The Price is (not that) Right

The New York Times recently published an article on the risks associated with the poor valuation of Bad Bank assets.

Essentially,

Placing too low a value would force institutions selling and others holding similar investments to register crushing losses that could deplete their capital and make it harder for them to increase lending.

…

But inflated values would bail out the companies, their shareholders and executives at the expense of taxpayers, who would swallow the losses if the government could not recoup what it had paid.

The article is accompanied by a description of how the valuation of a specific toxic asset can range from 97 cents on the dollar (financial institution holding the bond) to 38 cents on the dollar (actual trading level of the bond). S&P, “the extra set of eyes,” valued it at 83 cents.

With valuations hitting nowhere close to home (actual trading levels), it’s hard to believe that the government won’t end up permanently losing hundreds of billions of dollars to the financial institutions through its Bad Bank.

We decided to dig a little deeper...

The following table contains actual valuations for a -- wait for it, regional bank's -- portfolio of TruPS CDOs (a proud member of the toxic family) obtained either through a trading desk (quite possibly the same one that originated and sold the bonds in the first place) or a rating agency. The current ratings range from A1 to Ba1 without a single bond falling south of the 30 cent line (optimistic, to say the least).

PF2 evaluated the first three bonds (TruPS CDO 1 Tranches C1 & D1; TruPS CDO 2) -- all of which came out in the single digits. In fact, we valued the TruPS CDO 1 Tranche D1 (the junior-most mezzanine bond) at only 87 bps, which reflects the tranche's continued deferral -- since March 2008 -- of its interest payments (and, besides, close to 10% of the portfolio's already a goner).


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