The European Central Bank is facing large potential losses arising from exposure to €10.3 billion of assets left behind from defaulting bank counterparties to the Eurosystem last autumn. In addition to Lehman Brothers, three Icelandic banks – Glitnir, Kaupthing and Landsbanki – and Dutch bank Indover have defaulted.
Among the assets that the ECB has been left holding is a massive collateralized debt obligation containing deteriorating commercial real estate assets. The €2.17 billion note was the senior part of a two-tranche transaction structured by Lehman Brothers in the spring of 2008 – when the firm was desperate for liquidity – precisely for the purpose of gaining access to the central bank’s generous repo facility.
Despite being rated at single A, and that by only one agency – Standard and Poor’s – the CRE CDO still passed the ECB’s eligibility tests as acceptable repo collateral and the ECB advanced cash to Lehman against it. S&P has since downgraded the deal to BB+, citing the various key roles Lehman played in the transaction.
S&P’s presale report for Excalibur Funding No1 contains no mention of LTVs but, according to one banker, the issue was backed by assets of relatively low quality.