This idea may be trickier to follow for those not well versed in credit and / or structured products. I’ll do the best I can do keep it straightforward.
Idea: Lehman ABS 3.50% Adjustable Corporate Backed Trust Certificates, GS Cap Trust I (NYSE: JBK) is a synthetic version of Goldman Sachs 6.345% junior subordinated bonds due February 2034. The name is long, but the idea is simple: the underlying GS bonds trade at 117.15, with a yield to worst of 4.87%. the JBK bonds trade at 23.00, or a yield to worst of 7.16%. A 7%+ yield I think is pretty attractive in today’s environment. However, there is one big risk, and that is related to ongoing litigation of the trust.
History
2004: Lehman Brothers creates a trust and deposits $25 million worth of 6.345% GS bonds due 2034. Lehman adds an interest rate swap to the trust that swaps the 6.345% interest rate on the bonds for a rate of LIBOR +0.75% (subject to a floor of 3.50% and a ceiling of 7.50%). Lehman would act as the counterparty on the trust. US Bank is the trustee.
September 2008: September 15, Lehman Brothers files for bankruptcy. On September 22, US Bank sends a notice to JBK holders stating the swap has been terminated. Due to the bankruptcy filing, Lehman Brothers could no longer act as the counterparty on the swap trade. The trust remained live however, and US Bank applied the interest received on the GS bonds to JBK holders, essentially turning the trust into a pass through entity.
March 2012: The Lehman estate emerges from bankruptcy. Lehman Brothers Holding Inc. (“LBHI”) is the holding company that serves to pay off creditors and liquidate the remaining assets.
September 2015: Lehman files a complaint against the JBK trust and US Bank, claiming that the trust should have passed on the interest payments received from Goldman Sachs. They claim that Lehman Brothers filing for bankruptcy and failing to make payments under the swap agreement did not constitute a swap termination event.
Today: this issue continues to be litigated. I’m not a lawyer, but when I read the original trust document, it is pretty clear that a swap termination event occurred, with Lehman as the defaulting party. I’m not entirely sure I understand LBHI’s argument why it is due anything, but given the world of bankruptcy litigation, I’m not sure that matters.[1]
Downside
Obviously that somehow the trust loses the litigation or even settles. Whether or not I believe the argument has merit does not matter, and until there is clarity on the issue, it may be tough to do anything.
Upside
The trust wins the litigation. If the litigation overhang clears, there is a fairly obvious arbitrage opportunity with the underlying GS bonds.
Other Thoughts
The JBK trust is illiquid and with a $25 million notional value, I’m not sure any institutional investor would even care.
I haven’t bothered discussing the credit risk of the GS bonds, the interest rate risk, or any other fixed income risk. I’ll leave it that the GS bonds are Baa3 / BB rated.
Interestingly, these notes are actually one of many structured transactions Lehman Brothers created before going bankrupt, including on Toys R Us, General Motors and Kinder Morgan bonds.
[1] I’ve glossed over some of the technicalities around the litigation, but it is probably helpful to at least define who everyone is:
Lehman ABS Corporation (LABS): the depositor of the GS notes
Lehman Brothers Holdings Inc. (LBHI): lead debtor in the bankruptcy and a guarantor of the swap agreement. LBHI is currently winding down the Lehman estate
Lehman Brothers Inc (LBI): the underwriter for the trust. LBI was the broker-dealer subsidiary of LBHI and the parent to LABS
Lehman Brothers Special Financing Inc (LBSF): counterparty on the swap agreement
Investment Treats 