One man's trash is another man's treasure. Never was this truer than yesterday, when Merrill Lynch sold its CDO portfolio to Lone Star Funds for $0.22 on the dollar. The market rejoiced, thrilled that one of the big banks had finally shoveled all that crap off its balance sheet. Which, of course, is just the way Lone Star wanted it.
Headed by John Grayken, formerly of Morgan Stanley, Lone Star has been gorging itself on the flotsam and jetsam of financial crises for 20 years. In recent months, the Dallas-based private equity group bought commercial lender CIT's home lending unit for $1.5 billion (including $4.4 billion in debt). Lone Star also ended up acquiring Bear Stearns' mortgage business, as well as another mortgage lender Accredited Home Lenders Holding Co. for $295 million.
In short, Lone Star has been snapping up the real estate-related investments and businesses that banks and brokers just can't wait to get rid of. And thanks to the banks' desperation, it appears to be getting great deals when it does so. To recap the Merrill deal:
- $30.6 billion face value of CDOs for $6.7 billion
- Paid for with 25% equity and 75% a loan from Merrill Lynch (seller financing)
- Merrill loan secured only by the debt (Merrill still taking the risk)
The US housing market isn't going to zero, and it's unlikely that Merrill's CDO portfolio is going to zero, either. Could it end up being worth less than 22 cents? Yes, but if it is, Merrill will bear most of that loss. Meanwhile, if Lone Star can end up getting, say, 40 cents on the dollar, it will keep the entire gain.
Not surprisingly, Lone Star's deal with Merrill is only the beginning. WSJ:
Merrill is financing 75% of the transaction, leaving Lone Star with at least $8 billion to go shopping. With similar financing, Lone Star could end up buying debt now valued at about $32 billion and with a face value of more than $145 billion.
What's more, Lone Star has a big appetite to jump at more deals like this one, according to a person familiar with the firm's plans.
That may be great news for Citigroup and the other big banks that are still in denial about their own CDO woes. Citi still insists that its CDO portfolio consists of more desirable vintages and is worth more than the bargain-basement price that Merrill accepted. But don't be surprised if, somewhere down the line, Lone Star--or a similar fund--graciously steps in to take Citi's CDOs off its hands for even less.
See Also: Will Merrill's Write-Down Set Bottom For Financials?
How Bad Was That Merrill Deal? Check Out The Scary Fine Print
Hedge Funder John Paulson Calls Bottom On Financials
