Merrill Lynch has sold its Super-Senior Tranches of mortgage linked securities known as Collateralized debt obligations (CDOs)_ for 22 Cents to the Dollar, which means at a fifth of its purchase price. ML sold 30.6$ bn worth of CDOs at $6.7 billion to Lone Star, hence selling it at 22% of its value. These were already written down to $11 billion earlier.
Anyways, the real issue is that Citibank had marked its CDOs down to 53 cents to a dollar and now the market for CDOs suddenly has become marked at 22 cents to a dollar. Citibank is definitely going to announce some more writedown as it is still valuing the CDOs at 53 cents to a dollar.
The real twist is the fact that 75% of the sale to Lone Star has been financed by ML itself, which means, only $1.8 billion has been totally sold off and the remaining $5 billion can still be written off as loss by ML if the prices of those CDOs go down further. That implies that these CDOs are worth much less than 22 cents of the dollar. The market for CDOs is completely illiquid rite now and a lot of investment banks have been providing such financing to hedge funds and PE funds to get bad CDO's off their balance sheet.
The interest rate at which the financing occurs is often significantly lower than the appropriate rate at which this risk financing will occur. Merrill has not announced what are the terms of its financing of this deal and this leaves the serious suspicion of a heavily subsidized transaction. In the case of the Merrill transaction if the market value of this $11.1 tranche (now priced at $6.7 billion) falls another 25%, the collateral for the 75% financing will be worth less than the underlying assets and thus additional losses will be incurred by Merrill.
ML has raised money from the capital markets by issuing some shares (the firm raised $8.55 billion by selling new shares for $22.50 each, 60 percent less than Merrill's stock price at the beginning of the year), but it also needs to pay to Temasek and other investors for the 50% loss they have had for providing money to ML on issue of shares.It is paying Temasek $2.5 billion to offset losses on its earlier investment. ML shares have fallen the most after Lehman Brothers which is down over 75%.
ML has been selling off its assets in good companies including Bloomberg to avoid the bloodbath that it is facing and will face in the time to come. The company still has commercial real-estate investments, mortgages and other holdings that may be vulnerable to further writedowns
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2 comments:
Want to dispute the second paragraph where you claim that the CDO market is now going to be benchmarked @ 22cents to a dollar, and that Citi might need to reprice its CDOs since it is currently holding them at 53cents. The argument is that since CDOs are a collection of debt instruments, you can still make a case that the underlying debt of one CDO might be undisputably better than the other and thus deserves a better valuation. It is like using the same valuation multiple for comparing two companies with very different profitability and growth expectations, just because they are in the same industry.
Jatin
Well I agree with you that there can be a variety of debt instruments, viz equity tranche, next the mezzanine tranches, and finally the senior tranche. However, the price of the most toxic assets have been benchmarked at 22 cents to a dollar as per the sale of MLs latest CDOs. Citibank has also got a bulk of CDOs and there would be some really toxic assets that they have whose value was at53 cents..The better ones are of course higher valued...So these would go at around 22 cents implying write downs of over $8 billion...
CitiBank like ML also provides financing for its CDOs and hence the story is still far from over...Even though its off their balance sheets, the further lowering of prices will lead to further losses.
In my next post, I will detail the losses of all the investment banks have made till date due to writedowns of subprime assets and Citibank tops the list with over $46 billion!!
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