Those 2007 Merrill CDOs in Foole

Jul.31.08 | About: Merrill Lynch (MER)

Derivatives consultant Janet Tavakoli landed an RPG on Merrill Lynch’s (MER) we-sort-of-got-the-garbage-off-the-books party Wednesday, in a client letter strongly suggesting that more biohazards may be...ahem...lying in the weeds.

So, how did the CDOs that Merrill Lynch brought to market in 2007 perform? As expected, they are dreadful..

...As of June 10, 2008, of 30 CDOs totaling more than $32 billion in notional amount, 19 have declared an event of default, are in acceleration, or have been liquidated. Ten others are “toast,” as evidenced by downgrades of their “triple A” tranches to junk status, yet I could find no record of a declared event of default [EOD]. The remaining CDO has “triple-A” tranches downgraded to junk, but the two topmost tranches are still rated investment grade (the topmost is Aa1 neg/ AAA neg and the formerly “triple-A” tranche below that is Baa2 neg/ BBB+ neg). The EOD may be undeclared due to documents that avoid that declaration so that investors cannot trigger acceleration or liquidation (or the declaration may be pending).

While the main point of Tavakoli’s missive was to point out that the securitization market will remain becalmed until investors regain some trust in the investment banks and CDO managers that gorged at the trough, the assay of Mother Merrill’s 2007 bowel movements is eye-watering. Two things:

  • Merrill Lynch said that the stuff it loosely characterized as having “sold” to Lone Star was “US super senior ABS CDO, the majority of which comprises older vintage collateral – 2005 and earlier.” Interesting, as those older vintages were solid gold (although 2005 was probably only 9 ct) compared with the bags of wet newspapers issued in 2007.
  • It’s impossible to tell from Merrill Lynch’s entirely legal but deliberately and utterly Delphic disclosures how much of that vintage 2007 vintage is still on the books, and where it’s marked. Good luck, Temasek, especially now you’ve given up the death spiral part of the earlier deal!

Dead Calm: No One Trusts You
(Don’t miss the table on Page 3)
by Janet Tavakoli
Tavakoli Structured Finance Jul. 30 2008

Merrill Lynch Announces Initiatives to Further Enhance Capital Position
Press release
Jul. 28 2008