Securities Law Blog

Alistair Barr of Marketwatch reports that State Street Corp's decision to set aside $618 million to cover subprime litigation costs has increased concern that insurers offering policies covering such expenses could be hit with big claims from the credit crisis.

State Street said the reserve was needed to pay for lawsuits and possible settlements stemming from complaints about the fixed-income strategies managed by its State Street Global Advisors investment arm. The funds were hit by exposure to falling subprime mortgage markets and a lack of liquidity, the company explained. See full story

State Street has insurance covering legal costs and expects to get some of the money back from claiming on the policy, Ronald Logue, chief executive of State Street, told analysts and investors during a conference call on Thursday. The value of that coverage wasn't included in the reserve for accounting reasons, he added.

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Paul Davies of FT.com reports that almost $6.5bn worth of complex debt securities face fresh downgrades by Standard & Poor's because of their exposure to US mortgage-backed bonds, the credit rating agency said Friday.The news will add to the pain for investors in such instruments and follows downgrades issued to $3.7bn worth of similar instruments on Thursday from S&P. In all, the agency has either downgraded or placed on review more than $77bn worth of collateralised debt obligations (CDOs) that have direct exposure to the crisis in the US mortgage markets.

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NASD Notice To Members 04-30 notes that it is the responsibility of firms to take appropriate steps to ensure that their associated persons understand and inform their customers about the risks as well as the rewards of the products they recommend and offer.

To read the full NTM click here.

NASD Notice to Members (NTM) 04-30 provides that as the number of retail customers investing in bonds and bond funds grows, NASD is concerned that many investors may not fully appreciate the risks and costs associated with such products. It is the responsibility of firms to take appropriate steps to ensure that their registered representatives understand and inform their customers about the risks as well as the rewards of the products they offer and recommend. The purpose of this Notice is to remind firms that sell bonds and bond funds of their sales practice obligations in connection with such products.

To read the full notice click here.

CNNMoney.com reports that even the American Dialect Society knows how risky home mortgages are these days.The group of wordsmiths chose "subprime" as 2007's Word of the Year at its annual convention Friday.

"'Subprime' has been around with bankers for awhile, but now everyone is talking about 'subprime,"' said Wayne Glowka, a spokesman for the group and a dean at Reinhardt College in Waleska, Ga. "It's affecting all kinds of people in all kinds of places."

About 80 members of the organization spent two days debating the merits of runners-up "Facebook," "green," "Googleganger" and "waterboarding" before voting for an adjective that means "a risky or less than ideal loan, mortgage or investment."

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Michael Hudson and Aparajita Saha-Bubna of the WSJ report that turmoil in the subprime-mortgage market fanned out yesterday, hitting a group of investments that are exposed to this struggling class of home loans.

Moody's Investors Service said yesterday it may cut its credit ratings on slices of 91 collateralized-debt obligations, or about $5 billion of securities. It is a small percentage of the overall CDO market, but still an important development, because it is a signal that subprime fallout is rippling through financial markets to an important class of investments.

In another sign of these ripple effects, Fitch Ratings released a report yesterday raising cautionary flags about the commercial real-estate market. It projected rising defaults in this sector after years of increasingly lax lending standards, which could hit bonds backed by commercial real-estate loans.

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Michael Hudson of the WSJ reports that twelve years ago, Lehman Brothers Holdings Inc. sent a vice president to California to check out First Alliance Mortgage Co. Lehman was thinking about tapping into First Alliance's lucrative business of making "subprime" home loans to consumers with sketchy credit.

The vice president, Eric Hibbert, wrote a memo describing First Alliance as a financial "sweat shop" specializing in "high pressure sales for people who are in a weak state." At First Alliance, he said, employees leave their "ethics at the door."

The big Wall Street investment bank decided First Alliance wasn't breaking any laws. Lehman went on to lend the mortgage company roughly $500 million and helped sell more than $700 million in bonds backed by First Alliance customers' loans. But First Alliance later collapsed. Lehman landed in court, where a federal jury found the firm helped First Alliance defraud customers.

Today, Lehman is a prime example of how Wall Street's money and expertise have helped transform subprime lending into a major force in the U.S. financial markets. Lehman says it is proud of its role in helping provide credit to consumers who might otherwise have been unable to buy a home, and proud of the controls it has brought to a sometimes-unruly business.

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Continue reading "Follow the Mortgage" »

Carrick Mollenkamp and Serena Ng of the WSJ report that in recent years, as home prices and mortgage lending boomed, bankers found ever-more-clever ways to repackage trillions of dollars in loans, selling them off in slivers to investors around the world. Financiers and regulators figured all the activity would disperse risk, and maybe even make markets safer and stronger.

Then along came Norma.

