CDO Decision, Sell at a Loss or Milk for What It’s Worth

Ambac paid $850 million to CitiBank for impairment to a CDO (collateralized debt obligation) reportedly worth One Trillion 400 million dollars ($1.4 Trillion) and let Cibibank keep the assets. I found it interesting because the compensation was in regard to the difference in value from to mark to model as opposed to mark to market.

That is old news, but in the last week there have been multiple buy-backs of Auction Rate Securities (ARS). The comparison is “apples to oranges”. If I understand correctly a buy-back is forced at full value ARS. The equivalent of a money back guarantee or buyers rescission enforced because of statements of inflated value and security by rating companies and the package seller. Interesting because of the bond insurance compensation based on the insurance coverage for the ARS.

Some ARS are insured for face value for the level. In the CitiBank Ambac transaction, Ambac was on the hook for the level of impairment $1.4 Trillion and was able to negotiate the figure down to the estimated level of impairment, therefore paying the decline in value.

It makes me wonder “What happened to the collateral that backed these financial enterprises?” The reason I ask is probably archaic and naïve, but I remember a car my father had an accident in 1971. The accident was not his fault and the car was an import and difficult to estimate repair costs. In that case a car was purchased for $350 the insurance company paid $300 for the damage to the car and let my father retain control of the “asset”. Some repairs were made and I drove an ugly car for 2 years. When other repairs were necessary and parts were not available, the car was scrapped. The scrap yard paid $100. The profit on the car was $50 and it was driven daily for 2 years after the accident.

Later news from Australia related the loss in value of investment CDO’s. The story referenced declines in value of CDO investments from $500,000 to $37,000 and $5 Million to $4.2 Million. The story went on to say that while some CDO’s were sold at a loss, $5 Million were retained because they were still generating revenue.

To get back to my first point, where are the assets? What are they worth? Just because they can not be sold does not mean there is no value in collecting the payments. That reminds me of another story from my childhood. Our neighbor down the lane had an ugly Holstein cow. She was thin and had gotten pink-eye and was blind in one eye. The neighbor considered selling her, but it would cost twice as much to replace her. When asked about Holly , he’d scratch his head and reply “Yeh-up, I could replace her, but she’s giving as much milk as she ever did.”

It may be the most lucrative move Citibank has made for a while. Ambac and their investors feel they made out like the proverbial bandit paying 40 cents on the dollar. CitiBank received more than 40% of the bond’s value, still has control of the servicing rights, and collateral. Just who is zooming whom and laughing all the way to the bank, Citibank or Ambac?