Monday, April 14, 2008

After the TAF a CLO deluge?

(FT Alphaville) One interesting chart doing the rounds right now shows the Fed’s reserve holdings on July 18th last year and compares them to their current composition. Whereas in the summer of ‘07, nearly 90 per cent of the balance sheet was in Treasuries, as of April 2, just north of 50 per cent was. It doesn’t look healthy.

And in the past few days - in the wake of this and this - there’s been a lot of discussion about investment banks abusing the Fed’s new post-TAF discount windows (PCDF, TSLF) to turn a swift buck on the back of more structured chicanery.

Most has been written about the Lehman CLO - Freedom. Freedom is a $2.8bn collateralised loan obligation just closed by Lehman to shift all its LBO debt off its books.

It was rather elliptically suggested by Bloomberg (from a Morgan Stanley analysis) that Freedom’s notes had been used as collateral by Lehman in the Fed’s primary dealer credit facility. And that that was - in the main - the reason the CLO had been created and successfully closed.

But there’s some confusion. In this article, Bloomberg say Lehman sold the $2.2bn of senior notes in Freedom “in a private placement”, which can’t be true if they’re being used in repos with the Fed by Lehman. As for the equity tranche, it’s unrated, so the NY Fed won’t accept it as collateral.

The WSJ reports that only some of the senior notes may actually have been pledged to the Fed. The small amount was supposed to “test” what the Fed would accept.

Since the test seems to have gone well, can other banks be expected to jump on the CLO bandwagon? JP Morgan is understood to be doing just that - with rumours of senior notes of a recently closed CLO being pledged in the PCDF.
But even if Freedom, and other CLOs, were created with the express intent of pledging notes to get liquid collateral through the PCDF, so what?

Is this not, afterall, exactly the kind of greasing of the broken high-finance machine that the Fed is hoping to achieve? And forget not that a CLO with a first loss equity tranche, is going to be safer than the sum of its parts.

(Interesting aside: in its latest CDO monitor, JP Morgan analysts said that single-A CLO tranches were the “sweet spot” in the capital structure - unlikely to suffer losses even in a stressed environment yet still offering attractively high yields. Does the Fed know this?)

In a way, this all cuts back to the debate on just how successful - or not - the whole gamut of market-moving facilities established by the Fed (TAF, TSLF, etc etc) have been.

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