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UPDATE 1-Barclays, Deutsche Bank win auction of toxic AIG assets
April 26, 2012 / 8:51 PM / in 5 years

UPDATE 1-Barclays, Deutsche Bank win auction of toxic AIG assets

By Adam Tempkin and Karen Brettell

April 26 (IFR/Reuters) - Barclays and Deutsche Bank on Thursday won a fierce bidding war for a portfolio of toxic assets the US government acquired in the 2008 bailout of insurance giant AIG.

The Federal Reserve announced it had selected the two banks to buy two vast collateralized debt obligations (CDOs), consisting of bundles of commercial mortgage bonds, which have a face value of $7.5 billion.

The CDOs helped bring down AIG, which needed a massive federal bailout, and were not long ago seen as the kind of toxic re-packaged real-estate assets that spurred the financial crisis.

But with interest rates at current lows, even the worst of the mortgage bonds underlying the CDOs are now much more attractive investments -- just one reason that nearly every major Wall Street bank entered the auction.

Barclays and Deutsche Bank beat out two rival consortia, one comprised of Bank of America, Morgan Stanley and Nomura, and the other grouping Citigroup, Goldman Sachs and Credit Suisse.

The Fed did not disclose how much the winners would pay, although the assets were widely estimated to fetch around 60 cents on the dollar.

The banks likely bid greater than 65.6 cents on the dollar, suggesting that the winner paid full market value for their bonds, according to a research article published on Thursday afternoon by CMBS strategists at Amherst Securities. The analysts also reported that Deutsche Bank and Barclays were able to pre-place all of the underlying CMBS bonds.

“I am pleased with the level of interest and the results of this process, especially with the strength of the winning bid,” said William Dudley, president of the New York Fed.

All the groups of banks were actively soliciting their own bids from investor-clients before Thursday’s auction, indicating the CDOs are likely to be quickly re-sold - perhaps broken down into their constituent mortgage bonds or even re-packaged as AAA-rated securities.

Analysts who track AIG for Sanford C. Bernstein & Co said in a report earlier this month that the winning bidders would be able to realize a profit from breaking apart the CDOs and re-selling the separate pieces “in classic Wall Street fashion”.

But not all investors have been impressed by the real value of the assets, however they may be re-sliced and diced, as nearly half those underlying mortgage bonds are junk-rated.

“I probably would shed few tears for the type of investors inclined to get involved here,” said Chris Sullivan, chief investment officer of the United Nations Federal Credit Union.

“They’re big boys and girls who probably feel quite confident arriving at independent valuations of these structures,” he said.

UNEXPECTED RISKS

The Fed selected Barclays and Deutsche Bank just hours after bidding closed on the CDOs, part of a vast portfolio of former AIG assets known as Maiden Lane III.

Thursday’s sale is the latest move by the US government to unwind holdings it acquired in a slew of bailouts it undertook with taxpayer dollars during the depths of the financial crisis.

“This successful sale marks another important milestone in the wind-down of our crisis-era intervention,” the New York Fed’s Dudley said.

AIG, then the world’s largest insurer, was just minutes from bankruptcy -- it had no money to pay out credit default swaps it owed on these very same CDOs -- when the government stepped in to save the company in September 2008.

Maiden Lane III eased some of AIG’s obligations by buying CDOs from the insurer’s counterparties. In exchange for being bought out at 100 cents on the dollar, the counterparties agreed to terminate the swaps.

That deal was widely criticized as being a back-door bailout of the banks that AIG did business with, some of whom were bidders in Thursday’s auction.

The latest auction was limited only to the eight banks that bid on Thursday -- all of whom were specifically invited to bid by the Federal Reserve.

A CLOSE FINISH

Market sources familiar with today’s auction said that the bids from each of the partnerships were very close in price, and on the high side compared to what the Fed was expecting. Moreover, Barclays and Deutsche Bank won the bonds by a small margin, not a large gap.

Several investors complained that the fees charged by the consortia to investor clients for aggregating their bids for presentation to the Fed were “egregious”.

The Citigroup/Goldman Sachs/Credit Suisse group and the Bank of America/Morgan Stanley/Nomura consortium were asking investor clients to compensate them 25 basis points more than the dollar price of each bond.

“Implementing the large bid-aggregation fee transformed the consortiums winning bid into a losing bid and kept them from winning the auction,” said one trader.

While Barclays and Deutsche Bank did not mention a bid-aggregation fee in its partnership announcement sent to clients, traders said that the banks would ultimately charge a fee to unwind an embedded swap tied to the CDOs that Barclays was counterparty on.

The two European banks were favored to win the auction, because they already had a vested interest in the two complex securities on offer.

Deutsche Bank owned junior tranches of the two CDOs being sold and today’s successful bid means that it, along with Barclays, now holds majority ownership in the structure.

Barclays, meanwhile, is counterparty to a swap that is tied to the CDO, and this swap needs to be unwound before the deal could be “unlocked” and broken into the individual CMBS assets, market participants said.

That is exactly what investors want -- the individual CMBS backing the CDOs are valued in the markets at more than the CDO tranches themselves.

“You will have more investors to buy them. It is easier to sell the individual parts,” said Ron D‘Vari, chief executive officer at NewOak Capital in New York.

This differs from the approach taken by the two other consortia, which planned to sell the securities either in their current form as CDOs, or as a repackaged product known as a re-remic, which would allow a new investment-grade bond to be formed.

The re-remic approach would have attracted more hedge fund types which like the riskier parts of the restructured CDOs because they would offer hefty yields, D‘Vari said.

The commercial real estate securities market has come under pressure in recent days, partly on concerns whether the individual CMBS issues from MAX CDO deals would come to market.

When the US government sold a chunk of other AIG assets last year that were primarily backed by residential mortgages, the resulting glut in supply wreaked havoc with that sector of the bond market.

D‘Vari said some of these underlying CMBS face refinancing risks as some of the loans will mature later this year and in 2013.

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