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Actual Merrill CDO Sale: 5.47% on the Dollar

Tuesday, July 29, 2008 | 03:43 PM

in Credit | Derivatives | Mathematics | Valuation

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