[Hat Tips: Many thanks to @alea_, @crookery_, and @interfluidity.]
If only I had the offering circular for the Goldman-structured synthetic sub-prime mortgage CDO ABACUS 2007-AC1, which ostensibly closed on April 26, 2007, I might be able to fill in some of the gaps in what’s been publicly reported/leaked about the deal. Alas, I don’t, and so I’m left to speculate. I’ll try to sum up what I view to be the most likely timeline of events for the much ballyhooed deal and related bilateral transactions.
[Note: A lot of this is speculation. Unless a specific day and date is provided, I’m guessing as to what happened and when.]
December 2006: Paulson & Co. approaches Goldman Sachs expressing interest in purchasing protection (i.e. betting against) a basket of a BBB-rated, subprime-backed mortgage bonds that closed around the second half of 2006 (i.e. “06-2”).
NB: Goldman calls this a “reverse inquiry”—“reverse” because it the idea was hatched by one of its clients (in this case Paulson), rather than by some clever Goldmanite (e.g. Fabrice Tourre). Also note that the fact that trade germinated from an idea the short side (i.e. Paulson) rather than the long side (i.e. ACA and IKB) is moot to this nomenclature; reverse inquiry simply means it was not Goldman’s idea.
Late December/Early January 2007: Goldman calls potential investors (among them, German bank IKB)—probably from a list of past investors in previous ABACUS-branded deals—and asks if they would have interest in taking a long position in a 06-2 BBB subprime mortgage bond-backed synthetic CDO. Goldman gets enough interested parties (none of them yet committed, obviously) to start structuring a deal. But there’s a hitch. The investors want to know how the portfolio (which is to be static) will be selected; they want a reputable CDO manager calling the shots, which in a way is an outsourcing of their due diligence on the underlying portfolio.
First week of January 2007: Goldman approaches ACA to propose they serve as the “Portfolio Selection Agent” for the proposed CDO. ACA jumps at the opportunity—this is a service they can charge for, after all—and probably considers it a blessing that Goldman came to them, and apparently only them.
January 8, 2007: Goldman introduces ACA to Paulson at a meeting in Paulson’s offices among Goldman’s Fabrice Tourre and representatives of ACA and Paulson. At of this writing, we don’t yet know what, in these initial conversations, Goldman told ACA about Paulson’s involvement. Paulson and Goldman both allege that they were transparent with ACA, and that ACA knew that Paulson intended to go short the proposed structure. The SEC alleges differently—specifically, that Goldman (not Paulson) misled ACA into believing that Paulson was to be long the transaction. ACA has been silent, probably because they no longer exist—incidentally, for reasons not unrelated to the sorts of actions they took in connection with the ABACUS deal in question.
January 9, 2007: Goldman sends ACA the first proposed portfolio, concocted by Paulson, in an email with the subject line “Paulson Portfolio.” This initial portfolio consists of 123 subprime RMBS.
NB: According to one of Goldman’s defense letters to the SEC, the entire space of subprime RMBS deals that fit the parameters for the ABACUS deal totals only 293 bonds. This may become important in the SEC suit. If Goldman can show that even if ACA had selected securities for the portfolio in a vacuum without input from Paulson, then the portfolio would have gone bust anyway and the investor losses would have been the same, then Goldman can invoke the complex “no-harm/no-foul” defense.
January 9, 2007 to February 26, 2007: Paulson and ACA debate the contents of the portfolio. The parties agree on the final portfolio of 90 RMBS securities on February 26.
February 26, 2007: Goldman launches a road show to pitch the proposed deal to potential investors, including a snapshot of the expected capital structure and ratings. The pitch book shows a $2B total notional amount, and an optimistic Goldman seems hopeful at the time that they can drum up enough interest to fund $700M worth of notes.
NB: Since the portfolio wasn’t agreed upon prior to this date and the deal terms not yet finalized, Goldman not could have gotten one of the ratings agencies to commit to a rating by this date. For reasons discussed below, the terms that appear in the pitch book are not the same as those of the final deal.
March-April 2007: Goldman finalizes the terms of ABACUS 2007-AC1. After shopping the proposed deal to IKB and other investors, Goldman discovers that investor interest in the $700B of funded notes it’s been pitching has waned. This is probably due in no small part to the RMBS market beginning to show substantial weakness by this point, falling from prices in the high 90s at the time Goldman initially phoned potential investors back in December-January, to the low 80s by mid-April.
