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.