Merrill Lynch sold CDO's .05 cents on the dollar.

[Johnnybags]

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 !

[Cowlesy]

Right, but you need to add back the rate they're getting on the 75% loan they made which makes their return higher.

Obviously Loan Star is probably using an off-shore entity and I'd bet dollars-to-donuts the leverage is non-recourse, so Loan Star is protected. The interest was probably pre-funded on the 75% loan transaction.

Definitely dumping the loans on the cheap, but there is more than just the analysis above.

[Johnnybags]

Right, but you need to add back the rate they're getting on the 75% loan they made which makes their return higher.

Obviously Loan Star is probably using an off-shore entity and I'd bet dollars-to-donuts the leverage is non-recourse, so Loan Star is protected. The interest was probably pre-funded on the 75% was probably pre-funded in the transaction.

Definitely dumping the loans on the cheap, but there is more than just the analysis above.

They are acting like they got 22 cents on the dollar and everyone else has to value it at 22 cents, its a market transaction. I suspect its structured as you say and leaves Merrill on the hook for the financing. Its a phony transaction. Why not say you sold em for .50 cents and provide non recourse prefunded financing? At any rate all the Wall st gurus were quick to point out that now we have a market price. They were all busily attaching the price to other companies exposure. Heck, give me a million dollar mansion at 2 percent for 220k and I'll put down 55k and try to find a buyer for a few years. If not I'll give it back. Its all a shell game coming from one of the most respected houses on Wall st.