Research Roundup: M-LEC Superfund

Maybe it’s because its name is as opaque as the “structured investment vehicles” it is designed to rescue, but the “M-LEC” superconduit has been having a hard time garnering widespread support.

And when “the world’s greatest investor” Warren Buffett is critical, could that be the kiss of death for the fund designed to buy up some of the assets of struggling SIVs?

Quoted in the Financial Times, Buffet favors a more market-based solution: “I think there should be a requirement that before the securities are put into the new super-SIV, 10 % of the holdings should be sold into the market to people who are not associated [with the subprime problem. That way we can be sure that they are being put in at appropriate market prices . . . They should give the market the opportunity to price the super-SIV themselves so we can see what they are really worth.”

One of the lessons that investors seem to have to learn over and over again, and will again in the future, is that not only can you not turn a toad into a prince by kissing it, but you cannot turn a toad into a prince by repackaging it.

Citigroup, Bank of America and JP Morgan Chase have committed more than $75 billion to M-LEC, the Master-Liquidity Enhancement Conduit.

In a useful free background paper The Great Commercial Paper Meltdown of 2007 Global Insights says the new M-LEC super-fund approach “is fraught with potential risks, especially in view of further downward pressure from the housing market, and associated deflation in the prices of mortgage-backed securities. “

The Treasury needs to closely coordinate the launching of these funds with the Federal Reserve, as monetary policy needs to be supportive—at least from a macro policy risk minimization perspective—as a necessary condition for success.

In The SIV SuperConduit-Not So Super, CreditSights points out that by buying only the most attractive assets that they can reasonably buy either at or close to par, M-LEC will effectively be diluting the credit quality of the SIVs’ remaining Asset-Backed Securities portfolios.

That will mean that SIVs will be even more exposed to erosion of credit quality in the remaining assets, which will likely be more concentrated in the more problematic sectors like RMBS and CMBS.

In a terse comment, Moody’s Investors’ Service said “We believe the creation of M-LEC will have a generally positive impact on the SIV sector and when monitoring our SIV ratings, Moody’s will take into account the potential impact of the initiative as well as the exposure of each vehicle to credit and liquidity risks.”

Noting that it does not expect M-LEC to have an impact on the ratings of US banks, Standard & Poors says the hope of M-LEC is that natural tension will establish a market price for less liquid securities.

S&P says if M-LEC vehicle is not adopted, the following scenarios are possible:

• The SIVs find sufficient funding on their own;
• The SIVs are able to liquidate enough assets to reach sustainable levels of funding;
• The SIV sponsors, most of which are large universal banks support the SIVs through the purchase of rolling SIV CP or the consolidation of the SIVs onto their own balance sheets; and
• The SIVs experience further negative pressure.

The Economist’s view is that it raises more questions than it answers:

Even those who support the fund admit that it is, at best, a temporary solution, buying time so SIVs can find other sources of finance or wind down gracefully. It may also provide breathing space in which to sort out deeper problems facing the market, such as the unstable structure and opacity of SIVs.

SeekingAlpha’s Roger Ehrenberg thinks “the real question is if the M-LEC has enough positives to make it worthwhile relative to the unknowns. As it introduces friction, it costs money to assemble for participating firms, especially those selling assets into the vehicle.”

Though it doesn’t directly solve any fundamental credit problems it does create a ready market for high-quality SIV assets, in size, that streamlines the operational process of generating liquidity relative to selling discrete assets to many, many buyers, he says. “And it does provide an opportunity for market conditions to improve, possibly enabling some of the currently distressed paper to recover.”

So net net, it might be worth a go.

Technorati Tags: credit-risk, research-roundup, special-investment-vehicles, subprime-mortgage

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Monday, October 29th, 2007 : Credit Research, Public Sector : 5 Comments

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