Friday, January 18, 2008

Merrill's CDO Valuation Very Interesting

New Merrill Lynch (MER) CEO John Thain said something very interesting Thursday in an interview after the bank released earnings

"We had $15 billion of them (CDO's) on the books in September and now that has been written down to $4.4 billion. Essentially they are being valued on their interest only component". See the interview here:

This is stunning really. It also means that when the CDO market settles, the very same securities that have been eviscerated will see a surge in value. Thain also said that the CDO market was non existent in December and that recently they had sold a few of the securities.

He gave no details on the transactions but the fact there is even some liquidity in that market is good news indeed.

What has happened to the CDO markets is a bit like pricing all mortgage brokers for bankruptcy because one of them go. It is important to note that while defaults have risen, they are by no means above historical norms or in a danger area. Despite that, the entire universe of them have been hit.

This type of thing seems to happen in real estate due to its prolonged cycles. When Berkshire Hathaway's (BRK.A) Warren Buffett first bought into Wells Fargo (WFC) in 1990, he did so in the midst of a California housing crisis. Warren determined that bank's value as reflected by its stock price was being unfairly tainted by the market. A "guilt by association" thing. All things housing we sold off. While many lenders at the time were suffering due to loans made, Buffett felt that while Wells would take a small hit (much smaller than anticipated), when housing recovered, it was well positioned to then capitalized. He called the classic over-reaction of the market and has since made a killing on the stock.

What is happening today is very similar to that time frame, crisis's create opportunity....

Disclosure ("none" means no position): None

Todd Sullivan's- ValuePlays

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