Bank Spares Cdo Clients Investor Move From Subprime Deals

The Age

Thursday August 21, 2008

Vanessa O'Shaughnessy Investment Reporter

INVESTMENT bank Lehman Brothers has switched some hard-hit clients out of US subprime-related investments while defending the sale of structured credit products to councils and other community-based organisations.

Speaking to BusinessDay yesterday, Lehman Brothers Australia's chief administrative officer, Sean Moore, said no one could predict the outcome of the US subprime mortgage crisis and current credit crunch.

But for some clients, the bank had exchanged poorly rated US subprime-related investments for better-rated notes from Australian banks.

Mr Moore said 2.4% of the structured products sold to clients were directly invested in the low-end US subprime mortgage market.

The weakest product, a collateralised debt obligation known as "Federation", was one of about 50 types of CDOs sold by Grange Securities, which became part of Lehman Brothers in the middle of last year.

Some of these CDOs were created by Lehman Brothers, while others were issued by Deutsche Bank, Morgan Stanley, French bank BNP Paribas, Merrill Lynch, HSBC, ABN Amro, Toronto Dominion Securities, Calyon, Credit Suisse, Nomura, Royal Bank of Canada, Barclays and Citigroup.

"Of the CDO population, and even the CDOs that were distributed by Grange and Lehman, the subprime element of that was a tiny element," Mr Moore said.

"Sometimes there's a misinterpretation that (our clients) had subprime exposure whereas they may have had a CDO product or an FRN (floating rate note) or another kind of instrument that has been affected."

But clients that held subprime-related CDOs had dramatic losses. Many of the CDOs indirectly affected by the collapse of the subprime mortgage market and subsequent credit crisis have declined in value.

One NSW council has already taken the matter to court. Several more are considering taking legal action against Lehman Brothers.

"It's not a great situation for us to be in," Mr Moore said yesterday.

The investment bank has since ceased managing clients' portfolios, notifying them in December that it would switch to a "service" model for all clients.

Meanwhile, clients holding the "Federation" CDO have watched their investment plunge from a AAA rating to a CCC rating, according to Standard & Poor's ratings agency.

The product continues to pay a coupon of 8.29%, a rate akin to the best term deposits available.

But some clients, including local governments, must adhere to guidelines restricting their investments to the highest-rated products.

Lehman Brothers Australia's head of compliance, Shaun Ansell, said that of the 4885 CDOs that attracted a AAA rating from Standard & Poor's between 1984 and 2006, not one had failed.