officials, who also began to question the project’s suitability pending the completion of an environmental impact report.
Mr Wang declined to reveal where Sinopec and Kuwait Petroleum had agreed to move the plant to. Privately, provincial officials say it is most likely destined for the industrial port of Zhanjiang in western Guangdong, a much less populated and ecologically sensitive region.
The project was to have been sited in a new heavy industrial zone in the geographical centre of the Pearl river estuary, not far from a bird and wetland sanctuary. The site was marked out last year and villagers were relocated to new housing closer to the centre of Guangzhou.
The relocation is in keeping with a larger push by Mr Wang to engineer an industrial restructuring of the province, which accounts for about a third of China’s exports and which suffered a 20 per cent fall in foreign trade since the onset of the global financial crisis.
The FT also reports that Citigroup and Merrill Lynch,which lost $55bn in 2008, between them paid 1,400 employees bonuses of $1m or more each, according to a New York state report, released on Thursday, on banks propped up with taxpayer funds.
The study, compiled by Andrew Cuomo, New York attorney-general, showed that JPMorgan Chase and Goldman Sachs, which both finished in the black last year, paid the most million-dollar bonuses - 1,626 and 953, respectively.
However, the totals at a profitable bank such as Goldman were nearly matched by two of the year’s biggest losers on Wall Street. Citi, which suffered a $27.7bn loss, paid million-dollar bonuses to 738 employees. Merrill, which lost $27.6bn, paid 696 bonuses of $1m or more.
“There is no clear rhyme or reason to the way banks compensate and reward their employees,” Mr Cuomo said. “Compensation for bank employees has become unmoored from the banks’ financial performance.”
Republican Edolphus Towns, head of the House committee on government oversight and reform, pledged to hold hearings in September on the matter, suggesting the controversy over bankers’ bonuses is likely to continue later this year.
Earlier, Mr Cuomo had detailed the number of million-dollar bonus payments made at Merrill in the last days of 2008, before it was acquired by Bank of America. In his new report, sent to Mr Towns’ committee, Mr Cuomo detailed the number and size of bonuses at eight other banks that received billions from the federal troubled asset relief programme fund last October.
JPMorgan, which earned $5.6bn in 2008, set aside a total of $8.7bn for bonuses. The report shows that JPMorgan paid out bonuses in excess of $3m to more than 200 employees The bank received $25bn in Tarp funds last year and paid the money back last month.
At Goldman, the bonus pool last year was $4.8bn, more than twice the $2.3bn it earned for the year. Goldman paid $3m or more to 212 employees. The bank paid back $10bn in Tarp funds last month.
Citigroup set aside $5.3bn for its bonus pool, and paid bonuses of $3m or more to 124 employees. Like Bank of America, Citigroup received a total of $45bn in Tarp funds in 2008 and has recently converted some of that funding into common equity.
BofA paid bonuses of $3m to 28 employees and million-dollar bonuses to 172. The Charlotte, North Carolina, bank reported a profit of $4bn in 2008 and set aside $3.3bn for bonuses.
Morgan Stanleyearned $1.7bn last year and set aside $4.5bn for bonus payments. The firm paid bonuses of $3m to 101 employees and million-dollar bonuses to 428. Morgan Stanley received $10bn in Tarp funds last year, and paid back the money in June.
Among the other banks in Mr Cuomo’s report, Bank of New York Mellon paid 74 million-dolllar bonuses, Wells Fargo paid 62 and State Street paid 44.
The New York Times reports that new-car shoppers appear to have already snapped up all the $1 billion that Congress appropriated for the “cash for clunkers” program, leading the Transportation Department to tell auto dealers Thursday night to stop offering the rebates.
But a White House official said the program had not been suspended, creating confusion about its status. The program offers $3,500 to $4,500 for people who trade in an old car for a new one with higher fuel economy.
In a statement issued Thursday evening, Robert Gibbs, the White House press secretary, said: “We are working tonight to assess the situation facing what is obviously an incredibly popular program. Auto dealers and consumers should have confidence that all valid CARS transactions that have taken place to date will be honored.”
The program, formally known as the Car Allowance Rebate System, was scheduled to be offered until Nov. 1, or as long as the money was available. But the program was so successful that it has exhausted all the money allocated within the first week. Dealers have submitted applications on behalf of consumers seeking rebates on about a quarter-million vehicles.
