Super-Conduit = Vulture?

In previous posts, I’ve speculated that the MLEC Super-Conduit proposed by Treasury and a consortium of major banks is intended to operate as a Vulture Fund.

It would appear from posts in Naked Capitalism (SIV Rescue Plan : From Smoke and Mirrors to Jawboning) and Accrued Interest (Yeah, but who’s going to fund it kid? You?) that my use of the term has been misunderstood; possibly because I’ve mis-used it.

The term “vulture fund” has been taken to mean that I am suggesting Super-Conduit will be, or should be, buying lower quality assets; below AA in Naked Capitalism’s parlance, which is not what I had intended to suggest. It is my suggestion that Super-Conduit will seek to buy wonderful assets from distressed SIVs.

A recent publicly disclosed version of such a scenario is the Amaranth / Citadel deal, in which Amaranth realized sufficient losses on energy trades that it couldn’t finance them any more and was forced – that’s the key word, forced – to sell … with unfortunate results:

Transferring the investments would prevent further losses and decreased its loans but the deal was done “at a price that resulted in additional significant losses,” it added.

Right now, we have SIVs like Cheyne Finance and Rhinebridge defaulting. Defaulting!

They are doing this because, in the case of Rhinebridge:

The company suffered “a rapid decline in the portfolio value,” Fitch said. “The manager has determined that the market value of the remaining assets within the portfolio may be insufficient to meet the amount of outstanding senior liabilities.”

SIVs worldwide have been forced to sell about $75 billion of assets in the past two months to repay maturing debt as investors balked at buying securities linked to money-losing subprime mortgages. SIVs have different operating states to protect investors and allow the fund time to recover from a market slump. Enforcement is typically the last state, and is irreversible.

The assets in Rhinebridge’s portfolio are worth 63 percent of their $1 billion face value, having fallen $69 million in three days, S&P said. S&P also cut its ratings on the company’s debt to D for default. 

In other words, it’s a market value assessment, rather than a credit assessment, of the underlying assets  that is causing the problems. And we know that, for instance, prices of AAA paper have declined to ludicrous levels:

Briefly, let me give you a few examples of events that I [William C. Dudley, Executive Vice-President, New York Fed] never expected to see—ever:

  1. AAA-rated mortgage-backed securities selling at 85 or 90 cents on the dollar,

So here’s the scenario, with what I propose is a plausible scenario for an ideal situation for the MLEC’s sponsors.

  • SIV formed, purchases $100 of assets
  • These assets are financed with $90 of ABCP and $10 of Mezzanine/Capital notes (Ratio taken from reported structure of Golden Key Ltd.
  • Market Price of assets declines to $90
  • Super-Conduit offers $80 cash and $10 mezzanine notes for the assets (maybe less! Whatever they can get away with)
  • SIV sells the Super-Conduit mezzanine notes for $10 and pays off its ABCP senior note-holders
  • SIVs junior noteholders are wiped out
  • Super-Conduit’s senior noteholders are better secured than SIV’s senior noteholders were
  • Super-Conduit’s sponsors make an enormous whack of money when the AAA securities they bought for $90 matures at par

This argument relies on:

  • The AAA assets are actually unimpaired; they’re just trading at horribly low prices
  • The SIV is in a position of having to make a forced sale anyway
  • Super-Conduit is the only player with sufficient financial heft to go after these deals with a reasonable chance of actually holding the assets until maturity

Well, I think it’s a reasonable argument! It seems more reasonable to me than having Super-Conduit buy assets from healthy and well-capitalized SIVs, anyway! In short, my speculation as to motivations is that this is a money-making scheme (for the sponsoring banks) that will keep the ABCP market in existence (for the Treasury) on a better capitalized basis (for ABCP investors).

I think there’s a big whack of money going begging for a sponsor that can finance the assets long-term.

Right? Wrong? I haven’t seen it discussed elsewhere … only the implication that the $100 of paper trading at $90 is going to purchased by the Super-Conduit for $100 for various nefarious and manipulative purposes – which doesn’t make sense to me.

5 Responses to “Super-Conduit = Vulture?”

  1. […] whereby CITIC will take equity in Bear Stearns and Bear Stearns will, essentially, provide vendor financing. This should calm some fears about the future independence and financial viability of Bear Stearns going forward, and a joint-venture deal in Hong Kong with CITIC might even be profitable!whereby CITIC will take equity in Bear Stearns and Bear Stearns will, essentially, provide vendor financing. This should calm some fears about the future independence and financial viability of Bear Stearns going forward, and a joint-venture deal in Hong Kong with CITIC might even be profitable!Naked Capitalism has again done a good job of collecting media references to the Super-Conduit … and it looks like my speculation regarding the operation of this vehicle as a Vulture Fund is both right and wrong. Wrong because that’s not what the primary sponsors have in mind. Right because if it ain’t, there won’t be any secondary sponsors: One key concern is over the process by which it is proposed that the fund will decide on prices to offer SIVs for their securities. The lead banks are proposing that prices should be determined according to quotes provided by dealers for small volumes of the particular security rather than large trades. Critics say this means prices will be artificially high. “Banks are being asked to finance a vehicle full of overvalued assets which is not very attractive,” said one banker. Critics believe it would be better to work with true market prices – however painful. […]

  2. […] I have not yet seen this report confirmed by more usual sources – but I’m looking! I guess my reaction is dependent upon the interpretation of the word “value” in the above paragraph. If we can presume that “value” means “recent trading prices in small lots”, then I believe I have every right to refer to Super-Conduit as Vulture Fund … but if “value” means something else, then we’re back to uncertainty. We shall see! […]

  3. […] Well! As far as I know, that’s the first official admission that the Citigroup SIVs are in enough trouble that they’re going to sell to Super-Conduit (MLEC), assuming that Super-Conduit ever gets off the ground! This may not be a death-blow to my thesis that Super-Conduit = Vulture, but it’s a pretty good hit! […]

  4. […] In other news, it looks as if the MLEC / Super-Conduit is getting under way slowly, though not without carping from Naked Capitalism: am now wondering who, exactly, will purchase the commercial paper that will fund this new entity. While this is anecdotal, I have heard a fair number of people, including financially savvy ones, say they would take money out of a money market fund that invested in this entity. So retail money market funds are somewhere between a hard sell and a non-starter. Enhanced cash management fund would have been the perfect target, but a number have broken the buck recently. Some mangers are contributing cash to the fund to make investors whole; others are letting investors take losses. As a result, that type of fund is operating under a cloud right now. Expect there to be near-term net withdrawals and greater conservatism in investment, which works against the SIV rescue program. […]

  5. […] early days of MLEC (remember MLEC? It was going to save the world from a possible credit crunch) I argued that the only way it could work would be if it had the plan of buying wonderful assets from […]

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