Readers may recall that the Federal Reserve created three vehicles to hold dodgy assets it obtained via the Bear and AIG bailouts, namely Maiden Lane (for Bear), Maiden Lane II (for AIG residential mortgage backed securities) and Maiden Lane III (for CDOs the Fed bought as part of taking out AIG credit default swap counterparties at 100% of notional value).
The Fed yesterday reported gains on its exposures in these entities due to improved market conditions. Per the Financial Times:
The US public's hope of getting repaid for the bail-outs of Bear Stearns and AIG in the financial crisis increased on Thursday after the Federal Reserve reported a paper profit for the first time on all the holdings of securities bought from the companies.
A rise in the value of the mortgage-related securities that caused Bear's demise and AIG's near-collapse enabled the Fed to report unrealised gains on all three vehicles it set up to hold assets from the two stricken financial groups.
Yves here. The question is how seriously do we take this report. The authorities havea a funny way of touting mark to market gains, even in bubbly markets, as a sign that All Is Well, then deriding the same MTM values as irrationally depressed when they don’t like the outcome.
Our Tom Adams, who has done extensive valuation work on Maiden Lane III, weights in on the latest report. Not surprisingly, the central bank bank does not provide enough information on its website to allow for quantitative analysis. Tom’s bottom line is that while he finds the change in value reported this quarter to be not entirely implausible, he finds the earlier valuation to be exaggerated. In other words, the percentage gains shown may be defensible, but they were applied to a base number that looks inflated.
From Tom Adams:
The latest report on the Fed’s website for the Maiden Lane III is as of 3/31/10. Overview information:
The original Fed loan was $24.339 billion, AIG’s equity contribution was $5 billion.
As of 12/31/09, the Fed loan had been amortized down to $18.5 billion. In the first quarter, there was another $1.229 billion of amortization, bringing the amortized Fed loan balance to $17.325 billion.
Against this, the Fed claims to have CDOs with a fair market value of $23.699 billion, as of 3/31/10, up 4% from 12/31 of $22.794 billion.
96.6% of the deals in the portfolio are rated BB+ or below, and we know that many of these are in the CCC category.
The Fed’s report continues to break out CDOs by year of origination, even though we know now that companies like TCW traded much of the older collateral out of those earlier CDOs and into new, much worse 06 and 07 MBS. So this categorization by year of CDO closing is meaningless as a credit quality indicator.
By fair market value, 65.1% of the CDOs are “high grade”, 8.9% are mezzanine, 23.3% are CMBS CDOs. Interestingly, $269 million of the portfolio is RMBS – presumably, this is from deals that were liquidated. Another $354 million is cash, which may also have come from liquidations which together with the RMBS equals about 2.6% of the portfolio.
We also know now that the high grade designation is meaningless because so much of the collateral in these deals was other CDOs (an inner CDO squared).
I believe it is not improbable that during the first quarter of this year, the trading value of some CDOs appreciated, given the optimism about the markets recovery. I will expect that the recoveries would be concentrated in the higher rated portions of the collateral underlying high grade deals and CMBS CDOs.
In fact, the change in fair market value for the high grades was 0.24% – basically flat. The mezzanine CDO change in FMV was 5.48% – this seems improbable. The CMBS change in FMV was 17.53%. This doesn’t seem too outrageous. In total, the portfolio’s change in FMV was $905 million, of which $823 million was from the CMBS CDOs.
In general, I thought that the CMBS CDOs were not in as bad a shape as originally treated. In fact, they had much of their posted collateral backed out via the Maiden Lane exchange. These were the late additions from Deutsche Bank. As a result, in concept, I don’t seem it as unreasonable that these have recovered a bit.
However, the problem I have is with the valuation of the high grade deals, prior to the 12/31/09. while they didn’t show much change during the quarter, they appear to be seriously inflated prior to this point, especially given their current rating status.
I would argue that this is the area where Blackrock and the Fed are taking the most liberties by continuing to maintain the illusion that they are high grade and that their year of origination matters, when we know that they are packed with worthless CDO bonds and newer vintage RMBS collateral.
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