Thoughts on Maiden Lane III

After losing their court cases to keep bailout data secret, the Federal Reserve has finally complied with the minimum of what is lawful, and published PDFs of the Maiden Lane Portfolios.  The data is minimal – principal amount, deal/tranche description, and CUSIP (if any).  Out of the goodness of their hearts (not), the Fed locked the PDFs, making it impossible to copy the data into Excel easily.

I printed the documents and scanned them in using OCR, and pasted them into Excel.  Even with 99% accuracy, it took a while to scrub the data of the smallest portfolio, Maiden Lane III, which was the bailout of AIG.  I hope to do a similar analyses of II (likely) and I (maybe, tall order).

I don’t have access to advanced analytics that the best bond shops do.  If anyone wants to improve on what I have written here, e-mail me; I can send you an Excel file with correct CUSIPs and principal amounts.  It will save you two hours of time in your analysis.

Here are my main findings:

  • The average rating on the bonds in the portfolio is B-, with 61% rated CCC or lower.  (Composite rating of Moody’s, S&P, and Fitch.)
  • 98.3% of the portfolios are some type of CDO.
  • On average, the deals owned were originated in 2006, with 73% between 2005 and 2007, and 96% between 2004 and 2008.

Here are some tables:

RatingPrincipal $KPercentage
AAA386,339

0.7%

AA330,375

0.6%

A1,203,294

2.2%

BBB7,575,198

13.6%

BB1,500,841

2.7%

B10,662,978

19.2%

CCC22,734,918

40.9%

CC8,934,106

16.1%

C2,066,434

3.7%

D216,211

0.4%

Total55,610,694
Collateral TypePrincipal $KPercentage
CDO21,666,184

39.0%

CF-CDO4,900,206

8.8%

CF-CDO-SP28,078,341

50.5%

Other965,963

1.7%

Total55,610,694

98%+ CDOs.  50%+ structured product CDOs.

Issue YearPrincipal $KPercentage
2002803,181

1.4%

2003726,377

1.3%

20047,332,735

13.2%

200517,666,522

31.8%

200610,127,922

18.2%

200712,730,293

22.9%

20085,403,463

9.7%

2009820,201

1.5%

Total55,610,694

Offering Some Color

In the bond market, it is not uncommon for a broker to give, or for a portfolio manager or trader to ask for “color.”  Fill in the details; why is this bond so great, or lousy?  Though I don’t know all of the deals in detail, I have enough information to explain how lousy the collateral is that AIG gave the Fed.

First, the average rating on the bonds in the portfolio is B-, with 61% rated CCC or lower.  For those not familiar with ratings:

  • AAA means you can survive a Depression
  • BBB means that you can survive a normal recession.
  • BB is junk grade, and the strongest that might not survive a normal recession.
  • CCC means economic conditions must be perfect for the company to stay current on its debt.
  • D is default.

For those not familiar with managing credit-sensitive bonds, the difference in likely default losses is minuscule between AAA and BBB bonds.  That is why they are called investment grade.  Below BBB, loss rates turn up with a vengeance.  For the portfolio to be B- rated on average, with 61% CCC and below is very bleak indeed.

Now, these are CDOs, and over half are CDOs with structured products in them.  CDOs themselves are a structured product in their own right.  Structured products, when they default, tend to be total losses (or close to it), unlike corporates, where recoveries are 30-40% or so of the face amount.  Add to this that CDOs tend to be the worst performing structured product in a crisis.

With 61% of the portfolio rated CCC or below, and 80% rated B or below, there is a large possibility that the $56 billion of notes will have a hard time exceeding the $22 billion of fair value that the Fed marks the assets at.  These are horrible quality notes, and the structure inherent in the notes makes them weaker in a stress scenario.

Finally, the vintage of the bonds in the portfolio is concentrated in the worst years, credit-wise, to be originating deals.  My rule of thumb is that deals originated after 2005 are bad, 2005 and 2004 are suspect, and 2003 and before are fine.  Half of the deals were offered 2006 and after, and 80%+ 2004 and after.

As the bubble grew, deals issued later had worse credit characteristics.  Perhaps deals in 2009 are improvements over 2008, but there was credit devaluation 2003-2008.

Summary

AIG probably took the Fed for a ride here.  Personally, I suspect the Fed, despite all of the Ph.Ds that they employ, did not have enough “street smarts” to reject such a portfolio when the crisis hit.  One unwritten rule about CDO ratings is that if they go down,  they will go down much more, and often to default.  CDOs are among the shakiest asset sub-classes out there.  Why did the Fed accept them as collateral?  A lesson to all, do not make decisions during a time of panic; almost all of us make bad decisions then.

Again, if you want to help me with this and have more resource for analysis than an ordinary Bloomberg Terminal might have, please contact me.  Thanks.

