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| Maiden Lane III | |
| Size | $7.9 billion unwinding of Max CRE CDO |
| Date | April 2012 |
| Lead dealers | Barclays, Deutsche Bank |
| return to the Global Deals of the Year index | |
Wall Street traders typically believe that the business of profiting from capital flows works best with minimal interference, but given the impact that the US government, in the form of the Federal Reserve, had on the structured finance market last year their perceptions might well have changed.
The Fed’s first commercial real estate CDO sale in April from its $47 billion Maiden Lane III portfolio of toxic AIG assets, assumed as part of the insurer’s 2008 bailout, not only boosted liquidity and pricing transparency but was a defining moment in the recovery of the structured finance market, which since the credit crisis has been as good as dead.
The $7.9 billion MAX CRE CDO sale – the largest individual sale of illiquid CDO securities from Maiden Lane by the Fed – was remarkable on many levels, not least because it enabled the Fed to rid itself of a large chunk of once toxic, crisis-era liabilities, while at the same time making a tidy profit for US taxpayers.
But before any of this could happen, the Fed, with the support of BlackRock Solutions, had to choose via an auction which investment banks it wanted to use for the sale.
It was a decision that ultimately would rest on the best solution for deconstructing the securities under the objective of achieving the best possible sale price for the two pieces on the block – MAX 2007-1 and MAX 2008-1 – and executing the sale without causing a market disruption, as was feared.
The joint bid from Barclays and Deutsche Bank – two investment banks that had unique vested interests as swap counterparty and owner of the junior tranches, respectively – won, and on April 20 they were officially mandated to form a partnership, which had two main aims.
The first was unwinding the CDO, ending Barclays’ swap obligation and Deutsche Bank’s ownership of the junior tranches, and the second, broadly distributing the underlying collateral – commercial-mortgage backed securities – to their clients.
Jaime Aldama, head of US Credit and ABS structuring at Barclays in New York, says it was a fiendishly complex set of problems to try to solve, and an incredibly short timeframe of 10 days in which to do it.
“At the time of the transaction, the buyer base of legacy CDOs was quite limited,” Aldama says. “There was only a small number of large private equity and fast-money accounts that could have participated in legacy CDOs and, as a result, the liabilities of the CDOs traded on a value that incorporated a liquidity discount to the underlying collateral value.”
He adds: “So, what we managed to do was to release the liquidity discount by deconstructing the CDO, and we did this because the underlying collateral reference portfolio had a broader base or access point to real-money accounts – money managers, banks, insurance companies, etc – and they could not have taken on the CDO as it was.”
The Fed could have sold the CDO outright to any dealer or investment bank that could have then sold pieces of the CDO to investors. However, Chris Leslie, global head of securitized products sales at Barclays, says that would have been very difficult.
“The issue with this approach was that it severely restricted the universe of potential buyers, since very few investors would have been able purchase the CDO, given the ratings, capital charges and a number of other factors,” Leslie says.
So in essence, Barclays and Deutsche’s solution opened up the CDO to a far greater universe of real-money institutional investors that wanted exposure to the underlying collateral reference portfolio.
But even though they were successful in doing that, they still had to navigate one of the chief concerns of this entire exercise – the potential to cause a market disruption by selling such a big portfolio of collateral.
Aldama says: “Obviously, bringing $7.5 billion notional value of assets to a market that normally trades around $100 million a week could potentially have caused a huge disruption. There was a lot of discussion about that at the time, but almost everybody underestimated the demand for yield and these assets. We were, in the end, able to bring to market and distribute over $4 billion of market value of risk in a matter of several hours.”
He adds: “Selling the position without disrupting the market was one of the priorities for us, and we achieved that. Importantly, one of the key elements of this transaction is that by extracting the liquidity discount, we were able to maximize the recovery of this position for the Fed.”
That the Fed could actually sell the MAX CDO and have the risk distributed without disrupting pricing in the market was an incredible feat that ultimately enabled it to execute several other successful follow-on sales from Maiden Lane III, the last of which was completed in August last year – contributing to a net gain of $6.6 billion for the US taxpayer.