The National Automobile Dealers Association surveyed its members in recent days and warned the Transportation Department on Thursday that it had a very large backlog of applications, said Bailey Wood, a spokesman for the association.
Late in the day, the group said the Transportation Department had responded by telling it to stop taking applications at midnight. The government and the dealers were concerned that buyers would close trade-in deals to buy new cars assuming they had a big rebate coming only to discover later that money was not available.
The dealers’ group said late Thursday night that it had not heard about the White House policy reversing the decision. Mr. Wood said that his group would ask Congress and the White House to add money to the plan.
Transportation Secretary Ray LaHood has already been making calls to members of Congress, telling them about the situation. The Michigan delegation was planning a meeting Friday morning to discuss the situation, a Congressional aide said.
On Thursday evening, the government Web site describing the program, http://www.cars.gov/, still showed a chart shaped like a fuel gauge that indicated $779 million was available for trade-ins of cars and light trucks. Earlier Thursday, the Transportation Department issued a news release that said that applications for fewer than 23,000 vehicles had been submitted as of Wednesday, with a rebate value of just under $100 million.
The Transportation Department had begun accepting applications for the rebates on Monday, when rules putting the program in place took effect. But car dealers had been accumulating the applications since July 1, when Congress put the law into effect.
The program had two goals: aiding the ailing car industry and improving fuel economy of the vehicles on the road.
Cars submitted under the program were to be junked. They had to be less than 25 years old and have a fuel economy, as rated by the window sticker, of 18 miles a gallon or less.
The size of the rebate depended on the fuel economy of the replacement vehicle. Consumers were also supposed to receive the scrap value of their trade-ins.
From the dealers’ point of view, the program was a resounding success.
“Two hundred and fifty thousand vehicles in four weeks?” Mr. Wood said. “One word comes out of my mouth: Wow.”
As word spread unofficially on Thursday night, car dealers were suddenly unsure of what to tell would-be buyers.
A Ford dealership in Paramus, N.J., did not know of the apparent suspension until a reporter called seeking comment.
Other dealers said they had no idea what the status of the program was, or whether the deals that they had already signed would be honored by the government. Some said they were notified by e-mail message by fellow dealers.
The dealers’ association, however, had been warning that the money would go quickly.
Under the program, a buyer who picked a car with a mileage improvement of more than four miles per gallon but less than 10 were eligible for $3,500; a buyer whose new vehicle was rated 10 miles per gallon or better than the old one was eligible for $4,500.
Until the cash-for-clunkers program began, the auto industry had been on track for annual sales of about 10 million units, down from the peak of about 16 million units a year.
The NYT also reports that next to a Chinese restaurant in Burlington, Vt., lurks a quiet guardian of Wall Street — an obscure insurance company that is supposed to protect big-money investors in the event of a catastrophic failure of a major brokerage firm.
A failure, for instance, like the one that brought down Lehman Brothers nearly 11 months ago. Now, after years in the shadows, the insurer, the Customer Asset Protection Company, could finally be put to the test, and questions are starting to swirl.
The worry is that the company, which has never paid out a claim, might be unable to cope with the Lehman bankruptcy.
If it were overwhelmed by claims, the banks and brokerage companies that own Capco, as it is known, could end up owing billions of dollars.
Capco representatives dismiss such concerns, but state insurance regulators are keeping an eye on the company. Officials at the New York State Insurance Department are concerned about the company’s ability to withstand the Lehman bankruptcy, the largest in history.
By some industry estimates reviewed by the insurance department, Capco could face nearly $11 billion in claims but has only about $150 million with which to meet them. The state is examining whether the company sold policies without the means to cover them, according to a person with direct knowledge of the inquiry who had signed confidentiality agreements.
The issue has even reached Washington, where a member of the Senate Finance Committee, Robert Menendez, has sounded an alarm. Mr. Menendez, Democrat of New Jersey, wrote the Treasury secretary, Timothy F. Geithner, in June to express his concern.
“It has become clear that this entity is thinly capitalized,” Mr. Menendez wrote in the letter. Capco, he said, potentially posed “systemic risk.” Capco was created in 2003 by Lehman and 13 other banks and brokerage companies as a kind of marketing tool. The pitch was that while Capco would not insure customers against investment losses, it would compensate them if the firms failed. Capco promises to provide virtually unlimited coverage above the $500,000 offered by the Securities Investors Protection Corporation and its equivalent in Britain.
