Posts filed under “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
• 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 !
We knew about the Merrill writedown on Friday… didn’t you?
FT, July 29th, 2008 at 11:46
Merrill’s $5.7B Write-Down, $8.5B Share Issuance (July 2008)
Rinse. Lather. Repeat. (July 2008)
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
New Home Completions, 1968-2008 click for ginormous chart Major New Home Building Housing expansions since 1968 are marked as a red horizontal line at bottom. They previously lasted 2-4 years (71-73; 76-79; 83-87) The most recent boom far exceeded all previous expansions, running form 1992 – 2003 — then exploding upwards for another 3 years…Read More
Welcome to the second half of 2008.
We begin the second half pretty much the same way we finished the first half: Equities under pressure in Asia, Europe, and judging by the futures in the US, domestically as well.
One of the things that us foolish idealists hope for is that the current set of crises will force the fantasy brigades to actually start interacting with that hypothetical construct known as reality. Perhaps by confronting the actual problems facing the economy, we can actually begin the process of repairing them by taking the painful write-downs and instituting the medicinal policies that make sense.
Such hopes are misplaced. The latest evidence of such comes from no other than Blackstone Group (BX) CEO Stephan Schwarzman. On the occasion of the private equity firm’s one year IPO anniversary, Schwarzman places the fault for the current crises squarely on FASB 157.
You read that correctly: This was not the fault of incompetent lending to borrowers who could never afford to pay back mortgages; nor was it the fault of the rating agencies that slapped AAA on paper that turned out to be garbage; nor was it the responsibility of an MIA Fed that utterly failed in their responsibilities as the chief supervisor of the banking system; nor was it the liability of fund managers who in a misguided grab for yields bought billions of dollars worth of securities that they had no idea of the specific details contained therein.
No, it was the accountants’ faults.
You see, those persnickety bean counters forced banks and brokers to actually write down paper for which there was no market.
Therein lies the foible of Schwartzman’s Folly, for if you own marketable securities for which there is no market, then by definition, these are not really marketable securities.
How then to price all of this paper on the books? Why, just rely on the people who bought them in the first place! Never mind that they don’t understand what they own, they failed to do their due diligence before buying this garbage in the first place. Do not acknowledge these folks have an enormous personal incentives NOT to mark this junk down.
You can trust them! They’re good people.
Perhaps this helps to explain why Blackstone Group’s stock is off nearly 50% since the IPO: The foolish shareholders of BX have been making the mistake of marking the stocks-to-market. My suggestion: Forget that they are a private equity firm, and consider instead your own approximate fair value interpretation of what the company is worth!
Attention fund managers: Here is my new Stephan Schwarzman inspired idea. Y’all should be buying Blackstone in the open market today at $18, and at the four o’clock close, be marking it at $36. That will be not only be your fair value interpretation of what it’s worth, but it reflects a 100% gain instantly.
And, that’s before the $.30 dividend.
Indeed, for those investors struggling with the current selloff, I suggest you forgo mark-to-market accounting at present, and instead start implementing mark-to-subjective-self-interested valuations. Your portfolio returns, and you’re outside investors, will thank you for the immense improvements in your performance.
Musical reference and soundtrack via the Talking Heads
FASB 157 — Delayed, or Not? (November 15, 2007)
SFAS 157: Market Prices Too Low? Just Ignore Them! (March 31, 2008)
Are Bean Counters to Blame?
ANDREW ROSS SORKIN
NYT, July 1, 2008
Summary of Statement No. 157
Fair Value Measurements
Mohamed El-Erian Argues for Propping Up Asset Prices
Naked Capitalism, MARCH 18, 2008