Bailout

Did ABN Amro hedge its ACA exposure?

By Felix Salmon

I just found this, buried in a Landon Thomas story on Abacus at the end of last week:

Some inside ABN Amro were leery of Abacus early on. Indeed, several traders there immediately bought credit default swaps ? insurance-like instruments ? from Goldman Sachs to hedge their exposure to ACA.

Now it’s worth noting that the headline on the story is “A Routine Deal Became an $840 Million Mistake”, and Thomas repeats many times in the story that the deal ended up costing Royal Bank of Scotland, which bought ABN Amro, $840.1 million.

But the bit about the CDS hedge is intriguing — especially the detail that the hedge was bought directly from Goldman Sachs, which was the company hedging its own exposure in the first place. If Goldman was happy to write credit protection on ACA, and presumably buy offsetting ACA protection elsewhere in the market, then why didn’t it just use ACA to insure the Abacus deal directly, and then turn around and hedge its ACA counterparty risk?

The answer, I think, might have something to do with collateral posting: Goldman only wanted CDS hedges where it could ask for collateral in the event of a downgrade or a fall in market prices, while ACA only wanted to insure the deal if it didn’t risk needing to post hundreds of millions of dollars with Goldman. So Goldman went through ABN Amro instead, which was happy to agree to Goldman’s collateral requirements.

I’m not clear how the $840.1 million was calculated — was that net of the hedges, or was that before Goldman paid out on them? And if ABN was hedging its ACA exposure with Goldman, why did it make any sense to do the deal in the first place? I’m sure that Goldman charged ABN Amro more than 17bp for ACA protection, so it’s hard to see how a hedged ABN could make any money on the deal at all.

Maybe if and when the UK government sues Goldman Sachs for RBS’s losses, we’ll learn more. But right now it’s all very vague where those super-senior losses really did ultimately end up.

Full post as published by Macroprudential on April 26, 2010 (boomark / email).