Learn about Bailout 12: Lone Star Transaction Video

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Learn about Bailout 12: Lone Star Transaction

Learn about Bailout 12: Lone Star Transaction I tend to do a lot of videos with simplified examples and round numbers but let’s get a little a bit of dose of reality and actually analyze a real transaction that happened just to show to you that some of these CDOs are selling for—well below what the people paid for them or what they were listed as on the books. And even the price is actually, probably even worth less than what the person actually pays, let’s just analyze this and then I’ll let you make your own conclusions. So, this was a press release. This is part if the press release that Merril Lynch sent out on July 28th and just remember, they had just finished reporting earnings as of June 30th date. That’s when the do a snapshot of their books so to keep that in the back of your mind, right? So it says, on July 28th, Merril Lynch agreed to sell $30.6 billion gross notional amount of U.S. super senior ABS CDOs to an affiliate of Loan Star Funds. So this is important. So the $30.6 billion, what is that? That’s the number that either Merril Lynch originally paid for or with the amount that they originally valued those CDOs is. So, it is $30, B gross notional—notional. I have a notion that’s worth this. Notional amount of U.S. super senior—that sounds safe. Super Senior ABS, which is short for Asset Back Security CDOs. We know a lot about CDOs now; collateralized debt obligations—to an affiliate of Loan Star Funds. So this is a Taxes Private Equity firm. I’ll underline them in green because I think they know what they’re doing. For a purchase price of $6.7 billion so just off that first line, it’s very superficial before do any other real analysis. Notice that at one time, there was an asset that someone had a notion was worth $30.6 billion and now, they sell to this private equity firm for $6.7 billion. So what’s the recovery on that asset; just superficially? And we’re going to do some—we’re going to dig in a little bit and realize that the cover is even worse than that. So they paid—they we’re able to sell for 6.7, something that they originally thought was worth 30.6. So that’s 22 cents on the dollar. So this at least with that first sentence implies that this 22 cents on the dollar—at least relative to the original amount that those assets were put at. At the end of the second quarter of 2008—notice, the end of the second quarter of 2008 was 4 weeks ago relative to this press release, that’s June 30th, four weeks ago, right? Not a lot can happen in four weeks. At the end of the second quarter of 2008, these CDOs were carried at $11.1 billion. So this is interesting. So Merril Lynch shed 1.—probably last year—had these assets on their balance sheet for $30.6 billion. They too realized that they were stinky assets and they were said, well we have to—you know, just to be somewhat genuine, we have to write it down, these assets a little bit but—and I notice they don’t want to write them down too much because if they write them down too much, no one else is going to want to invest in Merril Lynch or maybe they’ll say, Merril Lynch a problem—not even have anything left. But at some point they said, you know what? We’ll be pseudo honest with the market and these things that were worth $30.6 billion, we’re going to write them down to $11.1 billion. So they must have taken—if they did that in one period, I don’t know how many periods it took them to realize that this $30.6 billion asset was really worth 11.1. But in those periods, they would have had to take—what is that? It is $29.5 billion right down, right? But as recent—and you know they did that to look I guess pseudo honest that the asset is worth 11 billion. But they evaluated 11 billion and then four weeks later, they sell it for 6.7 billion. So whatever was on their books on as far as this asset is concerned. Well, never was on their books on July 1 or in June 30th, what are they’re—we’re getting recovery relative to that. They’re getting $6.7 billion for something that is just four weeks ago. Not a lot can happen in four weeks. 11.1 And then I can delete that. So they got 60 cents of the dollar relative to what was on their books as of June 30th, right? So it’s a 60 cent recovery relative to what they thought it was worth only four weeks ago. And then they say—and in connection with this sale, Merril Lynch has to—we’ll record it right down, essentially we—you know, not we sold this thing so now we have to essentially come to terms with reality. So they recorded a write down of 4.4 billion pretax. And what’s 4.4? That’s the difference between what they thought it was worth; between the 11.1 billion. And what it ended up being worth or 6.7 billion. Now this is—what’s interesting here is that’s not the end of the bad news. You might think that’s bad enough, they were only able to get 22 cents on the dollar for something that they originally valued at 30.6 or what—four weeks ago, they evaluated 11.1 billion, right? And I don’t