Confusion surrounded the recent - and what some sources coined abrupt - modifications to existing French risk weightings (see ASR 5/27/02). Two weeks since the changes were implemented it appears that the main incentive is to prevent banks from structuring deals and retaining the mezzanine piece that can unexpectedly fall to the triple-C/single-D rating tier.
According to Dresdner Kleinwort Wasserstein, this may have been the case in several highly leveraged CDOs that were priced by French banks. A bank usually sells all rated tranches and keeps the equity piece to cap its loss. If it retains the mezzanine piece then the additional capital requirement will be 8%. For those tranches affected, the losses they would have incurred could in some cases be in excess of 8%.
But the new risk weightings still seem a bit drastic. "The number and the volume of deals we are referring to is relatively small and, while perhaps penalizing the culprits, it will affect other French bank investors to a much greater extent, [such as] those holding triple-B RMBS," reported Dresdner.
And market sources worry that the Commissaire Bancaire suggestion that banks should hold one-for-one capital against triple-B rated RMBS might spill over to triple-B-plus rated tranches and below rated corporates.
According to Dresdner's investment-grade analyst, while a bank does take on leverage when buying a mezzanine tranche, credit risk for a triple-B rated corporates should be based on rating migration statistics. Though the number of fallen angels has been considerable, one of the main reasons attributed to corporate credit deterioration has been the increase in corporate leverage in a weakened economic environment.
"Obviously, as we have discussed, there are negative exceptions in the ABS market," reported Dresdner. "Some CDO tranches and certain vintages have shown a worse migration than that of equally rated corporates. However, in Europe it has been the lumpiness in some investment-grade CDOs that has led to losses."
Dresdner argues that this "broad-brush" approach to ABS does not appropriately address the differences between triple-B ratings and warned of the danger if it spills over to corporates. "While not entirely inconceivable, it would be interesting to see the CB require all French banks that provide funding to France Telecom (Baa1Wneg/BBBWneg), for example, to set aside 100% equity capital for those exposures," said Dresdner. "This would bring the banking system down."