Actual Merrill CDO Sale: 5.47% on the Dollar
An active trader pointed us to this very familiar looking off-balance sheet shenanigan found in the following paragraph regarding Merrill's CDO Sale.
Direct from yesterday's press release:
"On July 28, 2008, Merrill Lynch agreed to sell $30.6 billion gross notional amount of U.S. super senior ABS CDOs to an affiliate of Lone Star Funds for a purchase price of $6.7 billion. At the end of the second quarter of 2008, these CDOs were carried at $11.1 billion, and in connection with this sale Merrill Lynch will record a write-down of $4.4 billion pre-tax in the third quarter of 2008.
On a pro forma basis, this sale will reduce Merrill Lynch’s aggregate U.S. super senior ABS CDO long exposures from $19.9 billion at June 27, 2008, to $8.8 billion, the majority of which comprises older vintage collateral – 2005 and earlier. . .Merrill Lynch will provide financing to the purchaser for approximately 75% of the purchase price. The recourse on this loan will be limited to the assets of the purchaser. The purchaser will not own any assets other than those sold pursuant to this transaction. The transaction is expected to close within 60 days."
Let's take this apart:
• Merrill appears to be moving $30.6 billion dollars of bad paper off of their books.
• This paper was carried at a value of $11.1, meaning there was almost $20B in prior related write downs.
• After this transaction, Merrill’s ABS CDO exposure in theory drops from $19.9 billion to $8.8 billion (hence, the $11.1B number).• The $6.7B purchase price relative to the $30.6B notational value is 21.8% on the dollar
However:
• Merrill is providing 75% of the financing –- and MER’s only recourse in the event of default is to retake the CDO paper back from the buyer.
• While Merrill hopes to be made whole, the reality is they still have potential exposure to these ABS CDOs via the financing;• Actual sale price = 5.47% on the dollar
Less than five and half cents on the dollar? That's an even cheaper sale than originally advertised.
What this transaction actually accomplishes is getting the paper -- but not the full liability -- off of Merrill's books.
How very Enron-like !
>
Related:
We knew about the Merrill writedown on Friday… didn’t you?
Sam Jones
FT, July 29th, 2008 at 11:46
http://ftalphaville.ft.com/blog/2008/07/29/14786/we-knew-about-the-me
Previously:
Merrill's $5.7B Write-Down, $8.5B Share Issuance (July 2008)
http://bigpicture.typepad.com/comments/2008/07/merrills-57b-wr.html
Rinse. Lather. Repeat. (July 2008)
http://bigpicture.typepad.com/comments/2008/07/how-fucked-are.html
Source:
Merrill Lynch Announces Substantial Sale of U.S. ABS CDOs, Exposure Reduction of $11.1 Billion
Merrill Lynch Press Release, Monday July 28, 5:25 pm ET
http://biz.yahoo.com/bw/080728/20080728006329.html
Tuesday, July 29, 2008 | 03:43 PM | Permalink
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Comments
ENRON is dead....
Long Live ENRON!!!!!!!
Posted by: MarkTX | Jul 29, 2008 3:52:25 PM
I don't understand the benefit to the purchaser of these cdos?. Leverage? but if the asset is not worth what u are paying what is the point?
Posted by: jay | Jul 29, 2008 3:55:08 PM
GWB told us most of the truth when he said: "Wall Street got a little drunk". (he was telling a short story, after all) When these g&g's are in town, spirits sales go up..
Posted by: Mark E Hoffer | Jul 29, 2008 3:56:49 PM
Posted by: jay | Jul 29, 2008 3:55:08 PM
straw purchaser
Posted by: Mark E Hoffer | Jul 29, 2008 3:58:15 PM
Merely just another shell game. Merrill and others in perilous shape (e.g. Citi, Lehman, WAMU, countless others, etc.) are merely delaying and moving shells around hoping they can stave off the barbarians long enough to raise enough case while hoping the market turns around.
Posted by: Jeff | Jul 29, 2008 3:59:57 PM
Sounds like MER just underwrote another subprime loan to get rid of one! Creative financing at its best. Is it me...or does anyone else smell desperation in the air?
Posted by: JimmyY | Jul 29, 2008 4:06:13 PM
"The purchaser will not own any assets other than those sold pursuant to this transaction"
Sounds ALOT like the SIVs that Enron used...
Posted by: jhunt | Jul 29, 2008 4:08:22 PM
Are these games ever going to stop? The poor souls that listen to their financial advisers babble on about "long term" are going to get crushed. At least it appears they will get crushed slowly.
Posted by: we are all screwed | Jul 29, 2008 4:09:28 PM
This is just another scam that passes as good business in the US.
Bonuses will be paid accordingly.
The smell of desperation, maybe,
The sound of extreme laughter, you bet your ass....
Posted by: MarkTX | Jul 29, 2008 4:13:04 PM
MarkTX - you nailed it.
Its called fleecing public shareholders and taxpayers to benefit a few insiders. These guys are working their comp plans. Just like Franklin Raines did at Fannie. Mean while Cox is chasing windmills to create the diversion for the chicanery!
Posted by: malabar | Jul 29, 2008 4:25:13 PM
imho, John Thain is a T-1000 sent from the future to both kill John Connor as well as the current (non-Temasek) shareholders of Merrill Lynch.