think they got a lot more information. I think they just put that 11.1 billion down and on June 30th just because it was probably a convenient number, enough of a write down to make it look like you’re writing things down but not so much of a write down to scare people too much. But this is the interesting part. I mean this paragraph talks a little bit about their exposure and we can get into that but if I talked about that, that I can talk for another 20 minutes. But let’s get to this last paragraph that was buried in the press release and this is really the cracks of things. And this I think will give you a clue of the shell games that the financial industry tries to play on people. Merril Lynch will provide financing to the purchaser for approximately 75% of the purchase price. So Loan Star Funds, they’re buying it for 6.7 billion but 75% of that is a loan for Merril Lynch. So, how much were they lending? Let’s see 6.7 × 0.75. They’re lending them 5—well roughly $5 billion, right? So Merril Lynch is lending $5 billion. Let me—I don’t like that color. It is $5 billion. So Loan Stars say s these things are so stinky, we’re only going to pay $6.7 billion for them. And in fact, they’re even stinkier than that. In order for me to buy them, I don’t even want to buy them with my money. You’re going to have to lend me most of the money to buy that asset. And even this wouldn’t be so bad if you just lent it generally the Loan Star and if—you know one day—you know Loan Star—if these assets were worth nothing, you can still go after Loan Stars other assets, right? If you could just go after Loan Star generally, maybe this loan isn’t such a crazy thing because maybe Loan Star has a lot of assets. I don’t know but I suspect that they’re a fairly large private equity firm. And this is—I mean this is just insult to injury right here. You got to give credit to those Loan Star guys. The recourse on this loan—so that—the recourse is essentially what you can go after if the person decides that they don’t feel like paying that loan. The recourse on this loan will be limited to the assets of the purchaser. The purchaser will not own any assets other than those sold pursuit to this transaction. So essentially, what Loan Star did—because Loan Star does own assets other than essentially this asset that is buying right now or I am guessing it does. And it’s a real private equity firm. What they probably did is they created a corporation that does not own anything else, right so that if they default, nothing’s left. So they created a corporation. They capitalized that corporation with whatever—$1.7 billion. They—so essentially Loan Star puts $1.7 billion in that fund. Merril into that—you know the Loan Star Funds or whatever; an affiliate. The affiliate is probably the corporation that they created. So, this affiliate is created by Loan Star. Loan Star puts in $1.7 billion into it. Merril Lynch lends this affiliate $5 billion. And then this affiliate buys or you know, Merril Lynch is able to off load this $6.7 billion onto that affiliate and this is a special purpose entity if I’ve ever heard of one because its purpose if very special essentially for Merril Lynch to take some off of its books and not have to write it down all the way. Because think about what happens. Let’s say that these assets are worth zero. Let’s just say that they’re completely worth it and actually out in the previous video, I showed you why that could the case. What’s the loss to Loan Star? Well Loan Star, they don’t have to pay the $5 billion back. We just said the purchaser will not own any assets other than those sold pursuit to this transaction. And that the recourse is only those assets, right? So, if they don’t pay that loan back, Merril Lynch, all they can do is take back those worthless assets. And then what’s going to happen? Well then Loan Star is just going to lose $1.7 billion. Or even better, what if those assets are only worth $1.7 billion, right? Let’s think about that example. Let’s say those assets are worth $1.7 billion and Loan Star says, you know what, we don’t feel like paying back this $5 billion loan. What’s going to happen? Merril Lynch is going to just take back those $1.7 billion of assets. So what’s the Loan Star’s downside? It is $1.7 billion. So essentially, what are they paying for it? They’re essentially paying $1.7 billion and they’re kind of sharing the upside in between $1.7 and $5. So really, if you think that they’re paying $1.7 or even a little bit more—really—what’s Loan Star putting at risk? $1.7 So $1.7 billion divided by—well what’s the original notional value of this asset? So they’re paying 6 cents on the original notional value. And what are they paying relative to what Merri Lynch told, its shareholders, this asset was worth four weeks before this press release? They’re paying 15 cents on the dollar relative to that. Well anyway—and this is a real world example. This was not made up by me and frankly I don’t think I could have made up something this outlandish but it hopefully gives you an idea of what is actually going on in the real world.

