ECB faces heavy loss on real estate CDO
Because of the minimal due diligence conducted at the time of repo, the ECB now is holding paper for which it has no way of determining how much it will receive.
The European Central Bank is facing large potential losses arising from exposure to €10.3 billion of assets left behind from defaulting bank counterparties to the Eurosystem last autumn. In addition to Lehman Brothers, three Icelandic banks – Glitnir, Kaupthing and Landsbanki – and Dutch bank Indover have defaulted.
Among the assets that the ECB has been left holding is a massive collateralized debt obligation containing deteriorating commercial real estate assets. The €2.17 billion note was the senior part of a two-tranche transaction structured by Lehman Brothers in the spring of 2008 – when the firm was desperate for liquidity – precisely for the purpose of gaining access to the central bank’s generous repo facility.
Despite being rated at single A, and that by only one agency – Standard and Poor’s – the CRE CDO still passed the ECB’s eligibility tests as acceptable repo collateral and the ECB advanced cash to Lehman against it. S&P has since downgraded the deal to BB+, citing the various key roles Lehman played in the transaction.
S&P’s presale report for Excalibur Funding No1 contains no mention of LTVs but, according to one banker, the issue was backed by assets of relatively low quality.