Norma CDO I Ltd., as its full name goes, is one of a new breed of mortgage investments created in the waning days of the U.S. housing boom. Instead of spreading the risk of a global home-finance boom, the instruments have magnified and concentrated the effects of the subprime-mortgage bust. They are now behind tens of billions of dollars of write-downs at some of the world's largest including the $9.4 billion announced last week by Morgan Stanley.

Norma illustrates how investors and Wall Street, in their efforts to keep a lucrative market going, took a good idea too far. Created at the behest of an Illinois hedge fund looking for a tailor-made bet on subprime mortgages, the vehicle was brought into existence by Merrill Lynch & Co. and a posse of little-known partners.

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Sree Vidya Bhaktavatsalam of Bloomberg reports that Merrill Lynch & Co. was subpoenaed by Massachusetts regulators after the value of collateralized debt obligations the brokerage firm sold to the city of Springfield plunged 91 percent because of losses tied to subprime mortgages.Secretary of State William Galvin yesterday issued the request for information to New York-based Merrill. Galvin, the state's top securities regulator, said in an interview today he wants the names and details of the CDOs by 3 p.m. Jan. 10. Merrill said it will cooperate with the investigation.

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Jody Shenn of Bloomberg reports that State Street Corp., BlackRock Inc., Societe Generale and Deutsche Bank AG units are among 28 managers of mortgage-linked collateralized debt obligations deemed at risk of being unable to fully pay off their most-senior classes.About $64 billion of CDOs, which repackage pools of assets into new securities with varying risks, have experienced so-called events of default since mid-October after a slump in the credit quality of their holdings, according to data sent to clients yesterday by Charlotte, North Carolina-based Wachovia Corp. analyst Justin Pauley. Harding Advisory LLC and Tricadia CDO Management LLC each manage five of such failing deals, the most.

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Anuj Gangahar and Daniel Pimlott of the Financial Times report that the subprime mortgage crisis claimed its first victim of the year yesterday as State Street, a leading US financial services group, announced the departure of its asset management chief as well as a $279m (€189m) charge to cover potential legal costs.William Hunt left only weeks after the company said four of its off-balance sheet vehicles held $29.2bn of asset-backed commercial paper, short-term securities that are often backed by revenues from subprime mortgages and consumer loans.

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Nicholas Rummell of Financial Week reports that there's plenty of blame to go around in the current credit crisis, but owners of mortgage-backed securities looking for someone to pin the mess on may be going after one target in particular: Wall Street firms that packaged the securities into collateralized debt obligations.

This week, charities and municipal councils in Australia sued a subsidiary of Lehman Brothers over risky CDOs that were sold to the councils in violation of investment guidelines.

Most CDO lawsuits so far have been brought against the sellers--investment banks such as Goldman Sachs and Bear Stearns--by shareholders who allege the investment vehicles' risks were never properly disclosed. But the other litigation shoe to drop in the CDO implosion will involve legal claims against banks and hedge funds by institutional investors, including other hedge funds and pension funds, experts predict.

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Continue reading "Collateralized Debt Obligation (CDO) Lawsuits May Increase In 08" »

Kathy Shwiff of the WSJ reports that Standard & Poor's Ratings Services has placed on watch for possible downgrade its ratings on 149 tranches worth a total of $6.42 billion from 43 U.S. cash flow and hybrid collateralized debt obligation of asset-backed securities transactions.

The move follows last month's downgrade of 793 classes of U.S. residential mortgage-backed securities backed by U.S. closed-end second-lien mortgage collateral issued in 2004, 2005 and 2006.

All of the CDO tranches with ratings placed on CreditWatch with negative implications are from CDOs of asset-backed securities collateralized by structured finance securities, including U.S. RMBS backed by closed-end second-lien collateral.

CDOs, which use sliced-and-diced assets such as subprime-mortgage bonds to create customized products offering various levels of risk, have been at the heart of steep write-downs at big banks and brokerage firms.

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Bloomberg News and Reuters reports that Citigroup said that it had lost more money than it had made from financial instruments based on U.S. subprime mortgages.At the same time, the share prices of major U.S. securities firms fell on Wall Street amid fears about the effect of the mortgage crisis on earnings.

William Mills, chief executive of Citigroup's markets and banking division in Europe, said the bank had suffered "reputational damage" from the fallout even though the bank had made "adequate disclosures" to customers who were trading in collateralized debt obligations and similar instruments.

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Continue reading "Citigroup Admits Subprime Investments Were Losers" »

Kathleen Howley of Bloomboog reports that as storm clouds gathered over New York on July 10, Standard & Poor's started a 10 a.m. conference call to discuss why the credit rating company was about to take its most dramatic action in more than two years.S&P analysts said they might cut ratings on $12 billion of the world's worst-performing subprime mortgage bonds, some of them less than a year after they had been given investment-grade designations. Not since 2005, when it downgraded Ford Motor Co. and General Motors Corp., had S&P generated so much attention.

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