Tuesday, November 06, 2007
super-siv looks dead, and so may citi be
The risk of fire sales of mortgage-backed securities was rising on Tuesday after rating downgrades pushed a clutch of complex debt vehicles into default, threatening a further escalation of the turmoil caused by the subprime mortgage meltdown.
The prospect of forced sales comes as a US Treasury-backed plan for a “superfund” to buy up distressed mortgage securities appears to have stalled.
The threat of forced sales of mortgage-backed assets has prompted the US Treasury to back the proposal by three top US banks to set up for a $75bn superfund to buy securities from cash-strapped structured investment vehicles.
However, the plan has fallen badly behind schedule with no other banks yet making a firm commitment to join Citigroup, Bank of America and JPMorgan Chase.
Executives at other banks believe the plan has been hurt by the turmoil at Citigroup, which lost its chief executive, Chuck Prince, on Sunday after admitting it faced further mortgage-related writedowns of up to $11bn.
“As far as we can see, it appears dead in the water right now,” said one senior Wall Street banker.
However, one person close to the plan said progress had been made on deciding what assets would be eligible and syndication of the back-up bank lines was set to start late next week.
Some observers fear it might now prove impossible to create the superfund quickly enough to help banks deal with the funding problems dogging SIVs – off-balance sheet entities that use short-term debt to fund longer-dated investments.
Expectations are rising that banks might be forced to provide more help to the SIVs they manage in the coming weeks, to prevent a forced sale of their assets.
Citi, which manages SIVs with about $80bn of assets, had bought $7.6bn of commercial paper issued by its SIVs by October 31, out of a total commitment of $10bn, it disclosed in its quarterly filing with regulators.
but worse -- the $100bn in possible siv obligations is exceeded, as it is becoming known now in a report from ft, by citi's obligations to cdo's that it arranged and were once funded by commercial paper (alas, no more).
Commercial paper might be more familiar to most as the Achilles heel of that other credit crunch protagonist, the SIV. But forget Citi’s SIVs. Trouble in the commercial paper market for CDOs is causing much more pain for Citi. Not only are CDOs loaded with subprime - unlike Citi’s SIVs - but the bank also has far more significant funding commitments to them.
FT Alphaville understands that Citi has numerous agreements in place with CDOs that force the bank, as arranger, to buy CDO commercial paper if they cannot place it. That unplaceable debt has totalled $25bn so far - but there could be more.
Most CDOs, of course, don’t normally issue CP. Traditionally, CDOs issue straight tranches of rated bonds. But Citi made CDOs issuing CP good business pre-crunch. You might say that commercial paper CDOs are a scion of the SIV world - using CP issuance to supplement their normal debt issues and create a more dynamic, flexible portfolio, benefiting from low yielding CP.
But also just like SIVs, CDOs need to keep refinancing that CP to pay off upcoming redemptions. But where they differ is that CP issuing CDOs mitigate that rollover risks by using their arranging banks’ as underwriters on all new CP issues. Whatever CP they can’t sell, agreements are in place as backup that ensure banks will buy.
And just like with SIV CP investors, over the summer, CDO CP buyers have dried up.
Money market funds - formerly among the biggest players in the CP markets - are loathe to touch anything containing MBS.
So Citi - unable to place CP on subprime CDOs it arranged as far back as 2005, - is having to buy it instead. Right when it can least afford to do so.
Crucially we should make clear that Citi isn’t necessarily being “forced” into buying that debt: not in the most literal sense of the word. The backstop “agreements” it has in place are not set in stone. It could have said no. But had it done so it may have seen CDOs default, or else a rush to sell assets to meet amortizing CP. In the event, that was evidently too ugly an option to countenance.
And Citi may only now be ruing that decision. Commercial paper is classed as “super senior” debt in CDOs, and had until October, held out as a secure tranche. But the contagion has spread right up the tree, and the rating agencies have shown now mercy for even the highest grades of debt. Super senior debt is far from secure.
i haven't yet seen an estimate for just how much of this sort of semi-forced assumption of degrading cdo's citi might be in for, other than for ft's assertion that the obligation is more considerable than its siv obligations. for a bank already carrying more in level 3 assets than its equity, any further bloating will be reason for further skepticism about citi's ability to remain an independent going concern.
all this has citi stock plunging again, and cibc banking analyst meredith whitney called a citi breakup "inevitable". mish would agree. where will it find a bottom? and will the government replace the super-siv with some other bailout (veiled or otherwise) in order to avoid a forced deleveraging as citi's balance sheet balloons with assets that are of very poor quality and in danger of imminent rerating?