Don't be fooled by the sale of the CDOs. The way the deal is structured, doesn't it beg that they will rise from the dead and say "I'll be back!"
Posted by: HCF | Jul 29, 2008 4:27:02 PM
This is why you can't say things like "buy finacials because they are trading at book value". What's book value?
Posted by: Steve Dallas | Jul 29, 2008 4:29:36 PM
To recap if I understand this:
Merrill (ML) paid 30.6 billion.
Did ML recieve any dividends during the time it held it?
What tranche did ML hold? Statement says Super Senior, that doesn't sound like bottom tier, who holds that radioactive crap?
ML sells it for $1.675 billion and gets an IOU for $5.025 Billion that only pays if the toxic crap works out
Ok, we all know the genius at ML got the long end of this wrong and lost $28.925 billion.
But they also screwed the pouch on the short end. How?
Statement said they hedged the long shit with short positions worth $8.4 billion.
How much did they have to pay XL in fees to create and maintain these short hedges?
The holding by monoline XL is paying ML $0.5 Billion so they lost $7.9 billion on the short end. (Plus they've got another $7 billion out there, that's probably worthless too)
Jesus. How do you lose both your long position and your short hedged position?
Posted by: Michael Donnelly | Jul 29, 2008 4:38:36 PM
Did they really sell this to someone else while keeping most of the risks? It seems like the only way that I would agree to sell something to someone under these terms is if I would get to keep any profits as well. This deal kind of makes sense if you assume that Merrill sold it to a company that Merrill owns. If they lowballed the estimated value, then they get to start claiming earning surprises as soon as the bond market panic ends. If they overestimated its value, then the remaining losses have been moved to somewhere that people won't notice as easily.
Otherwise, they just sold possibly worthless bonds for practically nothing. I don't see how that can help them. This limits their losses by at most $1.7B. Why would they care about that? Unless they are trying to play games with mark-to-market rules to force margin-call selling all over the place. But that would imply that they think they can buy CDOs at panic prices. Which is not very consistent with needing to raise capital (if they can buy CDOs, they don't need more money).
Something is not right about this deal.
Posted by: jkw | Jul 29, 2008 4:42:31 PM
sorry for all the cursing. Most of my 401 and parents stuff is at ML and I'm getting nervous. Plus they are supposed to be the smart guys
Posted by: Michael Donnelly | Jul 29, 2008 4:43:34 PM
"Short story"...har har. You're funny, Mark Hofer. At least with Dubya, you get the short story. If you get Mad Mac in the White House, all you will get is a very bewildered look as if to ask, "Wall Street, what's that?"
Posted by: CNBC Sucks | Jul 29, 2008 4:44:41 PM
MER seems to be willing to take a big hit now in order to appear to be "doing something about the situation" The bet would seem to be that the sooner they get out from under the big shitpile, the sooner they can start pumping their (enormously diluted) share prices again.
"Non-performing loans" would appear to be Lone Star's metier.
From Lone Star's website:
"...Lone Star has been a successful investor in non-performing loans and real estate. The volatility of capital flows and the tendency of the banking system to cyclically over-finance and then under-finance the property and other sectors provide investment opportunities for Lone Star around the world. Global real estate and capital markets continue to offer opportunistic investment situations. Periodic disruptions, private/public market price disparities and out-of-favor assets provide financing opportunities for a fast-moving investor such as Lone Star. In this environment, Lone Star has the ability to identify, structure and finance investments efficiently and discreetly to produce optimal results."
Posted by: xtophr | Jul 29, 2008 4:48:41 PM
This is another example of why strict regulation is necessary. By the way, Mr Bush, who grew up on a ranch, keep the foxes out of the hen house.
Posted by: winslow | Jul 29, 2008 4:48:53 PM
...if only Elliot Spitzer were alive and well
Posted by: winslow | Jul 29, 2008 4:53:00 PM
Hasn't Lone Star in effect bought a "call option" on $30.6B for (.25 x $6.7 = ) $1.7B?
If the securities go up about 5% they are whole and if they increase 10% Lone Star has doubled it's money. If the securities default, Lone Star declines the "option" and back to Merrill they go. Does not appear to be an expiration date but I have not read the small print.
Sounds like any other open ended call option.
Jim
Posted by: NC Jim | Jul 29, 2008 4:57:02 PM
let's not assume that their legal team can't find some way to wiggle out of it later. they passed on the ticking bomb to someone else, let's see how it turns out.
Posted by: Mark | Jul 29, 2008 5:14:39 PM
Now you know where all the accountants from Arthur Andersen went to work.
Posted by: AGG | Jul 29, 2008 5:17:18 PM
Well, they're not the only ones doing writedowns:
National Australian Bank is writing off 90% of its US conduit loans.
Posted by: Chuck | Jul 29, 2008 5:32:39 PM
The pundits on tv still have the ratchet provision wrong. Its 2.5 bn for the common equity and 2.4 bn for the preferreds. 4.9bn total. This all depends on the offering price too.
Posted by: RobT | Jul 29, 2008 5:37:07 PM
What's the chances of Lone Star giving these back? Seems to me that it is almost an implicit garantee.
Posted by: JustinTheSkeptic | Jul 29, 2008 5:46:13 PM
