Toxic assets from financial crisis could become AAA bonds

Tue Apr 24, 2012 4:59pm EDT

April 24 (IFR) - Bank of America and Morgan Stanley plan to re-sell some of the toxic real-estate securities damaged during the financial crisis as high-grade bonds, if they can win them at auction from the Federal Reserve, sources said on Tuesday.

The two banks have teamed up to bid this week on some of the assets on offer in Maiden Lane III, part of the portfolio the Fed acquired when it bailed out AIG in 2008.

The highly technical securities, underpinned by commercial real-estate mortgages, some of which went sour in the crisis, would be repackaged to make them more palatable to investors.

BofA and Morgan Stanley are among eight broker-dealers invited to bid on the latest batch of AIG assets being sold by the Fed, and have teamed up in a joint bid for the securities.

According to an investor who has seen their proposal, the assets would be re-structured as a product called a "re-remic" -- allowing the banks to create AAA-rated securities out of slices of the original assets that are almost 50% junk-rated at present.

The two institutions announced on Tuesday that they were teaming up to vie for the $7.5bn in collateralized debt obligations, or CDOs, currently on offer.

Goldman Sachs, Credit Suisse, and Citigroup are also uniting to bid on the assets, while Deutsche Bank, Barclays and Nomura are each submitting individual bids.

Bids are due on Thursday morning, though there is no fixed timetable for the sale to be completed. Bank of America and Morgan Stanley both declined to comment.

THE ART OF THE DEAL

Re-remics are now fairly common investment vehicles offered by broker-dealers, who have tried to re-sell the toxic assets that helped spur the worst crisis since the Great Depression.

Because of new capital regulations put in place since then, banks have an urgent need to replace the downgraded assets on their balance sheets with investment-grade holdings.

At the same time, high-grade ratings would open the door to institutional investors that are prohibited from investing in junk-rated bonds -- that is, they would widen the pool of potential buyers.

But while the enhanced ratings help boost investor appeal, these sophisticatedly repackaged re-remics can be hard to discern from the original toxic securities out of which they were created -- and many have not performed well in the market.

Sources said the team of Citigroup, Goldman Sachs and Credit Suisse would not re-remic the securities if it wins the auction, while one source said the Barclays pitch includes a re-remic.

The current structure of the Maiden Lane III bonds on offer are estimated to be worth between upper-50 cents to lower-60 cents on the dollar.

"We are hearing some dealers saying (the Maiden Lane III CDOs) are in fact 're-remicable'", one trader wrote to clients in a note last week.

"That's an awfully big bet to take, and seems very expensive," the trader said, citing legal fees as well as the cost for a ratings agency to grade the new re-remic.

As they stand, the Maiden Lane III CDOs on offer are rated B+/Ba1 by S&P and Moody's, respectively -- both junk ratings.

Bank of America, in a research report last week, said turning them into a re-remic structure would garner vastly expanded investor interest.

The bank's analysts said there would also be interest in the subordinated debt portions of the new structure, which would "appeal to opportunity funds or private equity type accounts looking for potential yields in the mid-to-high teens."

But there could well be obstacles to creating the new structure -- not least that Barclays is already counterparty to a derivative swap on the Maiden Lane CDOs.

That position would have to be unwound before the CDOs could be turned into a re-remic, which would be expected to make the already highly complex proposal even more difficult.

And the re-remic structure itself could make it difficult to break down the Maiden Lane III CDOs to get at the underlying assets most coveted by investors -- securities backed by bundles of mortgages, known as CMBS, and many of which remain AAA-rated.

The CMBS underneath the Maiden Lane CDOs are widely considered to have a much greater market value than the CDOs themselves, and whoever wins the auction would presumably break the CDOs apart to sell them as the smaller, more lucrative pieces.

"If you re-remic it," said one CMBS investor, "the chance of collapsing it is almost zero.

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