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The auction of a Federal Reserve portfolio of junk-rated assets has spurred a series of unlikely alliances on Wall Street, with three rival coalitions of banks now set to bid.
On Monday it emerged that Citigroup, Credit Suisse and Goldman Sachs had teamed up to bid on the securities in the New York Fed’s “Maiden Lane III” portfolio, a result of the US government’s 2008 bailout of AIG.
Later on Bank of America Merrill Lynch, Morgan Stanley and Nomura signed a deal to form a competing group. Barclays and Deutsche Bank, the last remaining independent bidders, joined forces on Wednesday.
Bankers say the co-operation in bidding for the Maiden Lane assets has been triggered because this particular sale involves two huge collateralised debt obligations, or bundles of sliced and diced mortgage bonds. All three groups appear to have a different strategy for selling the complex assets to investors.
The “Max” CDOs were originally arranged by Deutsche Bank, insured by AIG and have a face value of $7.5bn. The German bank is widely believed to still own parts of the CDOs, while Barclays is known to be the counterparty on interest rate swaps embedded in the deals.
Market participants have said the underlying bonds would fetch higher prices than CDO securities but both Deutsche and Barclays would need essentially to be bought out by other buyers to liquidate the CDOs and sell the underlying collateral.
Because of this position, some market commentators believe Barclays and Deutsche to be the strongest natural bidders. The two banks on Wednesday were taking bids from their investor clients on the underlying bonds and are believed to be bidding with the intention of collapsing the CDO.
But a person familiar with the Citi, Credit Suisse and Goldman coalition said the group intends to “sell the risk to investors in its current form”, if it wins the assets.
Merrill, Morgan Stanley and Nomura have told investors that they plan to repackage the CDOs into potentially higher-rated tranches.
The three banks could carve out a $1.72bn triple A-rated tranche from the two CDOs, which carry junk ratings from Standard & Poor’s, the group told investors.
Re-securitising the CDOs to include a triple-A tranche could widen the potential investor base, upping the price that investors are willing to pay and feeding into the group’s bid to the Fed.
Earlier this year the New York Fed sold the remainder of Maiden Lane II, another portfolio related to AIG’s rescue, but one that housed bonds backed by pools of subprime and other risky US home loans.