Posted on 11/07/2007 7:48:59 PM PST by bruinbirdman
When Citigroup announced – hot on the heels of Chuck Prince’s departure as chairman and chief executive – additional writedowns of up to $11bn related to subprime mortgages, the most surprising thing was that many of the losses were on $25bn worth of previously off-balance-sheet exposure.
“The first question I asked was: ‘Where did that come from?’ ” says one analyst.
The answer was buried deep in the notes to Citigroup’s results in the so-called 10Q filing with the Securities and Exchange Commission – under the heading of “Variable Interest Entities”.
This heading covers a multitude of activities at Citi and other banks – many of which are the very activities that have been at the centre of this year’s financial liquidity storm. And its total exposure to such vehicles is more than $140bn.
Asset-backed commercial paper (ABCP) conduits are there, as are structured investment vehicles (SIVs) and investments in collateralised debt obligations (CDOs).
A close reading of Citi’s accounts this year would have given investors and analysts some clues as to the US bank’s exposure to CDOs in which it has a significant interest, but which it does not have to consolidate on to its balance sheet. However, few looked that closely at the disclosures and details were scant in any case.
“The whole question of CDO exposure and off-balance-sheet vehicles is such a black box in many ways – but that’s investing in financials,” says Mike Mayo at Deutsche Bank. For instance, in Citi’s second-quarter filing, the bank did not break down the detail of its maximum exposure to loss from such activities in the same way as it did this time.
So while the total size of CDO-type transactions it was exposed to was listed at $74.7bn in June, up from $52.1bn in December, there was no disclosure of Citi’s actual exposure to these deals. This time around, the filing shows that the December maximum exposure was $34bn (out of the $52.2bn total) and that this rose by the end of the third quarter to $43bn (out of a $84.4bn total size of the related CDO deals).
More intriguing is the fact that in the second-quarter filing Citi made no mention of its activities in ABCP conduits – which exist to supply cheap funding from the short-term debt markets to lending activities or investments in higher-yielding, longer-term securities or debts. In the third-quarter filing, there is the sudden addition of a $69bn exposure to such conduits with assets of $73.3bn.
It is not that these did not exist before, because the same filing shows the comparable figures from December – an exposure of $56bn on $66.3bn worth of conduits. The lack of inclusion is not particularly fishy, according to analysts. “Disclosure does evolve with investor interest,” says Howard Mason of Sanford Bernstein.
“Perhaps last time it was thought that there was just not sufficient investor interest.”
Citi has one of the largest maximum exposures to loss from such off-balance-sheet activities among its rivals. Its total exposure is $141bn, up from $109bn at the end of December.
Among recent filers, Goldman Sachs is no slouch in this field with a maximum loss exposure of $65.5bn in activities related to CDOs, real estate investing, mortgage-backed bonds and principal-protected notes. However, this figure has declined from $72.5bn at the end of November 2006.
JPMorgan Chase is also very big in the field. It has not yet filed its most recent 10Q, but in its second-quarter filing it listed its exposure at $86.9bn as at the end of June, up from $67bn at the end of December.
Merrill Lynch has also yet to file, while Lehman Brothers and Morgan Stanley have both reported much smaller figures in their recent filings.
All banks say that these exposures do not represent anticipated losses from the VIEs – but none says what level of losses they do account for, or if other writedowns are on the horizon.
However, the real question here is how much more of this activity could be linked to subprime or whether any of it could lead to further writedowns if supposedly safer assets also suffer large market value declines. “This does point to the potential for further write-downs that could come over and above subprime,” says Mr Mason.
Auditors will also be looking very closely at this area. In a recent paper, entitled “Consolidation of commercial paper conduits”, the Center for Audit Quality set out a reminder that whether or not such vehicles ought to be consolidated on to a bank’s balance sheet needed to be reassessed regularly and with reference to market values of the assets involved.
Cutting through the complex jargon of the trade and references to the relevant accounting standards, the message reads: “Although a sponsoring bank may believe that the market is not properly valuing certain assets ... a sponsoring bank is required to use market assumptions” when assessing whether a vehicle remains off-balance-sheet or not.
There are also questions to be raised about whether these maximum loss exposure figures are set to keep rising for some banks. In Citi’s third-quarter statement, it lists maximum exposure to its SIVs as $3bn as at September 30.
But elsewhere in the same statement it says that its group of seven SIVs had drawn $7.6bn out of a $10bn facility by October 30.
There has to be some concern that if the Citigroup-led “super-conduit” project fails to get off the ground, this figure at least is only going one way.
Citigroup did not return calls seeking comment on this area of its accounts.
SIVs at risk of downgrade
Ratings agency Moody’s put on review for downgrade debt issued by 16 different structured investment vehicles including, for the first time, some large bank-sponsored vehicles thought to be the strongest.
The agency said the SIVs continued to suffer from the liquidity freeze and that it was becoming likely they would have to realise losses on the sale of assets.
The roll-call included three SIVs run by Citigroup and two run by HSBC.
For a while there was talking of cracking down on what went into the “notes” sections of 10Qs. Don’t know what became of it, though.
$140BB in exposure.
Wow, it is only the first inning.
So, what’s their plan, write down $11BB/Q for 13 more quarters?
You're welcome.
a little math humor...
LOL!
These mega banks are looking like Enron. Creative to the point of destroying themselves. Well, most people in finance saw this coming, and here we are.
I thought this stuff was against the law, after enron they passed some legislation that made CEO and execs more accountable? Let’s see about that.
more acronyms than ya can shake a STIK at.. the one that gets ya in the end is DEBT. oh well, debt haPPens.
Yea now they have to give back a whopping 60% of what they stole. I tell ya it’s hard out there for a pimp.
Worse yet, a WSJ article last week pointed out that the banks’ internal models for valuing these non-traded securities rely heavily upon credit ratings, so, when the agencies downgrade, the banks must take additional writedowns on these securities, even if nothing material has changed except the ratings agencies’ recognition of risk after the fact.
Oh man! Dang, that is important in this whole mess. Never thought of that, but you’re right, that will make the value fall like a rock, especially with credit spreads widening like crzy...
Those are Level III assets. They are valued on a wing and a prayer.
This time, it wasn’t even creative. It was a rehash of the junk bond schemes of the 80’s. Package bad debt into bonds and sell them.
Then, the debt was corporate. Now the debt is mortgage.
I’ll bet a cruller some idiot tries to package retail debt, credit cards and such, and try to sell that.
Might take five years to come around, but we’ll see it.
PING
It’s already done - credit-card debt packages in much the same way. Even CC and other debts discharged through bankruptcy are packaged and sold for fractions of a cent-on-the-dollar, and then firms attempt to collect. It is probably illegal to collect on bankruptcy-debt but that doesn’t stop anybody these days.
The credit-card implosion is probably next on the horizon because a lot of folks are trying to buy a bit more time on their soon to be foreclosed home by transferring mortgage payments to their credit cards.
Well.
That’s reassuring.
Too bad it only took 5 years.
What they didn't consider was that fear is a little understood contagion.
BUMP
Yep, they thought they could write a program for it.
The Lord wrote those algorithms and he isn't divulging the codes.
yitbos
Word today is Chucky gets $40 million of Citi shareholders’ money, after he has already screwed them out of half of their investment. Corporate governance in not working in America when the Boards of Directors of most corporations are puppets of the CEOs. So much for SarbOx.
Friday WSJ states he gets on severance. Just an admin assistant car etc.
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