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Learn about Bailout 12: Lone Star Transaction

I tend to do a lot of videos with simplified examples and round numbers but let’s get a little a bit of dose of reality and actually analyze a real transaction that happened just to show to you that some of these CDOs are selling for—well below what the people paid for them or what they were listed as on the books. And even the price is actually, probably even worth less than what the person actually pays, let’s just analyze this and then I’ll let you make your own conclusions.

So, this was a press release. This is part if the press release that Merril Lynch sent out on July 28th and just remember, they had just finished reporting earnings as of June 30th date. That’s when the do a snapshot of their books so to keep that in the back of your mind, right?

So it says, on July 28th, Merril Lynch agreed to sell $30.6 billion gross notional amount of U.S. super senior ABS CDOs to an affiliate of Loan Star Funds. So this is important. So the $30.6 billion, what is that? That’s the number that either Merril Lynch originally paid for or with the amount that they originally valued those CDOs is.

So, it is $30, B gross notional—notional. I have a notion that’s worth this. Notional amount of U.S. super senior—that sounds safe. Super Senior ABS, which is short for Asset Back Security CDOs. We know a lot about CDOs now; collateralized debt obligations—to an affiliate of Loan Star Funds. So this is a Taxes Private Equity firm. I’ll underline them in green because I think they know what they’re doing.

For a purchase price of $6.7 billion so just off that first line, it’s very superficial before do any other real analysis. Notice that at one time, there was an asset that someone had a notion was worth $30.6 billion and now, they sell to this private equity firm for $6.7 billion. So what’s the recovery on that asset; just superficially? And we’re going to do some—we’re going to dig in a little bit and realize that the cover is even worse than that.

So they paid—they we’re able to sell for 6.7, something that they originally thought was worth 30.6. So that’s 22 cents on the dollar. So this at least with that first sentence implies that this 22 cents on the dollar—at least relative to the original amount that those assets were put at.

At the end of the second quarter of 2008—notice, the end of the second quarter of 2008 was 4 weeks ago relative to this press release, that’s June 30th, four weeks ago, right? Not a lot can happen in four weeks. At the end of the second quarter of 2008, these CDOs were carried at $11.1 billion. So this is interesting.

So Merril Lynch shed 1.—probably last year—had these assets on their balance sheet for $30.6 billion. They too realized that they were stinky assets and they were said, well we have to—you know, just to be somewhat genuine, we have to write it down, these assets a little bit but—and I notice they don’t want to write them down too much because if they write them down too much, no one else is going to want to invest in Merril Lynch or maybe they’ll say, Merril Lynch a problem—not even have anything left. But at some point they said, you know what? We’ll be pseudo honest with the market and these things that were worth $30.6 billion, we’re going to write them down to $11.1 billion. So they must have taken—if they did that in one period, I don’t know how many periods it took them to realize that this $30.6 billion asset was really worth 11.1.

But in those periods, they would have had to take—what is that? It is $29.5 billion right down, right? But as recent—and you know they did that to look I guess pseudo honest that the asset is worth 11 billion.

But they evaluated 11 billion and then four weeks later, they sell it for 6.7 billion. So whatever was on their books on as far as this asset is concerned. Well, never was on their books on July 1 or in June 30th, what are they’re—we’re getting recovery relative to that. They’re getting $6.7 billion for something that is just four weeks ago. Not a lot can happen in four weeks. 11.1 And then I can delete that.

So they got 60 cents of the dollar relative to what was on their books as of June 30th, right? So it’s a 60 cent recovery relative to what they thought it was worth only four weeks ago. And then they say—and in connection with this sale, Merril Lynch has to—we’ll record it right down, essentially we—you know, not we sold this thing so now we have to essentially come to terms with reality.

So they recorded a write down of 4.4 billion pretax. And what’s 4.4? That’s the difference between what they thought it was worth; between the 11.1 billion. And what it ended up being worth or 6.7 billion.

Now this is—what’s interesting here is that’s not the end of the bad news. You might think that’s bad enough, they were only able to get 22 cents on the dollar for something that they originally valued at 30.6 or what—four weeks ago, they evaluated 11.1 billion, right? And I don’t think they got a lot more information. I think they just put that 11.1 billion down and on June 30th just because it was probably a convenient number, enough of a write down to make it look like you’re writing things down but not so much of a write down to scare people too much.

