Whitney Tilson_

Merrill CDO Deal: How Can It Book a 'Sale'?

A friend just emailed me what sounds like a reasonable answer:

I see the Merrill CDO sale to Lone Star differently. The financing was non-recourse, so Lone Star effectively bought a call option on the assets with a strike of $5.025 billion and a premium of $1.675 billion. Depending on the volatility assumption, that implies a value of the assets around $4 to $5 billion. So Merrill should have marked the assets down from $11.1 billion (the mark prior to the sale) to (say) $4.5 billion, showing an additional $6.6 billion loss (not the $4.3 billion they reported). The sale of the call option to Lone Star is presumably at the arm’s length price of $1.675 billion, leaving Merrill with $2.825 billion remaining equity in the asset. So that’s sale proceeds of $1.675 billion, remaining asset value $2.825 billion and $6.6 billion loss; instead of sale proceeds of $6.8 billion, remaining asset value of zero and $4.3 billion loss.

Merrill CDO Deal: How Can It Book a 'Sale'?

To Patrick1980SC's thoughtful comment that Merrill's action DOES qualify as a sale: I agree. My point relates to how the proceeds from the sale are accounted for. MER sold some assets and is getting $1.675 billion for them, PLUS the first $5.025 billion above this, IF the assets are worth this, and then Lone Star gets everything above this. How this is booked as a $6.7 billion sale is beyond me...