Actual Merrill CDO Sale: 5.47% on the Dollar

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?    
Sam Jones
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

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What's been said:

Discussions found on the web:
  1. MarkTX commented on Jul 29

    ENRON is dead….

    Long Live ENRON!!!!!!!

  2. jay commented on Jul 29

    I don’t understand the benefit to the purchaser of these cdos?. Leverage? but if the asset is not worth what u are paying what is the point?

  3. Mark E Hoffer commented on Jul 29

    GWB told us most of the truth when he said: “Wall Street got a little drunk”. (he was telling a short story, after all) When these g&g’s are in town, spirits sales go up..

  4. Mark E Hoffer commented on Jul 29

    Posted by: jay | Jul 29, 2008 3:55:08 PM

    straw purchaser

  5. Jeff commented on Jul 29

    Merely just another shell game. Merrill and others in perilous shape (e.g. Citi, Lehman, WAMU, countless others, etc.) are merely delaying and moving shells around hoping they can stave off the barbarians long enough to raise enough case while hoping the market turns around.

  6. JimmyY commented on Jul 29

    Sounds like MER just underwrote another subprime loan to get rid of one! Creative financing at its best. Is it me…or does anyone else smell desperation in the air?

  7. jhunt commented on Jul 29

    “The purchaser will not own any assets other than those sold pursuant to this transaction”

    Sounds ALOT like the SIVs that Enron used…

  8. we are all screwed commented on Jul 29

    Are these games ever going to stop? The poor souls that listen to their financial advisers babble on about “long term” are going to get crushed. At least it appears they will get crushed slowly.

  9. MarkTX commented on Jul 29

    This is just another scam that passes as good business in the US.

    Bonuses will be paid accordingly.

    The smell of desperation, maybe,
    The sound of extreme laughter, you bet your ass….

  10. malabar commented on Jul 29

    MarkTX – you nailed it.

    Its called fleecing public shareholders and taxpayers to benefit a few insiders. These guys are working their comp plans. Just like Franklin Raines did at Fannie. Mean while Cox is chasing windmills to create the diversion for the chicanery!

  11. HCF commented on Jul 29

    imho, John Thain is a T-1000 sent from the future to both kill John Connor as well as the current (non-Temasek) shareholders of Merrill Lynch.

    Don’t be fooled by the sale of the CDOs. The way the deal is structured, doesn’t it beg that they will rise from the dead and say “I’ll be back!”

  12. Steve Dallas commented on Jul 29

    This is why you can’t say things like “buy finacials because they are trading at book value”. What’s book value?

  13. Michael Donnelly commented on Jul 29

    To recap if I understand this:

    Merrill (ML) paid 30.6 billion.

    Did ML recieve any dividends during the time it held it?

    What tranche did ML hold? Statement says Super Senior, that doesn’t sound like bottom tier, who holds that radioactive crap?

    ML sells it for $1.675 billion and gets an IOU for $5.025 Billion that only pays if the toxic crap works out

    Ok, we all know the genius at ML got the long end of this wrong and lost $28.925 billion.

    But they also screwed the pouch on the short end. How?

    Statement said they hedged the long shit with short positions worth $8.4 billion.

    How much did they have to pay XL in fees to create and maintain these short hedges?

    The holding by monoline XL is paying ML $0.5 Billion so they lost $7.9 billion on the short end. (Plus they’ve got another $7 billion out there, that’s probably worthless too)

    Jesus. How do you lose both your long position and your short hedged position?

  14. jkw commented on Jul 29

    Did they really sell this to someone else while keeping most of the risks? It seems like the only way that I would agree to sell something to someone under these terms is if I would get to keep any profits as well. This deal kind of makes sense if you assume that Merrill sold it to a company that Merrill owns. If they lowballed the estimated value, then they get to start claiming earning surprises as soon as the bond market panic ends. If they overestimated its value, then the remaining losses have been moved to somewhere that people won’t notice as easily.

    Otherwise, they just sold possibly worthless bonds for practically nothing. I don’t see how that can help them. This limits their losses by at most $1.7B. Why would they care about that? Unless they are trying to play games with mark-to-market rules to force margin-call selling all over the place. But that would imply that they think they can buy CDOs at panic prices. Which is not very consistent with needing to raise capital (if they can buy CDOs, they don’t need more money).

    Something is not right about this deal.

