Tuesday, July 29, 2008

Quick comment on Merrill Lynch's ABS CDO Sales

Here are some quick comments on Merrill Lynch's sale of ABS CDOs.

First, don't confuse ABS CDOs with other types of structured finance, or even other types of mortgage securities. ABS CDOs were truly the most toxic, most dangerous securities ever to carry the AAA rating. This post describes the problem of structure squared best. Its also explained here and here.

Second, I hate the phrase "worst is over." What does that even mean? If you sell a bond for 22% of par, by definition the worst is over. Its already lost 78 points, it can't lose another 78 points! So here we have CNBC claiming that traders are betting the "worst is over." Whatever.

What's really happening is that shorts in stocks and CDS got scared. Look, the odds are high that Merrill Lynch will still be around after this is all over. And we know that Merrill has a profitable brokerage business that is going to be worth a hell of a lot more than $20/share when this is all over. That goes doubly for a less impacted name like Bank of America, and even more so for the whole XLF index. That stuff isn't going to zero. So at some point, if you are short those names, you are going to want out. Given that real money is no where to be found, when the shorts want out, the market is going to move in a big way.

One of these short squeezes is going to mark an actual Bottom (tm). As AI readers know, I hate the sport of Bottom Calling, so I'm staying out of that fray. But a Bottom (tm) is coming someday.


Anonymous said...

22%? you don't count merrill financed 75% of that? with no recourse other than the assets? more like 6%.
and what exactly is the merrill brokerage worth in this era? too much pumping lately pal.

Tony Towers said...


The other big news was the agreement ML reached with SCA to commute eight contracts for $500 MM. This action is very positive news for other bond insurers.

JoshK said...

I would love to get an understanding of this trade. They called this
super senionr". That means they are first in line to collect principal and interest, right? Even if defaults are 30%, then wouldn't they see a much better return on this by holding and collecting?

And, they already marked it way down, so shouldn't they have just held on to it at this point and let the rest of it bleed into the firmwide p/l over the next 10 years? Why take the hit now? Worst case they could have marked it down a little bit each year.

And, what kind of crazy arrangement is this to finance most of it with no recourse? This seems like a bad move for MLCO,but I'm sure there's an explanation that I'm not seeing.

RoachApproach said...

Sorry, I am not an English native and I wonder what tm in brackets means (after Bottom). Could you please clear it up for me.


JoshK said...

tm = Trademark. Registered by US government copyright. Just a joke.

PNL4LYFE said...

Josh: The problem is that these are "super senior" tranches of CDOs that are composed entirely of mezzanine tranches of other MBS and/or CDOs. Assuming that those tranches are all 7-9% loss tranches of regular MBS, that would mean that these super senior tranches would be completely wiped out by 9% losses in the underlying mortgages. If losses end up being 7% or less, they will get par. That's an oversimplification, but it shows how small changes in assumptions about the performance of underlying loans makes a huge difference in value.

It sounds like you're referring to the senior tranches of regular MBS should have much better recovery.

ccm said...

"ABS CDOs were truly the most toxic, most dangerous securities ever to carry the AAA rating."

AI, I think you're exaggerating. There's just too much competition for the honor. Don't forget the CPDO, which the FT reported as misrated the day the rating was issued.

viking said...

most toxic ever?

how bout 06 and 07 CDOs?

they are about the 12th most toxic ever

Accrued Interest said...

Admin: I know its fashionable to assume everything is worth nothing. But clearly their brokerage unit is profitable and its worth something. As for MER financing the deal, I see that more as risk sharing than indicating that the bonds are really worth 5 cents. I mean, you should look at it like MER is retaining a significant risk, to be sure.

Tony: Agreed. But I don't think this saves MBI or ABK. Maybe it increases their odds from 2% to 5%. I'll get more into that in our next installment.

Josh: Read my piece on structure squared.

Viking: Uhh... we're talking about '06-'07 ABS CDOs. What are you talking about?