Saturday, July 18, 2009

A Closer Look at JP Morgan and Maiden Lane LLC

One of the shadier - for lack of a more appropriate adjective - aspects of the Federal Reserve's activities is the presence of three borderline translucent LLC's on it's balance sheet: Maiden Lane LLC (ML LLC), Maiden Lane II LLC(ML II LLC) and Maiden Lane III LLC(ML III LLC). For now we will focus on ML LLC, the entity created to "acquire certain assets of Bear Stearns and to manage those assets through time to maximize the repayment of credit extended to the LLC and to minimize disruption to financial markets" (from NY Fed website). The creation of ML LLC occurred as a means by which to assist JP Morgan(JPM) complete the purchase of the investment bank formerly known as Bear Stearns. Presumably, the assets that found their way into ML LLC were selected due to their sheer toxicity, and more importantly, JPM's desire that it not acquire said assets. In other words, ML LLC is the financial equivalent of a leper colony, comprised of those assets deemed unsuitable by JPM.

Unlike a traditional leper colony however, ML LLC makes regular interest payments to JPM; payments that have amounted to nearly $300M since the inception of the limited liability corporation. This is a fact that receives little acknowledgment by those charged with the assessment of bank earnings. As Bank of America (BAC) and Citigroup (C) have been derided by the financial press and analysts for reporting "weak" earnings that were "bolstered by one-time gains", JPM's secretive subsidy is largely ignored; allowing the large bank to wallow about in it's largely favorable press coverage. Perhaps this means that JPM has quietly acted shrewder than even Goldman Sachs (GS), as that (investment?) bank has been the subject of mounting excoriation from an angry populace.

Nevertheless, a brief look at ML LLC's assets would suggest that the Fed is choosing to value it's holdings in an exceedingly optimistic light. The Fed states that in March of 2008, ML LLC's assets totaled roughly $30B. As of March 31,2009, the value of these same assets is reported at $25.3B, a decline of 15.6%. In it's brief explanation of the valuation methods applied to these securities, the Fed states that they are held at a "fair value", based upon the price at which a buyer would be willing to pay under "orderly market conditions". No definition of orderly is provided. Based upon the limited information provided by the Fed, we can determine the following concerning the composition of ML LLC's assets:
  • 45% of the residential mortgage loans were secured in either California or Florida
  • 79% of the commercial mortgage loans are classified under the "hospitality" property type
  • 51% of the non-agency CMO's were secured in either California or Florida
  • No private investor would ever want to touch these securities
What price could ML LLC's assets fetch under today's market conditions? Absent any real data, it is impossible to know. However we did find an interesting REIT, Hospitality Properties Trust (HPT), whose stock trades publicly on the NYSE - in theory subjecting it's property portfolio to a market based valuation. According to HPT's website, the trust's strategy is to "maintain and grow an investment portfolio of geographically diverse hotel and travel center properties". At the end of Q1 '08, HPT's share price stood at $34.02; by the end of Q1 '09, a share of HPT could be had for $12 - a decline of 64.7%. Obviously, the share price of HPT is not the most accurate bellwether for estimating the true value of ML LLC. However, with a notable dearth of information of any kind concerning ML LLC's rotting assets, it stands to reason that our approach is as good as any. That being said, we would encourage all readers to contact your Congress person and express your support for HR 1207, introduced by Ron Paul in February. You can do this by clicking here - the process takes less than a minute.

And that's the way it is.

*no position in any securities mentioned, although arguably, our tax dollars helped facilitate the Maiden Lane transactions.

Maiden Lane LLC Financial Records 2008 Sphere: Related Content

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