A Riveting Disclosure in the $1 Billion Swiss Re Writedown

These days, a mere $1 billion writedown is such an penny-ante event as to not merit much interest. Indeed, what made the fact that Swiss Reinsurance Co., the world’s biggest reinsurer, lost that much on mortgage related derivatives noteworthy was the fact that it was engaged in that activity at all. It turns out the Swiss giant has a financial services division, headed by former Fed vice chairman Roger Ferguson, that had a “credit solutions” operation that sold complex products to clients.

As told in Bloomberg and in the Financial Times, Swiss Re wrote two credit default swaps sold to protect portfolios consisting largely of mortgage-backed products.

This was the section in the FT that caught my attention:

Swiss Re decided to reduce to zero the value of the lowest-quality tranches of securities involved, and to cut significantly the estimated value of even the higher-grade paper. The underlying portfolios comprised largely mortgage-backed securities, including residential and commercial mortgage-backed paper. “While the majority of the exposure is to prime and mid-prime securities, there is exposure to subprime and, more importantly, to asset-backed securities in the form of collateralised debt obligations,” it said.

All asset-backed CDOs in the portfolios are deemed worthless and the subprime components have been written down to 62 per cent of their original value.

The Swiss Re statement is detailed without being forthcoming, so it is hard to know what those CDOs were. If they were equity or mezz tranches, writing them off is a no-brainer. But if any were A or higher, this could be a nasty harbinger of thing to come. Without giving the basis for the CDO loss assumptions, confirmation comes a Goldman Sachs conference call, as quoted in Calculated Risk:

We believe … the industry will suffer $148 Billion total losses related to CDOs, to date we’ve accounted for roughly about $40 billion of those, so we’re estimating another $108 billion in writedowns over the next several quarters.