April 13, 2012 / 8:47 PM / 8 years ago

Maiden Lane III sale hamstrung by swap, transparency issues

NEW YORK, April 13 (IFR) - An in-place derivative contract is complicating the potential sale of two commercial real estate (CRE) collateralized debt obligations (CDOs) from the Federal Reserve Bank of New York’s Maiden Lane III portfolio of legacy AIG assets.

The issue is keeping the commercial mortgage-backed securities (CMBS) market on edge over whether or not the CDOs will eventually be unwound into their component parts, or traded as a whole.

Moreover, investor accounts are complaining that they have recently been unable to access detailed information about the swap, and this lack of transparency is making it difficult to price the contract or determine how complicated it might be to unwind.

The unwinding of the swap is a prerequisite to collapsing the CDOs into their underlying CMBS parts. The CMBS bonds underpinning the complex structures could fetch higher values on the market than if the CDOs were sold in their current form.

Deutsche Bank originally structured the two CDOs, which date back to 2007 and 2008, and already owns the junior slices and so-called interest-only pieces of the securities, according to three investor sources familiar with the situation.

If the bank now successfully acquires the senior-most portion of the CDOs, which the New York Fed is likely to auction off as soon as next week, only Deutsche Bank will have the power to collapse the CDO into its CMBS components — for a price, that is.

The German bank would therefore be able to profit handsomely from the whole process, according to securitization specialists.

“You have to own everything in order to sell everything,” said one CMBS trader. “It all comes down to how these deals were originally structured.”

Deutsche Bank declined to comment.


Other hurdles are coming into the fore as various investment banks square off against one another to bid for the CDOs.

At least one so-called balance-guaranteed swap exists on the Max CMBS I Ltd, Series 2007-1 and Series 2008-1 static cash CRE CDOs, which represent US$7.5bn in face value of the Fed’s US$47bn Maiden Lane III portfolio. Barclays is the swap counterparty on the contract; the swap itself was rated Triple A by Moody’s in 2010.

In other words, Barclays is on one side of the contract, and the CDOs — now owned by BlackRock, in its role as investment advisor for the regional federal bank — are on the other side.

The New York Fed recently said it was entertaining the idea of auctioning off the two CDOs if it could fetch good value for them.

Balance-guaranteed swaps are typically added to a fixed-rate transaction to create floating-rate payments. Securitization specialists say that Barclays has been receiving a fixed-rate coupon and paying out a Libor-linked floating-rate amount to the CDO. This has been an attractive arrangement, since interest rates have been so low.

“They’re going to want to be paid to break such an attractive contract,” one CMBS investor said.

The swap was originally put in place to hedge interest-rate risk. But unlike a swap linked to a CDO of corporate bonds, swaps on CDOs of securitized mortgage-related assets are more unpredictable and harder to price.

This is mainly because the maturities on amortizing assets such as mortgages are more difficult to predict. There are many factors involved; for instance, if there is a tougher overall economy, it might take longer for borrowers to pay off their mortgage debt.

To account for this unpredictability, a balance-guaranteed swap assures that the balance of the swap is always equal to the balance of the underlying collateral. Moreover, the maturity of the swap is also equal to the maturity on the underlying collateral.

It’s a simple fact that Barclays will need to be paid off in order to exit the swap, which is a must if the CDO will be collapsed. The question is, how much will they be paid?

Investors claim that they need detailed information in order to model the swap, but they currently don’t have access to that information.

Most importantly, the duration of the underlying bonds is not known. This is key to figuring out how much it will cost to pay off Barclays to exit the balance-guaranteed derivative contract.

According to market sources, details on the swaps and the underlying bonds’ cashflows were available a few weeks ago on a website administered by Intex, a company that provides deal cashflow models and analytics for structured finance transactions.

However, since the sale of the CDOs by the New York Fed became public knowledge, the information on the deal on the Intex website has been more difficult to access.

This has led to differing opinions from market participants on how difficult it might be to unwind the swap, which is a crucial step if the CDO will eventually be “collapsed” into its more-valuable underlying CMBS components.

Barclays declined to comment.


The determination of how the securities will trade and in what format - either as large CDO exposures or, alternatively, as a glut of supply of underlying CMBS bonds - will have significant implications for trading prices in the secondary CMBS market. A burst of supply of so-called mezzanine Triple A (AM) and junior Triple A (AJ) CMBS can unhinge a market that was just beginning to recover.

Almost a year ago, a similar supply of subprime RMBS from the Fed’s Maiden Lane II auctions nearly derailed a recovery in prices for those securities.

At least four banks - Barclays, Deutsche Bank, Credit Suisse and Morgan Stanley - are preparing bids for the CDOs, but this week investors were unsure whether to defensively sell CMBS in anticipation of a CDO unwind, or alternatively buy AMs and AJs, which currently offer attractive relative value.

Street strategists offered varying opinions, with some predicting that the CDO unwind was too complicated to happen, and others urging a sell-off in anticipation of a flood of CMBS supply.

“Unwinding a CDO position is a fairly complex process, so I don’t think this supply of AMs and AJs is going to happen any time soon, if at all,” said Darrell Wheeler, the head of CMBS strategy at Amherst Securities. “If I could buy AMs yielding an extra 50bp at this time, I’d do it.”

Moreover, the holder of the balance-guaranteed swap, Barclays, is probably already hedged, Wheeler guessed, which would make the process even more complicated.

On the other hand, other strategists on the Street were urging clients to sell CMBS now, in the belief that the CDOs would eventually be sold as individual CMBS bonds.

Investors currently holding AM and AJ CMBS bonds would have a more difficult time selling them if the market suddenly became inundated with a fresh supply generated from the CDO liquidations, the strategists said. (Reporting By Adam Tempkin)

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