13 Comments

  • jck says:

    Maybe the notes are horrible quality, but they were bought at a massive discount and they throw a lot of cash: $7.4 billion of the original loan ($24.3 billion) has been paid back (that’s 30% of the original balance, ML II has paid back 23% of its loan).
    The Fed is in the position (forced position now that the portfolio is public) of being able to wait for the actual credit losses to materialize, and so far they are minimal, none on the MAX series on the book held by ML III.
    It will be very hard for the Fed to lose money on that deal. I don’t agree that AIG took the Fed for a ride, rather AIG, just like a trader unable to meet a margin call, was liquidated and forced to take a mark to market loss at the worst possible time.
    I find the focus on ML III interesting, it is the best performing of the ML family by far. Meanwhile the ML vehicle(Bear Stearns) has paid back nothing, if the Fed has been taken for a ride it’s by JPM.

    • jck, thanks as always. Could you point me to those payments? I looked for them but could not find them.

      My comment was based off of the $22 billion fair value estimate, which is indeed deeply discounted, but may not be discounted enough. I have some thrid parties looking at pricing, and hope we can shed more light on the topic.

  • DAS says:

    In general it doesn’t matter which firm took the Fed for a ride. We all can see that the Fed knowingly acquired these assets from these firms understanding how poor the assets were; otherwise why would they have to acquire them to begin with? It is interesting though to see what is going on with the people involved with these purchases on the Fed side. It seems like the conflicts of interest exposed when an industry’s regulators get advice from the very people that they regulate – and need help because of their ill conceived efforts to circumvent those very regulators, can create scary levels of transparency. If anything, I hope that these disclosures shine a light on the flawed system and how the American taxpayer is being pushed around by the confidence men at the heart of the decision making during this period. I just hope that the Fed doesn’t show a bias in their monetary policy decisions going forward, in an attempt to keep these assets performing at a level that won’t raise more questions and criticism. Sadly, if they do, we are going to see massive inflation and low interest rates for only bankers, as the risk premium for everyone else starts reflecting the real market risks created by those bankers. I hope that people don’t start looking into how the actions of the banks and the Fed have affected the States an Municipal governments, who got use to high tax revenue created by the inflated housing prices (real estate tax) and the large consumer spending (sales tax) perpetuated by the easy money that was available. Never mind the derivative losses and the easy access local governments had to their own cheap money, that is the tip of the iceberg, not the part tearing into the hull.

  • cellardoor says:

    To make your life easier, unsecured, data-directly exportable, copies of ML and ML II. (I assume since you ocr’d and cleaned III already, you don’t need a copy of those:

    ML I
    http://ifile.it/6p1v4as

    ML II
    http://ifile.it/0uyhmga/ML_II_Holdings.pdf

  • Sam says:

    Thanks for the analysis. For those without access to a Bloomberg terminal like me, this is eye-opening indeed.

  • jck says:

    Shown on the weekly H.4.1 release “Information on Principal Accounts of Maiden Lane..” in “Memorandum Items” #4 #5 #6
    The fair value estimate on the balance sheet is not the amount of the loan.
    Best to check and compare the balance outstanding vs original.

  • maynardGkeynes says:

    Buying assets where there is even a possibility of an insufficient haircut, which it appears that jck concedes here, is fiscal policy, not monetary policy. This is what Volcker hinted at when he said that the Fed had gone to the very edge of its legal authority if not beyond. He is right, and it needs to be examined for legality, and clawed back from JPM.

  • Your discussion of the Ratings scale may be a bit off as CDO’s were rated using a seperate scale. Corporate, municipal and sovereign debt and CDO’s used different scales, so the “survivability” analog may not be accurate in terms of survivability.

    A better indicator of quality may be the speed with which a cohort of the respective debt is degrading in either performance, related tranches prices and or ratings.

  • Nick, could you point me to the difference in the rating scales? Thanks for posting.

  • csissoko says:

    Thank you for the info.

    Building on jck’s info:

    The changes in the book value of the NY Fed’s Maiden Lane III account are as follows (millions of dollars):

    11/26/2008 15134
    12/24/2008 9205
    3/11/2009 -303
    4/8/2009 -494
    5/6/2009 -550
    6/10/2009 -592
    7/8/2009 -1643
    8/12/2009 -561
    9/9/2009 -622
    10/7/2009 -538
    11/11/2009 -421
    12/9/2009 -456
    1/13/2010 -416
    2/10/2010 -376
    3/10/2010 -438

    Which raises some more questions:
    Why wasn’t there a cash payment in January or February 2009?
    Why was there such a large cash payment in July 2009?

  • jck says:

    “Why wasn’t there a cash payment in January or February 2009?”
    because they were building the “Expense Reimbursement Sub-Account and Investment Reserve Sub-Account”
    “Why was there such a large cash payment in July 2009?”
    because they depleted the “Expense Reimbursement Sub-Account and Investment Reserve Sub-Account”

  • csissoko says:

    @ jck Thank you!

  • Fat Man says:

    “AIG probably took the Fed for a ride here.”

    Forget AIG, they did not get the money. Goldman Sachs and a bunch of European Banks took the Fed for every cent they could.

1 Trackback