Tuesday, August 5, 2008

CDO Issuance and Merrill Sale

I spent some time looking at the recent Merrill announcement in detail. Let's combine a few data: First, from a terrific series in the Financial Times

Notice that the bulk of the CDO issuance is 2006 and beyond. Now let's look at the exact phrasing of the Merrill announcement:
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.

1. Only "super senior" tranches were included. "Senior" and lesser tranches are omitted. They might have a trillion dollars in exposure, but we'd never know from this release.

2. The majority of $8.8B of continued exposure (which might be 50.0001%) is pre-2005. If the ratio of the original $20B of exposure was in the ratio of the Financial Times graph, then the part that got sold off was post-2005 by a wide majority.

3. Until there are realistic valuations of Tier 3 items and an elimination of off-balance sheet items, a safe assumption would be to assume that Merrill's 22¢ on the dollar sale (really 5.5¢, since they financed the buyers) is an upper bound for seller-financed deals.

When sellers have highly asymmetric information about an item for sale, intelligent buyers should demand a discount. I cannot think of a better example of this than MER common stock. God only knows what other crap is waiting for recognition on the books.

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