Capitalizing in part on lessons learned while serving as financial adviser to bankrupt Orange County, Salomon Bros. Inc. on Friday said it would buy up to $8.1 billion of complex derivative investments and repackage them as less-risky "plain vanilla" bonds.
Earlier this year, Salomon helped Orange County sell more than $5 billion risky derivative securities from its loss-riddled investment pool and replace them with short-term, money-market securities.
"The one thing that Orange County did was create an awareness that these securities are in people's portfolios," a Salomon official said Friday. "Many smaller investors don't have the market access that Orange County could garner. What this tender does is create a market-clearing price that a smaller investor can participate in."
Wall Street observers predicted a healthy profit for Salomon and a strong demand for the repackaged securities. Within hours of Salomon's announcement, Morgan Stanley & Co. and other investment houses were signaling their intent to bid on the notes being tendered.
"There's a cloud over these structured notes because of what's gone on the last six months in Orange County," said Zane Mann, publisher of the Palm Springs-based California Municipal Bond Advisor. "But these are smart people; they know how to make money off these (restructurings). They're not doing this as a some church-like service for investors."
Leslie Rahl, a principal with Capital Markets Risk Advisors in New York, said Wall Street firms "do these sorts of (deals) every day. There's usually a stronger demand for one type of security than another, . . . and they've found a (profitable) way to repackage these securities."
The value of a derivative security is driven by an underlying stock, bond, commodity or financial index. The bonds Salomon will buy initially were sold by the Federal National Mortgage Assn., the Student Loan Marketing Assn. and other agencies.
Derivatives have been linked to several high-powered financial losses in recent months, including the debacles that sank Orange County and Britain's Barings investment bank. Salomon and other major investment banks that dominate the market are attempting to regulate the derivatives trade themselves in a bid to forestall government controls.
Salomon will provide desired liquidity to holders of derivatives by buying structured notes, which in many cases are selling at depressed prices, and repackaging them with a more attractive interest-rate structure. The new "plain vanilla" bonds will be tied to the London inter-bank-offered rate, or Libor, a published interest rate that is more readily understood and determined than the complex rate interactions that drive structured notes.
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