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Credit protection costs rise on Spitzer worries
http://news.ft.com/cms/s/386d1e2e-2392-11d9-aee5-00000e2511c8.html
Credit protection costs rise on Spitzer worries
By Jenny Wiggins in New York
Published: October 21 2004 20:16 | Last updated: October 21 2004 20:16
The cost of credit protection on US and European insurance companies is soaring as investors start to worry about the financial ramifications of Eliot Spitzer's probe into industry abuses.
Credit default swaps on insurance companies have widened as much as 30 basis points on some companies over the week, amid concerns that an investigation into the industry initiated by the New York attorney-general could damage the creditworthiness of companies and change the way they do business.
“It's clear that the insurance business is not the same as it was two weeks ago,” one derivatives trader said. Credit ratings agencies have not taken action on the ratings of any insurers but have warned they may do so if companies suffer from litigation costs and reputational damage.
If insurers are hit by ratings downgrades, their cost of funding in the capital markets will increase. In addition, some companies may have to come up with additional cash for collateral payments on credit derivative transactions.
Insurers' high credit ratings make them attractive counterparties in credit default swap transactions. Insurers are the biggest sellers of credit protection after banks, with some $213bn (€169bn) in net notional exposure at the end of 2003, according to Fitch Ratings.
AIG's top-notch “AAA” ratings make it a particularly attractive counterparty, ranking number 17 in a Fitch listing of the top 25 counterparties in 2003 behind market leaders JPMorgan, Deutsche Bank and Goldman Sachs.
Some derivative contracts call for companies that suffer ratings downgrades to post collateral to their counterparties.
“A lot of derivatives contracts have ratings triggers built in,” said Keith Buckley, managing director at Fitch Ratings. Industry participants say that insurance companies should be prepared to cope with increased demands for collateral if such demands should arise.
“While regulators, such as the UK FSA, have noted the participation of insurance companies in selling credit protection as an area to monitor, they have concluded that there is no undue cause for alarm,” said Bob Pickel, chief executive of the International Swaps and Derivatives Association.
However, some investors are more sceptical. Warren Buffett, the billionaire investor, closed down derivatives dealer Gen Re Securities after buying Gen Re, judging it to be “dangerous”.
A company trying to meet demand for cash collateral after being downgraded can be thrown into a “liquidity crisis”, Mr Buffett warned investors in Berkshire Hathaway's 2002 annual report.
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