Wednesday, 12 December 2018

Americas Structured Finance Issue

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Turning on the risk trade: In a year that saw strong but largely plain-vanilla primary flow product, it was a secondary trade that captured Wall Street’s attention for weeks and helped clear one of the biggest risks the Federal Reserve had left from the financial crisis. The US$7.5bn sale of the 2007 MAX CRE CDOs is IFR’s Americas Structured Finance Issue of the Year.

To see the full digital edition of the IFR Review of the Year, please click here.

The New York Federal Reserve’s stunningly successful and dramatic first CRE CDO sale in late April from its US$47bn Maiden Lane III portfolio of toxic AIG assets opened the floodgates for securitised products and tightened spreads for the remainder of the year. In short, it turned the tide for the risk product.

The deal captivated the market, did not disrupt pricing with a flood of supply, inspired confidence in structured debt, boosted liquidity, and was a key moment in the Fed’s deleveraging from the burdens of the financial crisis.

No primary deal or new financing had even a sliver of the influence that the MAX CRE CDO sale had on the overall trajectory of debt capital markets in 2012.

“I think it was a watershed moment for the market,” said Tom Hamilton, who was head of securitised products trading at Barclays at the time of the MAX CDO, and who is now a senior adviser at the bank. “It gave people tonnes of confidence to be long structured product.”

“What was the deal of the year? It was obviously MAX,” said the head of CMBS at a broker-dealer that was invited to partake in the limited auction. “It was by far the most excitement we had around the trading floor in two years.”

The deconstruction of MAX provided all-important pricing transparency for distressed legacy bonds and dragged spreads tighter.

Three groups of powerhouse Wall Street banks banded together to vie for the sale of a US$7.5bn chunk of Maiden Lane III made up of pieces of MAX 2007-1 and MAX 2008-1. BlackRock Solutions conducted the sale for the Fed.

The team of Barclays and Deutsche Bank ultimately won the auction. Those two banks already had a vested interest in the two complex securities on offer, and were able to take early bids from investor clients on the underlying CMBS backing the CDOs, which often were valued higher than the CDOs themselves.

Deutsche Bank owned junior tranches of the two CDOs being sold and, along with Barclays, held majority ownership in the structure.

The UK bank, meanwhile, was counterparty to a swap that was tied to the CDOs, and this swap needed to be unwound before the deal could be “unlocked” and broken into the individual CMBS assets. Therefore, Deutsche and Barclays were the only banks that had the keys to “unpack” the value in the CDO.

“The MAX sale had all the qualities of a successful film script: suspense, intrigue, drama … and finally, positive resolution,” said Christopher Sullivan, the chief investment officer of the United Nations Federal Credit Union. “Investors that were lined up pre-sale to peruse bonds expressed far more than expected interest for structures that had been unavailable in either size or yield for so long that they could barely contain themselves.”

“These were huge blocks of bonds that investors had been craving for a very, very long time,” added one mortgage trader that participated in the sale.

Within 18 hours, and working overnight, Deutsche Bank was able to aggregate US$18bn of orders from investor clients hungry for the bonds. The bank was able to deliver bonds to clients and maximise profitability for the Fed at the same time.

Thousands of bids were received. Trading volume of leveraged commercial mortgage securities is typically US$100m per day. “We did US$8bn in 10 minutes,” Hamilton said.

The fact that the Fed could sell MAX, clear it, have the risk distributed, and not disrupt pricing in the market, was remarkable.

The MAX sale laid the groundwork for numerous follow-on sales from MLIII that worked in the same way: limited auctions. By the end of August, the Fed sold the last of the remaining MLIII securities, with a net gain of US$6.6bn for the public benefit.

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