But this is the interesting part. I mean this paragraph talks a little bit about their exposure and we can get into that but if I talked about that, that I can talk for another 20 minutes. But let’s get to this last paragraph that was buried in the press release and this is really the cracks of things. And this I think will give you a clue of the shell games that the financial industry tries to play on people.

Merril Lynch will provide financing to the purchaser for approximately 75% of the purchase price. So Loan Star Funds, they’re buying it for 6.7 billion but 75% of that is a loan for Merril Lynch.

So, how much were they lending? Let’s see 6.7 × 0.75. They’re lending them 5—well roughly $5 billion, right? So Merril Lynch is lending $5 billion. Let me—I don’t like that color. It is $5 billion.

So Loan Stars say s these things are so stinky, we’re only going to pay $6.7 billion for them. And in fact, they’re even stinkier than that. In order for me to buy them, I don’t even want to buy them with my money. You’re going to have to lend me most of the money to buy that asset. And even this wouldn’t be so bad if you just lent it generally the Loan Star and if—you know one day—you know Loan Star—if these assets were worth nothing, you can still go after Loan Stars other assets, right? If you could just go after Loan Star generally, maybe this loan isn’t such a crazy thing because maybe Loan Star has a lot of assets. I don’t know but I suspect that they’re a fairly large private equity firm.

And this is—I mean this is just insult to injury right here. You got to give credit to those Loan Star guys. The recourse on this loan—so that—the recourse is essentially what you can go after if the person decides that they don’t feel like paying that loan. The recourse on this loan will be limited to the assets of the purchaser. The purchaser will not own any assets other than those sold pursuit to this transaction.

So essentially, what Loan Star did—because Loan Star does own assets other than essentially this asset that is buying right now or I am guessing it does. And it’s a real private equity firm.

What they probably did is they created a corporation that does not own anything else, right so that if they default, nothing’s left. So they created a corporation. They capitalized that corporation with whatever—$1.7 billion. They—so essentially Loan Star puts $1.7 billion in that fund. Merril into that—you know the Loan Star Funds or whatever; an affiliate. The affiliate is probably the corporation that they created.

So, this affiliate is created by Loan Star. Loan Star puts in $1.7 billion into it. Merril Lynch lends this affiliate $5 billion. And then this affiliate buys or you know, Merril Lynch is able to off load this $6.7 billion onto that affiliate and this is a special purpose entity if I’ve ever heard of one because its purpose if very special essentially for Merril Lynch to take some off of its books and not have to write it down all the way.

Because think about what happens. Let’s say that these assets are worth zero. Let’s just say that they’re completely worth it and actually out in the previous video, I showed you why that could the case.

What’s the loss to Loan Star? Well Loan Star, they don’t have to pay the $5 billion back. We just said the purchaser will not own any assets other than those sold pursuit to this transaction. And that the recourse is only those assets, right? So, if they don’t pay that loan back, Merril Lynch, all they can do is take back those worthless assets. And then what’s going to happen? Well then Loan Star is just going to lose $1.7 billion.

Or even better, what if those assets are only worth $1.7 billion, right? Let’s think about that example. Let’s say those assets are worth $1.7 billion and Loan Star says, you know what, we don’t feel like paying back this $5 billion loan. What’s going to happen? Merril Lynch is going to just take back those $1.7 billion of assets.

So what’s the Loan Star’s downside? It is $1.7 billion. So essentially, what are they paying for it? They’re essentially paying $1.7 billion and they’re kind of sharing the upside in between $1.7 and $5.

So really, if you think that they’re paying $1.7 or even a little bit more—really—what’s Loan Star putting at risk? $1.7 So $1.7 billion divided by—well what’s the original notional value of this asset? So they’re paying 6 cents on the original notional value. And what are they paying relative to what Merri Lynch told, its shareholders, this asset was worth four weeks before this press release? They’re paying 15 cents on the dollar relative to that.

Well anyway—and this is a real world example. This was not made up by me and frankly I don’t think I could have made up something this outlandish but it hopefully gives you an idea of what is actually going on in the real world.

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