One more little piece of the Lehman puzzle.
Deus Ex Macchiato points us in the direction of Volume IV of the court-appointed Examiner’s report into the Lehman Brothers’ bankruptcy. Specifically, the bank’s use of the Federal Reserve’s Primary Dealer Credit Facility, or PDCF, something which has already been covered here and here.
Here’s how it worked:
Under the PDCF, the FRBNY would make collateralized loans to broker‐dealers, such as LBI, and in effect, act as a repo counterparty. Unlike a typical counterparty, though, with the creation of the PDCF, the FRBNY was generally understood by market participants to be the “lender of last resort to the broker‐dealers.” Reflecting the fact that broker‐dealer liquidity had become increasingly dependent on overnight repos to obtain short‐term secured financing, the PDCF was structured as an overnight facility.
Similar to the Fed’s discount window then, and generally something banks were reluctant to use because of an associated stigma. Only Lehman promptly went about finding the best way to employ the facility as soon as possible.
According to the report, Lehman staff viewed the PDCF as “available to serve as a ‘warehouse’ for short term securities [b]acked by corporate loans” — a way for Lehman to offload some of its more problematic assets in exchange for Federal Reserve-sponsored funding.
Here’s what they did:
Lehman did indeed create securitizations for the PDCF with a view toward treating the new facility as a “warehouse” for its illiquid leveraged loans. In March 2008, Lehman packaged 66 corporate loans to create the “Freedom CLO.” The transaction consisted of two tranches: a $2.26 billion senior note, priced at par, rated single A, and designed to be PDCF eligible, and an unrated $570 million equity tranche. The loans that Freedom “repackaged” included high‐yield leveraged loans, which Lehman had difficulty moving off its books, and included unsecured loans to Countrywide Financial Corp.
Lehman did not intend to market its Freedom CLO, or other similar securitizations, to investors. Rather, Lehman created the CLOs exclusively to pledge to the PDCF . . .
Lehman may have also managed its disclosures to ensure that the public did not become aware that the CLOs were not created to be sold on the open market, but rather were intended solely to be pledged to the PDCF. An April 4, 2008 e‐mail containing edits to talking points concerning the Freedom CLO to be delivered by Fuld stated:
“Given that the press has not focused (yet) on the Fed window in relation to the [Freedom] CLO, I’d suggest deleting the reference in the summary below. Press will be in attendance at the shareholder meeting and my concern is that volunteering this information would result in a story.”
It is unclear, based solely on the e‐mail, why a reference linking the FRBNY’s liquidity facility to the Freedom CLO was deleted. One explanation could be that Lehman did not want the public to learn that it had securitized illiquid loans exclusively to be pledged to the PDCF. Another reason may have been to hide the fact that Lehman needed to access the PDCF in the first place, given that accessing the securities dealers’ lender of last resort could have negative signaling implications
Loyal FT Alphaville readers will remember that Freedom CLO received some coverage back in April 2008, and on Bloomberg. The impression then was that the bank had indeed ‘sold’ off about $2.2bn of the senior notes, while retaining the circa $570m equity tranche. Little did we know.
In fact according to the report, Lehman went on to pledge the Freedom CLO at the Fed’s PDCF three times, starting on March 24 2008 and even before the Fed actually started talking with the bank about the CLO’s underlying assets (that didn’t happen until April 9).
Lehman received $2.13bn for each PDCF transfer, or $6.39bn in total.
The question that immediately springs to mind, of course, is whether other banks had any similar ideas.
The suggestion is yes, they did.
This is all we could find so far, but here, from Total Securitization, is a CLO with a very similar pedigree to Freedom’s. And it looks to have been created by JP Morgan sometime in spring or summer 2008:
Watch this space…