Financial Services Bloodbath

Turmoil in Credit Default Swaps and other derivatives is now affecting the Australia & New Zealand Banking Group. The CEO of ANZ says Credit "Bloodbath" Cuts Profit.

Australia & New Zealand Banking Group Ltd. fell to a 2 1/2-year low in Sydney trading after Chief Executive Officer Michael Smith said the "bloodbath" in debt markets will erase profit growth this year.

"Credit costs are going up, well above underlying earnings growth," said Smith, who joined ANZ from HSBC Holdings Plc last year, in a webcast briefing. The Melbourne-based bank, Australia's third largest, will also take a $200 million charge for derivatives linked to U.S. debt insurer ACA Capital Holdings Inc.

ANZ spokesman Paul Edwards confirmed the insurer as New York-based ACA, which had its rating sliced 12 levels to CCC by Standard & Poor's in December, casting doubt on more than $75 billion of debt the company guarantees, including $69 billion of securities such as collateralized debt obligations.

"This is a financial services bloodbath," Smith said of the subprime fallout in credit markets. He said the Australian banking system was in "remarkably good shape" given global conditions.

ANZ had bought default protection on a portfolio of investment grade companies from ACA using a credit-default swap, a derivative used to speculate on corporate credit quality. After ACA was cut to non-investment grade, the bank was required to raise an "individual provision'' of $200 million, it said.

Ambac To Split Up?

The Wall Street Journal is reporting Ambac in Talks to Split Itself Up.

Ambac Financial Group Inc. is in discussions to effectively split itself up in a move aimed at ensuring that municipal bonds backed by Ambac retain high credit ratings, according to a person familiar with the situation.

A deal could fall apart because of the complexities in such a move, this person said. Bond insurers in recent weeks have become ground zero in the global credit crisis because the companies contractually have agreed to stand behind billions of dollars in securities underpinned by U.S. subprime mortgage ... rest by subscription only.

Ripple Impact If Monolines Split Up

Bloomberg is reporting Asia-Pacific Bond Risk Increases on Proposal to Split Insurers.

Corporate default risk rose on concern that a proposed breakup of MBIA Inc. and Ambac Financial Group Inc., the world's two biggest bond insurers, may deepen losses linked to U.S. home loans. Banks globally may write off $400 billion of losses, according to Group of Seven estimates.

"There are worries about the credit contagion from the U.S. subprime and monoliners," said Tim Condon, head of Asian research at ING Groep NV in Singapore. "Any weak data contributes to the poor sentiment in the credit markets."

FGIC Corp., the bond insurer stripped of its Aaa ranking by Moody's Investors Service last week, asked to be split in two to protect the ratings on municipal bonds it guarantees.

Fraudulent Conveyance

I am not a lawyer but the proposal to split up Ambac looks like Fraudulent Conveyance.

A fraudulent conveyance, also fraudulent transfer is a civil cause of action. It arises in debtor/creditor relations, particularly with reference to insolvent debtors. The cause of action is typically brought by creditors or by bankruptcy trustees. The usual fact situation involves a debtor who donates his assets, usually to an "insider", and leaves himself nothing to pay his creditors as part of an asset protection scheme.

Ripple Impact If Monolines Downgraded

Banks and municipalities worried about the Ripple Impact of a $534 Billion Debt Downgrade are hoping this all gets straighted out to everyone's satisfaction. It won't come close. Expect some significant ripples over this no matter what happens.

For a moment, assume the proposed split gets approval. Lawsuits would start flying over who gets stuck with the worthless CDOs. And exactly what would Ackman and others bears be short? Such lawsuits would leave lingering doubts of the guarantees of the monolines. More doubt is the last thing the market needs right now. Those doubts have virtually frozen the muni bond market.

Currently there is No Underwriter Support For Failed Muni Auctions.

In contrast, the simple Buffett solution puts all that complexity to bed. However, it does kill the monolines so they will fight it. Also look for legal battles if Rescue Plans Fail and New York Governor Eliot Spitzer carries out his threat to step in within days to fix things.

In the meantime, calling this a bloodbath is a bit premature. Events now are but a small down payment for what's to come.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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