Goldman tries to spin this as good news—an opportunity for more attractive yields—but alas, the pitched deal is substantially undersubscribed. When the dust settles, only one of the original potential investors, IKB, is still interested. They commit to $150M. But once again, there’s a hitch. IKB wants ACA, the ostensible portfolio selection agent, to have some skin in the game. ACA, who you’ll remember stands to earn fee income from IKB for this service, agrees to pony-up $42M for some to-be-AAA-rated paper.
April 26, 2007: ABACUS 2007-AC1 closes. While we don’t yet know the exact terms of the notes at closing, I’ve found evidence in Bloomberg of only two classes: $50M of Class A-1 Notes (paying LIBOR+85bps) and $142M of Class A-2 Notes (paying LIBOR+110bps), both originally rated AAA by S&P (and a month later by Moody’s too). Based on the alleged facts from the SEC complaint and corroborated by Goldman’s defense letters, IKB held all $50M of the A-1 Notes and $100M of the A-2 Notes, with ACA picking up the remaining $42M of A-2 Notes. Concurrent with the deal closing, in which Goldman purchases structured protection exactly mirroring the terms of the issued notes (via a single-tranche bespoke basket default swap) from the ABACUS 2007-AC1 special purpose entity (a legal entity registered in the Cayman Islands), Goldman sells this protection in a back-to-back transaction to Paulson. It’s unclear whether Goldman keeps a spread between these two trades as consideration for helping broker and structure the deal. It’s also unclear whether Goldman earned its reported $15M fee from Paulson at the time of this closing or at the time the supersenior trades closed (see below).
NB: I don’t know much more about the exact terms of these notes or the ultimate size of the reference portfolio underlying them. As @alea_ has helpfully pointed out to me, it’s not essential that they bear the same total portfolio notional as the subsequent supersenior trades (see below). And so since I’m already speculating… One possible structure might be thus:
May 2007: Paulson wants more protection (i.e. a bigger short position) than the $192M Goldman managed to close via ABACUS. Based on the terms of the pitch book, it appears Paulson was prepared to short a $1.8B (10%-100%) tranche of the $2.0B reference portfolio. Paulson asks Goldman to see what it can do to arrange a big supersenior bet on top of the already-closed ABACUS deal. They’re looking for a protection seller for a 45%-100% supersenior tranche up to a notional of $2B.
NB: Perhaps Goldman and Paulson had an agreement (written or otherwise) to solicit investors and protection sellers up to certain target amount that Paulson had in mind. And perhaps Goldman’s fees were tied to hitting this target.
Later that May 2007: Goldman’s Tourre goes back to ACA to see if they’re interested in writing supersenior protection. ACA’s parent company, ACA Capital, just so happens to be in the business of providing financial guarantee insurance (i.e. writing protection) on structured products. ACA agrees and the parties negotiate a 50bps premium for protection on the supersenior tranche on $1.8B of total notional reference the same ABACUS portfolio. But there’s another hitch. Goldman and ACA can’t agree on the terms of the collateral arrangement.
NB: I don’t know if Goldman solicited anyone else to write the supersenior protection, but I can think of one notorious name who got themselves up to their eyebrows in the stuff. In any event, it would have made sense to ask ACA first, since they’d already done the due diligence and wagered $42M of their own money on a more subordinate tranche.
Still May 2007: Goldman calls ABN, looking to find someone willing to work out a solution to the impasse between Goldman and ACA Capital. ABN agrees to intermediate the Goldman-ACA Capital deal by effectively guaranteeing ACA Capital and agreeing to post collateral on its behalf to Goldman, all in exchange for 17bps. Goldman’s risk managers are pleased, but now Tourre has to go back to Paulson with mixed news. He managed to find a protection seller, but only for a $1.8B 50%-100% tranche and for a rather high total premium (for supersenior deals) of 67bps. Paulson, perhaps recognizing that the RMBS market is on the verge of a significant downturn (as it turned out, it was), seizes the deal on largely these terms. But Paulson knows it still has some goodwill with Goldman. So it tries to leverage its relationship with Tourre to convince Goldman to write protection on 45%-100%, as originally contemplated. To get it done, perhaps Paulson agrees to pay some incremental premium to Goldman for retaining the slim 45%-50% supersenior tranchelet. Tourre works his magic with the risk managers and closes the deal.
May 31, 2007: Both supersenior deals close. Shortly thereafter, the RMBS market tanks hard, kicking off the financial crisis that would culminate over a year later with the collapse of Lehman Brothers. But that’s another story.