Thursday, October 18, 2007

Superfunds, Reinsurance and the Big Unwind

My colleague, Joe Tanega, compared the new Superfund put together by Citigroup, JPMorgan and Bank of America as a reincarnation of the Lloyds reinsurance brouhaha some years ago that resulted in the formation of Equitas.

The job of Equitas is (it's just had its 10th anniversary) to reinsure the syndicates that were caught short and achieve a solven run-off. The independence of Equitas allows Lloyds to continue without these accumulated liabilities. The key to the success of Equitas was that it took over all liability.

The Superfund is clearly not buying all the distressed debt in the credit-squeezed market. It wants only the "good" assets to help avoid firesales in the market. According to Gillian Tett in the FT, "They have estimated that the scheme will need $75bn to $100bn of back-up liquidity lines, and will only buy high-quality assets."

While a super-conduit may help reinvigorate the market and restore some liquidity, it omits from the equation the low-grade assets slopping around in structured investment vehicles. It's these that have the capacity to wreak havoc if not dealt with.

SIVs are meant to be separate from their so-called parent institutions, ie. orphan entities off the balance sheet, but because of the credit squeeze, these supposed barriers are being breached as money is pumped in.

They are already causing trouble. Cheyne Finance (an offshoot of a hedge fund) is the first SIV to stop paying its short term debt. Even though it has $1.3bn of cash its administrator has managed to persuade the court that it is breach of insolvency tests. According to the administrator this will avoid a firesale. Would a Superfund buy its assets? Supposedly four banks are bidding for them.

There will at some point need to be a stronger concerted effort by the major financial institutions to deal with this problem. There will be more SIVs and SIV-lites heading towards insolvency. The Equitas solution might not provide the answer here, so what will, if anything?

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