Monday, August 18, 2008

Merrill's "surprise" CDO writedown?

(FT Alphaville) When did Merrill know about its surprise CDO writedown?

Commentators last week were revisiting the issue of “tranche warfare” on CDOs, and some of the legal tussels which have been going on. Which, it turns out, might shed a little light on Merrill Lynch’s supposedly out-of-the-blue sale of CDOs to Lone Star in late July.

Some may remember that back then - on Monday 28th to be precise - Merrill announced a $6.7bn CDO sale - and consequent $4.4bn writedown - barely two weeks after it had officially marked down its CDOs to a value of $11.6bn in its second-quarter filing. The question being what, if anything, had changed and whether Merrill knew the second writedown was coming at the time of its 2Q?

This is one thing that changed.

Merrill and monoline SCA capital (parent XLCA) reached the end of a lawsuit they’d been wrangling over for quite some time. Since March 19, in fact. A little detail on that, here.

The lawsuit was effectively impeding the sale of any monoline-insured CDOs by Merrill. As soon as it was resolved, the CDOs were stripped of their CDS insurance, and a sale could be achieved. The lawsuit was settled on July 28th, and hey presto, on July 28th, CDOs were sold to Lone Star.

Given that the lawsuit has been underway for nigh on four months, any notion that the July 28th post-writedown writedown was in any way a surprise to Merrill’s top brass - one which supposedly materialised in the days following the 2Q on July 18 - should be dispelled.

Merrill execs must have known full well that no matter which way the legal case with SCA went, the moment it was resolved, another writedown would materialise. If they won, which they effectively did, then a planned sale was given the green light, and if they lost, which they effectively didn’t, then they would have to take a writedown on uninsured CDOs.

All of which makes the credibility of statements like these, all the more questionable.

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