  15. Michael Donnelly commented on Jul 29

    sorry for all the cursing. Most of my 401 and parents stuff is at ML and I’m getting nervous. Plus they are supposed to be the smart guys

  16. CNBC Sucks commented on Jul 29

    “Short story”…har har. You’re funny, Mark Hofer. At least with Dubya, you get the short story. If you get Mad Mac in the White House, all you will get is a very bewildered look as if to ask, “Wall Street, what’s that?”

  17. xtophr commented on Jul 29

    MER seems to be willing to take a big hit now in order to appear to be “doing something about the situation” The bet would seem to be that the sooner they get out from under the big shitpile, the sooner they can start pumping their (enormously diluted) share prices again.

    “Non-performing loans” would appear to be Lone Star’s metier.

    From Lone Star’s website:

    “…Lone Star has been a successful investor in non-performing loans and real estate. The volatility of capital flows and the tendency of the banking system to cyclically over-finance and then under-finance the property and other sectors provide investment opportunities for Lone Star around the world. Global real estate and capital markets continue to offer opportunistic investment situations. Periodic disruptions, private/public market price disparities and out-of-favor assets provide financing opportunities for a fast-moving investor such as Lone Star. In this environment, Lone Star has the ability to identify, structure and finance investments efficiently and discreetly to produce optimal results.”

  18. winslow commented on Jul 29

    This is another example of why strict regulation is necessary. By the way, Mr Bush, who grew up on a ranch, keep the foxes out of the hen house.

  19. winslow commented on Jul 29

    …if only Elliot Spitzer were alive and well

  20. NC Jim commented on Jul 29

    Hasn’t Lone Star in effect bought a “call option” on $30.6B for (.25 x $6.7 = ) $1.7B?

    If the securities go up about 5% they are whole and if they increase 10% Lone Star has doubled it’s money. If the securities default, Lone Star declines the “option” and back to Merrill they go. Does not appear to be an expiration date but I have not read the small print.

    Sounds like any other open ended call option.


  21. Mark commented on Jul 29

    let’s not assume that their legal team can’t find some way to wiggle out of it later. they passed on the ticking bomb to someone else, let’s see how it turns out.

  22. AGG commented on Jul 29

    Now you know where all the accountants from Arthur Andersen went to work.

  23. RobT commented on Jul 29

    The pundits on tv still have the ratchet provision wrong. Its 2.5 bn for the common equity and 2.4 bn for the preferreds. 4.9bn total. This all depends on the offering price too.

  24. JustinTheSkeptic commented on Jul 29

    What’s the chances of Lone Star giving these back? Seems to me that it is almost an implicit garantee.

  25. OhNoNotAgain commented on Jul 29

    Is it just me, or is anyone else getting a Spaceballs vibe every time they read “Lone Star” ?

    If this Lone Star company is a shell, then this is Enron to a tee. What’s the history on this company ?

  26. Don commented on Jul 29

    I actually like the stock sale part of this deal.
    Sell $4billion in stock to Temasek.
    Pay them $2.5 billion on reset
    Sell $3.4 billion in stock to Temasek
    Sold Temasek $7.4 billion in stock and netted $4.9 billion…..

  27. Pat G. commented on Jul 29

    “Less than five and half cents on the dollar?” Isn’t that what the dollar’s worth?

  28. Gloomy commented on Jul 29

    This does sound Enron like. What Enron did was illegal. Isn’t this?

  29. Liv commented on Jul 29

    So if Merrill wrote 30 billion worth of
    CDOs down to 6.7 billion, what is the likely effect on the 29 billion that the Fed is taking the losses on for JP Morgan? Any idea about this?

  30. jc commented on Jul 29

    Grayken The Great Forecloser…
    Lone Star CEO and Founder John Grayken is pictured below ..after having just returned from testifying at his firms trial over market manipulation in South Korea.

    Grayken’s firm is now positioning itself to purchase distressed debt and aggressively foreclose on both residential and commercial real estate properties here in the U.S. “The race is on to play this situation,” he said. Grayken also noted that his firm was not hurt by the subprime meltdown because they only originated the loans, having purchased a “large subprime originator in San Diego.”

    Grayken added that this is as good a market we’ve seen for making lots of money in years and the “key is liquidating collateral.” What this means is that their primary strategy is to aggressively foreclose on both residential and commercial property.

  31. JC commented on Jul 29

    The 75% lent to Lone Star, at what interest rate, zero or just less than market? They financed the Bloomberg sale too, Bloomberg had them by the balz – knew ML had to sell, allowed ML to save face with an OK sale price but again – what were the terms of the loan?

    The devils always in the details, I think the details of the sales and the stock issuance will show their desperation. ML is in a death spiral.

