Most importantly, Merrill announced a "substantial sale of US super senior ABS CDO securities resulting in an exposure reduction of $11.1 billion from June 27th, 2008." Furthermore, Merrill has terminated some hedges with XL Capital. This is really fabulous news! The company is punting $11 billion of its most toxic garbage and settling the acrimonious dispute with XL. If you scroll down a bit, you get to the not so good news. The company needs to take a pre-tax write-down in the third quarter of 2008 of approximately $5.7 billion. "The write-down is comprised of a $4.4 billion loss associated with the sale of CDO's, a $500 million loss on the termination of hedges with XL Capital and an approximately $800 million maximum loss related to the potential settlement of other CDO hedges with certain other monolines." Scroll down even further and you get to the really juicy part about the CDO sale. First of all, Merrill is selling $30.6 billion in gross notional amount of CDOs which were carried on Merrill's books at $11.1 billion at the end of the second quarter. Merrill is selling these CDO's for $6.7 billion to an affiliate of Lone Star Funds. But that's not all! It is providing financing to the purchaser for 75% of the purchase price. Better yet, the recourse on the loan will be limited to the assets of the purchaser and the purchaser will not own any assets other than those sold in this deal. Got that? Basically, Lone Star set up a fund with around $1.65 billion in capital. It borrowed the rest of the money from Merrill to buy the $6.7 billion in CDOs. If this really is the bottom, Lone Star gets all the upside. If the CDOs go to zero, Merrill will lose $5 billion because it can't go after Lone Star's other assets, it only has recourse to the CDOs. Although technically it looks like Merrill is getting rid of the assets, it still retains risk that the Loan Star affiliate will default or will be unable to meet margin calls and then Merrill will seize the collateral and be stuck with the ensuing losses. This deal smacks of desperation, but Merrill is in fact desperate to put this mess behind it and move on.
As for the stock offering, Temasek Holdings, the Singapore investment fund has agreed to purchase $3.4 billion in Merrill's offering. Temasek, if you recall, thought $48 was a great price for Merrill back in January, 2008 when the investment fund took a $4.4 billion stake in Merrill. If you loved it at $48, you might as well buy more at $24. Unfortunately, this will require regulatory approval as Temasek's stake was close to 9.4%. Furthermore, Merrill has agreed to pay Temasek $2.5 billion due to certain obligations under reset provisions contained in Temasek's earlier investment, which Temasek will reinvest in the offering.
If you were wondering why Merrill's shares were taking such beating in the past few days, even relative to its broker dealer friends, this is the news you've been waiting for. Whoever knew about the common equity issuance did a fairly decent job of telling a few of his closest friends without having it wind up in the mainstream press (as a few of the untrue Lehman rumors did). What do you call a rumor about a common equity issuance that turns out to be true? That, my friends, is called insider trading. Where's Christopher Cox when you need him?
3 comments:
Aren't hedges supposed to go the opposite direction of the investment they are hedging? What were they using to hedge their CDO exposure -- real estate?
Yeah, proof that you're a fantastic trader: You lose money on the trade, the hedges, and even the equity issuance! You definitely want to give these guys your money to manage.
Insider trading indeed! Where's Beaks?
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