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Morgan Stanley Plans to Turn Downgraded Loan CDO Into AAA Bonds
By Pierre Paulden, Caroline Salas and Sarah Mulholland
July 8 (Bloomberg) -- Morgan Stanley plans to repackage a downgraded collateralized debt obligation backed by leveraged loans into new securities with AAA ratings in the first transaction of its kind, said two people familiar with the sale.
Morgan Stanley is selling $87.1 million of securities that it expects to receive top AAA ratings and $42.9 million of notes graded Baa2, the second-lowest investment grade by Moody's Investors Service, according to marketing documents obtained by Bloomberg News. The bonds were created from Greywolf CLO I Ltd., a CDO arranged in January 2007 by Goldman Sachs Group Inc. and managed by Greywolf Capital Management LP, an investment firm based in Purchase, New York.
Two years after the credit markets began to seize up, costing the world's biggest financial institutions $1.47 trillion in writedowns and losses, banks are again taking so- called structured finance securities and turning them into new debt investments with top credit ratings. While the Morgan Stanley deal is the first to involve CDOs of loans, banks have been doing the same with commercial mortgage-backed securities in recent weeks.
A lot of banks and insurers "cannot buy anything but AAA," said Sylvain Raynes, a principal at R&R Consulting in New York and co-author of "Elements of Structured Finance," which is due to be published in November by Oxford University Press. "You're manufacturing AAA out of not AAA, therefore allowing those people who have AAA written on their forehead to buy."
Copying Re-REMICs
New York-based Morgan Stanley is copying a financing structure known as Re-REMICs that bundle mortgage securities into new bonds that often offer investors an additional layer of protection, or collateral, from downgrades. Credit-rating cuts may sometimes force investors to sell the debt and cause financial institutions that own the bonds to increase capital.
Jennifer Sala, a spokeswoman for Morgan Stanley, and Gregory Mount, a Greywolf partner, declined to comment.
Moody's reduced the $365 million top-ranked portion of Greywolf in June by six levels to A3 from Aaa as the default rate on the loans in the CDO rose to 7 percent. The rating company cut 83 loan CDOs with the top rankings from May 28 through June 26, according to Wachovia Corp.
Raising Capital
Structured finance securities fueled the writedowns and losses at the world's biggest financial institutions since the start of 2007, helping to plunge the U.S. economy into the worst recession since the 1930s. Finance companies have been forced to raise $1.27 trillion in capital, according to data compiled by Bloomberg.
CDOs parcel fixed-income assets such as bonds or loans and slice them into new securities of varying risk intended to provide higher returns than other investments of the same rating. Greywolf is a type of CDO called a collateralized loan obligation, or CLO, which focuses on doing the same with company loans.
Banks are using re-REMICs to protect against losses on residential-mortgage securities during the worst housing slump since the Great Depression.
About $27 billion of home-loan bond Re-REMICs have been issued this year, up from $17 billion for all 2008, according to a June 12 report by Bank of America Merrill Lynch. Re-REMIC stands for "resecuritizations of real estate mortgage investment conduits," the formal name of mortgage bonds.
'Make Magic'
The strategy is increasingly being used for commercial mortgage debt. Standard & Poor's said on June 26 that it may lower the rankings on $235.2 billion of bonds backed by loans on properties such as office buildings and shopping malls.
Banks have issued about $2 billion of the debt in the last three weeks, according to Barclays Capital. That compares with $5.8 billion of similar offerings in all of 2008, Credit Suisse Group data show.
"Somebody does something and it seems to make magic, and the other guy says 'Hey, let's do that, too,'" Raynes said.
New York-based Goldman Sachs plans to sell $216.9 million of repackaged commercial mortgage debt, according to people familiar with the sale who declined to be identified because terms aren't public. The re-REMIC is being carved out of four bonds sold in 2006, said the people. Michael DuVally, a Goldman Sachs spokesman, said he couldn't comment.
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