  32. Todd commented on Jul 29

    This is obviously Merrill Lynch’s desperate attempt to use accounting tricks to make earnings look better than they actually are so they can pay their vastly overpaid and overrated executives the typical huge bonuses, while the taxpayers end up holding the empty bag, not to mention their hapless shareholders.

    And, Merrill will of course justify those huge bonuses by claiming they will lose major talent if they don’t pay them. So, of course they’ll get paid. Anyone want to hazard a guess at year end 2008 the amount of bonuses paid out to Merrill employees?

    The names change but the same games go on just like always. Shame on you,John Thain.
    And thanks, BR, for exposing this bullshit to the light of day.

  33. DearJohnThain commented on Jul 29

    Hi Barry,

    I know that it’s certainly conservative to assume that the financing is completely non-recourse to Lone Star, but we don’t know that. It’s pretty common for P.E. funds to have cross-default terms, margin agreements that roll up to an entity beyond the S.P.V., and other provisions ensuring that there isn’t a “jingle mail”–style walk-away event.

    So, while the financing might be non-recourse to Lone Star, that isn’t to say there aren’t protections in place other than the 25% equity being contributed (for example, Merrill might participate in upside). All the above notwithstanding, the fact that the details aren’t disclosed means something, I believe (unless the 60-day closing includes ironing out these terms).


  34. JR commented on Jul 29

    The key words in the article are “an affiliate of” [insert name of shell company here]. The article states that it’s a recourse loan, but it also states that the purchaser will not own any assets other than those sold pursuant to this transaction[has zero assets as collateral to begin with]…………What a sham….

    Use this garbage to get the equity deal done and it gets crazier! I’m just curious as to why Thain said that they shorted 23B of their CDO exposure last call but they still got smoked out!

  35. Groty commented on Jul 29

    If the underlying mortgages don’t perform, then Lone Star tells Merrill to stuff their loan and puts the CDOs back to Merrill.

    Merrill has given up all the upside but retains the downside risk.

    I’m having a brain cramp understanding how Merrill benefits. They’re simply swapping one asset (CDO) for others (cash and a loan), while effectively retaining the downside economic risk of the CDO.

    The devil is in the details. I’d like to look through the purcase agreement and other transaction documents on this one.

  36. DL commented on Jul 29

    I wonder how much pressure Bernanke is putting on the banks to sell their paper. Certainly at some point the Fed has got to stop accepting this mortgage-backed trash as collateral. Once a date certain for that is publicly announced, the paper will be harder to unload in the market, since the “vulture investors” will know at that point that the banks will have to sell at any price. I’m just thinking that maybe the Fed is putting time pressure on the banks to liquidate some of their holdings.

  37. Myr commented on Jul 29

    Barry, you hit the nail on the head. All Thain did was sell a very cheap call option on these super seniors. How can Thain possibly claim that ML sold these tranches? It’s a non-recourse loan to an entity whose only asset is the tranches that it bought from ML by using the loan. And they sold the option too cheaply! Now combine this piece of idiocy with the idiotic fundraising from last December wherein Thain gave Temasek a look back option should Merrill need to raise more money and you have grounds for firing him right now.

  38. techy commented on Jul 29

    can some one please explain to me:

    how can mortgage be reduced to 5.47% of its original value?

    what housing market has lost more than 90% of value?

    i guess i dont even know what those papers are.

  39. John Wellman commented on Jul 30

    Barry, thank you. This post is the epitome of why I read your blog. You provide transparency no average citizen could ever have. Thanks, John Wellman

  40. bob commented on Jul 30

    Who is Lone Star, and how do I join them? Heads they win big. Tails they get their money back. That’s a hellava deal.

  41. Mike in NOLa commented on Jul 30

    Barry, who wants facts? We don’t demand solid facts. What we demand is a total absence of solid facts.

  42. jkw commented on Jul 30

    This isn’t a mortgage, this is an ABS CDO. Depending on the structure, it could be worthless if the mortgages decline by a very small amount. has some good explanations of what all the acronyms mean and how all these structured debt instruments work if you look through the archives.

  43. jkw commented on Jul 30

    Sorry, the url is actually

  44. John commented on Jul 30

    And the stock price goes up…….. It is obvious that I just don’t understand everything I know about this little situation.

  45. John R. commented on Jul 30

    OK, so I’m an idiot. But can anyone tell me in simple layman’s terms why these off-balance-sheet items have any legitimate place in the financial world?