Capco is virtually unknown even in financial circles, but it is being thrust into the spotlight by the events at Lehman. Creditors and former customers are battling over who will get what and when from the fallen bank, including more than $32 billion of assets that have been tied up in Lehman’s London prime brokerage unit. Untangling the mess could take years. Some former Lehman clients, which include big hedge funds, are looking to Capco for answers — and money.
Dewey & LeBoeuf, the law firm that represents Capco, said in a statement that Capco had no current policies outstanding and was “preserving all assets to address claims that might arise out of the insolvency of Lehman Brothers Inc. and Lehman Brothers International (Europe).”
The law firm called worries about Capco’s potential exposure to Lehman “speculation.”
Capco, which is private, is something of a financial mystery. Its members include Wall Street giants like Morgan Stanley and Goldman Sachs, banks like JPMorgan Chase and Wells Fargo, smaller brokerage firms like Robert W. Baird & Company and Edward Jones, and Fidelity, the mutual fund giant. Capco was initially registered in New York but later moved to Vermont, where state law enables it to operate without disclosing much about its finances.
Capco’s owners referred questions about the company’s liability to Dewey & LeBoeuf. Since it stopped writing policies on Feb. 16, most of Capco’s owners have purchased account protection for their clients through private insurance companies like Lloyd’s of London. Pershing, a unit of Bank of New York Mellon, told clients in a December notice that their Capco insurance would expire and that the firm had a new policy with Lloyd’s to “provide our customers and their investors with extra comfort that their assets are safe.”
It’s unclear who actually serves as the current president of Capco, and the company’s main phone number connects to a recording that tells callers they’ve reached a “nonworking number at Morgan Stanley.” A unit of Marsh & McLennan, the giant insurance services company, is listed as Capco’s administrator, but no contact information is listed on Capco’s Web site. The unit is based in the same Burlington building as Capco.
Brokerage companies used to buy account protection insurance from large insurance companies like Travelers and the American International Group. But in 2003, those insurance companies stopped offering such policies, saying it was impossible to calculate their liability. Enter Capco.
The Capco members played up their coverage when pitching their brokerage services to clients, especially large hedge fund customers who could lose billions of dollars if a firm went under. Although Capco’s finances were never disclosed publicly, the company was initially a given high rating by Standard & Poor’s.
That rating, however, was cut to junk status last December, and the ratings were withdrawn altogether in February. In its report, S.& P. said it was concerned about potential claims from customers of Lehman’s London unit, which “could create a liability for Capco that exceeds the insurer’s resources.” Charles Schwab, UBS and Merrill Lynch never opted for Capco, arguing that the arrangement seemed risky. Schwab requested the company’s financial statements from the insurance department through a Freedom of Information Act request in 2004, but was told the books were confidential.
The New York State Insurance Department later told Capco’s members that the company would eventually have to release the information. Before that happened, however, Capco relocated to Vermont, a haven for so-called captive insurance companies, whose owners are the ones buying the policies.
“Right away, the whole Capco thing just did not pass the smell test,” said Robert Meave, an outside consultant for Schwab at the time, who evaluated the insurance company. “Schwab was not about to go to their clients and tell them we’re providing account protection and, oh by the way, they were owners of the insurance company.”
Firms who sought coverage elsewhere, mainly through Lloyd’s of London, could buy only up to $150 million of insurance per account and a maximum of $600 million for the entire firm. As a result, some customers moved their money to firms that offered Capco coverage.
“Let’s face it, none of us could have foreseen an event like Lehman, but we didn’t feel the capitalization of Capco as it seemed to be forming was going to be adequate in the extremely unlikely event that something happened,” Mr. Meave said.
Owners of the assets tied up in Lehman’s London unit, including pension funds and university endowments, believe they may have claims against Capco if all of their money is not returned by Lehman’s liquidator.
If Capco can’t pay out the claims and files for bankruptcy, several customers said they would bring lawsuits against the other brokerage houses.
“The bottom line is, this insurance should have never been sold to clients, and it just shows how Wall Street again miscalculated the risks involved with one of their own going under,” said an adviser working on the Lehman bankruptcy who was not authorized to speak for the company.
