Posted on 26 Apr 2012
Two bundles of bonds that once helped sink American International Group Inc. now have Wall Street salivating. Some of the biggest banks are teaming up to jockey for the securities, which may be sold in coming days by the Federal Reserve Bank of New York. The banks would then sell the bonds off to clients such as money managers, hedge funds and insurance companies.
With the Thursday morning bidding deadline looming, Credit Suisse AG, Goldman Sachs Group Inc. and Citigroup Inc. have joined forces in recent days, as have Bank of America Corp., Morgan Stanley and Nomura Holdings Inc. Two firms that have already have interests tied to securities, Barclays PLC and the original underwriter, Deutsche Bank AG, are planning on bidding together as well.
At stake are some $7.5 billion in face value of bundles of bonds known as collateralized-debt obligations, or CDOs. While the New York Fed has previously sold securities it picked up in its AIG rescue, this batch and others in the portfolio represent some of the most complex bonds of the pre-financial crisis era.
The bonds are composed of commercial mortgage-backed securities and were issued near the peak of the real-estate boom. The CMBS are now attractive to investors because they offer substantial interest rates at a time when high-yielding debt is in short supply.
The planned sales by the regional Fed bank come more than three years after banks including Bank of America, Barclays, Deutsche, Goldman and Morgan Stanley were paid billions of dollars by AIG and the New York Fed to exit souring trades the banks had with the insurer during the crisis. The banks in late 2008 were paid a total of 100 cents on the dollar for CDOs, which had plunged in market value. Investors can now buy the securities in some cases for less than half their face value.
The securities up for bid represent about one sixth of the bonds in a vehicle called Maiden Lane III that have an unpaid principal balance of $47 billion. The CDOs held in Maiden Lane III had an average fair-market value of about 36 cents on the dollar at the end of 2011.
A sale isn't certain, as the New York Fed has said that it would sell only if the price represented good value to the public. But market participants say there should be ample appetite for the securities. "It's a very good time to bring this to market," said Edward L. Shugrue III, chief executive of Talmage LLC, which has $1.7 billion invested in CMBS and real-estate debt.
That demand is drawing the interest of the banks, even though turning these bonds around will be no mere flip job: The winning bidders may have to repackage billions of dollars worth of their most arcane securities dating from the peak of the credit boom into new, highly rated bonds attractive to risk-averse investors.
"To see one of this size, that's been in isolation or one that's almost been in a cryogenic freezer for four years, that's a pretty rare event," said Darrell Wheeler, a CMBS strategist at Amherst Securities.
The bidding is the latest sign of the New York Fed's progress in selling the remnants of its 2008 rescue of AIG, which involved as much as $182 billion in aid and has left the government with a 70% stake in the insurer.
The Bank of America dealer group on Tuesday suggested in notes to investors that it might bid in the low-60 cent on the dollar range for the assets, which analysts at two other firms said were worth more than 80 cents on the dollar. The bid was probably factoring for possible costs of breaking the CDO into parts, and compensating for any decline in market prices pressured by related sales, according to analysts.
These costs are limiting what the dealers can offer the New York Fed, which could dissuade the bank from conducting the sale of the assets at all. But some dealers are trying to avoid breaking up the CDOs.
Taxpayers are unlikely to incur losses because not all the money the banks received came from the New York Fed. More than half of a $24.3 billion loan the Fed provided to fund the purchase of the CDOs has been repaid, and the securities are now worth significantly more than the remaining loan balance.
New issue volume for CMBS is a fraction of what it was during the boom years. The amount outstanding shrank by about $43 billion in the past year, to $584 billion, according to Bank of America Merrill Lynch.