Last week's public rebuttal from AIG regarding the infamous Hollywood Funding deals (see ASR 3/19/01, p.1) put Credit Suisse First Boston directly in the line of fire as the sole structurer and underwriter on the troubled transactions; but the thicket of facts surrounding the controversy has gotten even more dense.
Observers have pointed out that CSFB was not only placement agent, but also a significant stakeholder in Quadrant Capital's structured investment vehicle (SIV), Asset Backed Capital (ABC), which was the largest investor in the Hollywood Funding deals. In fact, along with BGB Bank, CSFB is one of the largest equity holders of Quadrant's SIV. This means that all large purchases for the SIV are thoroughly reviewed by the bank, and CSFB, as an "equity enhancer," has significant vetoing power over the bonds placed into the vehicle, a source noted.
Except this time around, the bonds were structured and underwritten by CSFB itself - albeit another arm of the company - and placed into Quadrant's arbitrage vehicle with the hopes of garnering juicy yields.
But instead of juicy arbitrage, the SIV had to be delevered as a result of AIG-Lexington's decision to investigate rather than pay out on Hollywood Funding No. 5 (HF5). Approximately $2.1 billion of assets were sold, freeing up $100 million in capital for the SIV.
So, if, as AIG stated last week, "CSFB should be asked to address the standard of care and scope of liability that it undertook in organizing these transactions," how did the bank's role as equity investor affect its decision to include the Hollywood funding deals in ABC, and was there an oversight in the due diligence process, as AIG implies?
Moreover, is CSFB's seemingly dual role significant, merely a footnote, or just an amusing irony in this ongoing saga?
"The bottom line here is that CSFB owns a chunk of Asset Backed Capital, and some part of CSFB will suffer a loss," said a source close to the controversy. "If there is some shakeout at CSFB over this, that will make some sense. But clearly AIG would have a tough time arguing that CSFB was somehow devious in this."
"CSFB wears two different hats, one as the equity investor in ABC, which has no bearing whatsoever on the Hollywood bonds," noted Timothy Lyons, chief executive officer of Quadrant Capital in London. "While CSFB can tell us not to buy something, they cannot tell us what to buy. So the fact that CSFB sat on the other side of the transaction has no real bearing on this at all, and no bearing on how we seek to recover our investment."
CSFB did not return repeated calls asking for comment on this particular topic. On the more general topic of last week's AIG press release, a company spokeswoman said, "CSFB relied on expert legal counsel and is completely confident.
Typically, when SIVs buy securities they make roughly 40 basis points off their whole portfolio. Their purchases of securities are funded through ABCP, which are purchased by money funds. However, the vehicles need a first-loss buffer - a credit enhancement - and hard money is required. This is where the equity investor steps in. The equity enhancer takes on the added risk, but gets profit participation - perhaps Libor +250, for instance.
Of course, the unit of CSFB that is equity investor is a completely different part of the company than the team that does the underwriting, and it is fully possible that the two units never communicated. In fact, one investor confirmed that it is not unheard of that a buyside unit and underwriting unit hardly interact.
However, Lyons did confirm that there were preliminary talks between CSFB and Quadrant prior to S&P's downgrading of the bonds to discuss possible remedies for Quadrant's situation. After all, the company did have many troubled bonds on its hands. "But it didn't lead to anything," Lyons said.
Do investors care?
Lyons contends that AIG's statement - bolstered by last Monday's decision from the English Court of Appeal that affirmed an insurer's right to void an insurance policy in a related case - has no bearing whatsoever on Lexington's obligations in the HF5 and HF6 deals, and "it will not negatively impact Quadrant's ability to recover their investments."
Referring to the specific policy outlined in the original deal documents, Lyons says: "Nowhere does the policy state that Lexington's obligation to pay is contingent on the films being made, nor does the policy provide any basis in which AIG/Lexington is relieved of its obligation to pay the claim."
Indeed, the latest court decision may be legally significant, but market sources say that it means very little to investors. According to several buysiders polled, multiline-wrapped paper is practically blackballed as a result of the AIG case.
"Investors have the luxury of choosing deals," one investor noted. "If AIG wants to make a claim, legally, that's fine. But we're never going to buy a multiline-wrapped deal again."
"The chance of AIG recovering from its reinsurers means nothing to us as investors," Quadrant's Lyons said, referring to the most recent decision from the British courts.
In fact, there is a new vigilance pervading the market in general. "In the short run, this is going to make people more wary of relying on anything that isn't a straight clean bond insurance policy," added Mark Adelson of Nomura Securities. "Market players will try extra hard to be careful about making sure disclosure is fair and complete."
And they also need to more prudently consider what they are purchasing for their conduits, some critics say. By their very nature, conduit managers might seek out riskier bonds because of the potential higher yields they give.
But in the case of Quadrant, ABC had $135 million exposure to AIG. "We are required to run a diversified portfolio - it can't be 100% credit cards," Lyons said. "When CSFB approached us with these transactions, they were less liquid, and carried a small premium over where triple-A guaranteed investment contracts are. Besides the fact that they were privately placed, there was exposure to AIG, which... is a prime triple-A-rated name. The movie company involved in this, Flashpoint Limited, was an irrelevance. It wouldn't have even mattered if their films were hugely successful.
"This was pure AIG risk we were considering. And all defenses on the part of AIG were waived, according to the wording of the policy."