When Merrill (MER) sold its CDO portfolio for $0.22 on the dollar, the market belted out the hallelujah chorus. Part of the reaction was the elimination of uncertainty. Another part was a “market price” that investors could use to evaluate what kind of losses other banks might take on similar assets. Unfortunately, as David Reilly at the WSJ explains, it’s not quite that simple: Banks like Bank of America (BAC) may be lucky to get 22 cents for their own CDO garbage.
Unfortunately for investors, it isn’t crystal clear just who should swallow hard. CDOs aren’t standardized products, and their values can differ based on a host of factors. That means investors can’t cut and paste Merrill’s prices into the values other institutions assign their CDOs…
In a report Tuesday, Morgan Stanley analyst Betsy Graseck argued that Citigroup may need to reduce their value by an additional 21%. While that may seem pessimistic, Merrill’s sale argues for a glass half-empty view.
A bigger question hangs over Bank of America. Of its about $11 billion in CDOs backed by subprime mortgages, $5.1 billion are CDOs made up of other CDOs. These so-called CDOs-squared are considered the most toxic of these products.
Yet Bank of America is valuing these CDOs-squared at about 35 cents on the dollar. That is well above the average 22 cents Merrill fetched for its high-grade and mezzanine holdings, considered less toxic. That makes no sense.
So, while Merrill’s sale does provide clarity, it doesn’t mean that Bank of America’s CDOs won’t end up being worth even less when it finally gets around to dumping them. The credit environment could still deteriorate further, the economy could worsen, defaults and NPAs could rise.
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