Commentaries

Is BlackRock going to rule the world?

It’s amazing how well the company has positioned itself to clean up the mess left behind by the financial crisis. It already has chummy ties with the government, including the Federal Reserve which tapped it to manage and eventually liquidate toxic assets the central bank took on from AIG. It’s also the risk and analytics manager in chief for the Fed’s MBS purchasing program.

The Wall Street Journal reports today that the National Association of Insurance Commissioners is also considering the giant money manager to sub for the rating agencies, which the insurance industry blames for getting insurers into such a pickle with structured finance investments.

BlackRock Inc., which scored multiple government assignments during the financial crisis, is a contender for another prestigious gig: helping state regulators size up risks in insurers’ investments.

The money manager and risk-advisory outfit is among a handful of firms that have talked with officials from the National Association of Insurance Commissioners lately about possibly taking on a slice of work now done by the major ratings firms, according to regulators and an official at the NAIC.

The article goes on to say that PIMCO could also be in the running.

The insurance lobbying outfit, the American Council of Life Insurances, is behind the plan to anoint a third party to run risk models on bonds back by mortgage bonds held by insurers. The thinking is that rating agencies aren’t properly measuring loss risk and the end result is insurers are being forced to tie up too much capital to comply with exisiting regulations.

First, I’m not sure it’s such a great idea for the insurers to set aside less capital rather than more given their exposure to residential and commercial mortgages. Second, is it a good idea to have big money managers also deciding how risky certain investments are for an industry that invests trillions in bonds?

Cat bondage

Catastrophe bond lovers and other insurance-linked securities enthusiasts should take a look at a report on insurance securitisation published today by the International Association of Insurance Supervisors (IAIS).

There is an interesting section in the report looking at the various cat bonds that have gone pear-shaped since the dawn of the market in the 1990s.

The first bond in which investors suffered losses was Georgetown Re, sold by Goldman in 1996.  The report explores four other deals that have come under stress since then due to losses from natural disasters or other insured risks.

All in all, the track record is pretty good for most of the 300-odd deals sold. Unfortunately, the dogs start to mount up after the financial crisis broke in 2007.

Most of the more recent deals that ran into trouble did so not because of the insured risks, but as a result of the way the deals were put together, and bankers’ occasional fondness for using them as dumping grounds for dodgy assets.

First there are the four cat bonds in which Lehman acted as a derivative counterparty and which were collateralised in some cases by asset-backed debt. Investors were left out of pocket when Lehman failed and the bonds’ had to rely on the toxic debt to pay interest and principal.

Then there is Ballantyne Re, sold by Bermudan insurer Scottish Re. This deal was supposed to provide the insurer with regulatory capital, but the collateral it held as cover for that insurance turned out to be subprime and other mortgage assets. That left Scottish Re short of insurance cover and hurt investors. A similar situation developed with Orkney Re II.

Killing two birds with a partial IPO

Banks and insurers are looking for ways to bolster their capital, while having the flexibility to strike if there are acquisitions to be had on the cheap. To achieve these twin goals, Spain’s Santander and now British insurer Aviva intend to float minority stakes in subsidiaries.

Aviva’s chief executive Andrew Moss, who cut the insurer’s dividend with its first-half result on Thursday, argued that it must be ready to take advantage of acquisition opportunities. Moss plans to float 25-30 percent of Delta Lloyd so that Aviva’s 92 percent owned Dutch insurance unit can take part in the restructuring of the Benelux insurance market.

This has echoes of Santander’s plan to float around 15 percent of Banco Santander Brasil. That move will not only allow the parent to bank as much as $4.5 billion from the sale, but will give the subsidiary an acquisition currency, allowing it to go out and buy more assets.

The logic of a minority IPO is fairly clear. It allows parent banks to raise capital by selling shares in more highly rated subsidiary companies, and also gives those subsidiaries a more highly rated acquisition currency. It sidesteps any objections parent company shareholders might have to capital raisings. And it is a way — at least in theory — to reveal the value of a “hidden gem”.

But there are plenty of pitfalls. Creating a listed subsidiary can spawn all sorts of other complexities. 

First, it limits the scope for any synergies between the subsidiary and the parent because of the need for a formal legal separation. Second, the subsidiary’s board needs to be accountable to the minorities as well as the parent. This raises governance issues, not least the question of arms-length transactions and ensuring that the offspring has an independent board. And there is the additional financial penalty of tax leakage if the parent’s stake falls below a certain threshold.

From the parent’s perspective, there is a risk that these drawbacks will lead to the market actually penalising the parent with a “conglomerate discount”. This somewhat defeats the valuation argument for listing a subsidiary.