    I mean, some entity somewhere ultimately does hold the bag on them, right? And if things fall apart it will inevitably work its way back to the party that moved it off its balance sheet to begin with, right?

    So in that sense, it’s very much ON the balance sheet, because if everything blows up, then sooner or later it will find its way back to the party that was trying to get it off its books in the first place.


    So what good is it then?

  46. Tom F commented on Jul 30

    Barry- I followed this link from your “Correction” (of Vince F.) in this a.m.’s Columnist Conversation, where you include a partial quote from ML as stating they sold the <=2005 stuff and thus retained the extra-bad 2006-07 stuff on their books. In fact, the full quote is "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"....Read it again---their describing what is left after the sale, the stuff they RETAINED is mostly '05 in earlier (though I htink it would be nice if they told us what the percentages are...). And a technical point with respect to the bullet points above, the notional value of the CDOs is $30bn, but that doesn't necessarily mean Merrill PAID $30bn; they may have paid less (do we kow they have prviously written down $20bn on this portfolio?).

  47. Tom F commented on Jul 30

    JohnR asks:
    “But can anyone tell me in simple layman’s terms why these off-balance-sheet items have any legitimate place in the financial world?”

    Because lawyers and investment bankers make a sh!tload of money putting them together.

    This has been another edition of “Simple Answers to Simple Questions” :)

  48. John Glover commented on Jul 30

    Merrill Gives Up Gains, Is `On Hook’ for CDO Losses (Update2)

    July 30 (Bloomberg) — Merrill Lynch & Co. gave up any potential gains on $30.6 billion of securities it sold this week while remaining “on the hook” for losses, Bank of America Corp. analysts said, revising their earlier positive view of the sale.

    Merrill agreed to sell collateralized debt obligations to private-equity firm Lone Star Funds for about 22 cents on the dollar and to lend about 75 percent of the purchase price. Bank of America analysts, who said yesterday the sale “suggests the endgame” for banks’ CDO risk, today wrote they had overstated the “positive implications” of the transaction.

    A drop in the value of the CDOs by about a further 5 cents would wipe out the equity from Lone Star and “leave Merrill back on the hook for the exposure,” said the analysts, led by Jeffrey Rosenberg in New York. Lone Star bought “the upside of the underlying subprime assets in the CDO pools” while Merrill retained “most of the downside,” they wrote.

    Merrill, the third-biggest U.S. securities firm, has written down or lost almost $52 billion mainly on mortgage-backed CDOs since the third quarter of last year. Financial firms worldwide have marked down or lost $474 billion since the start of the credit crunch.

    Merrill yesterday raised $8.55 billion by selling new shares to cushion the loss on the asset disposal. The bank will have recourse only to the CDOs it sold should Lone Star fail to repay the loan, it said July 28.

    5-Cent Call Option

    Lone Star effectively “purchased a call option on the value of the subprime assets backing the CDO” for the $1.68 billion it paid from its own funds, or about 5 cents on the dollar, the Bank of America analysts wrote today. That is about the level indicated by the lowest-rated portions of the benchmark Markit ABX.HE BBB- indexes of mortgage-backed securities.

    An option gives the holder the right and not the obligation to buy or sell a security at a stated price. A call option, which gives the right to buy, is a bet the price of a security will rise.

    The Bank of America analysts wrote yesterday that the sale “creates initial losses but relieves future uncertainty,” before issuing its report today, titled “On Second Thought?”

    The cost of protecting Merrill against non-payment of its debt fell 15 basis points to 265, according to credit-default swap prices from CMA Datavision in London.

    Credit Quality

    Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A decline indicates an increase in the perception of credit quality. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

    Merrill rose as much as 7.6 percent to $28.25 in New York trading and was at $26.67 by 10:22 a.m.

    Merrill’s sale “may set a benchmark that will be followed by other financials,” BNP Paribas SA analysts wrote in a client note today, saying they “do not believe that other banks” have written off 75 percent of the value of their CDOs as Merrill has.

    “As more firms follow, writedowns will inevitably occur,” according to BNP.

    Citigroup Inc., the biggest U.S. bank, will probably write down the value of CDOs by $8 billion in the third quarter, Deutsche Bank AG analyst Mike Mayo said yesterday. The company may be forced to raise more capital as a result, Mayo said.

    CDOs repackage bonds, loans and credit-default swaps and use the income to pay investors.

    Merrill spokeswoman Jessica Oppenheim in New York said the firm’s policy is to decline to comment on analyst reports.

    To contact the reporter on this story: John Glover in London at

    Last Updated: July 30, 2008 10:50 EDT

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