Tag Archive for 'Citigroup'

Regulation should set information free

Imagine that you’re a manager for a large investment fund and you’ve recently been contemplating your position on Citigroup.  How would this press release from Citi affect your opinion of their prospects?:

New York – Citi today announced the sale of its entire ownership interest of three North American partner credit card portfolios representing approximately $1.3 billion in managed assets. The cards portfolios were part of Citi Holdings. Terms of the deals were not disclosed. Citi will continue to service the portfolios through the first half of 2010 at which time the acquirer will assume all customer servicing aspects of the portfolios.

The sale of these card portfolios is consistent with Citi’s strategy to optimize the assets and businesses within Citi Holdings while working to generate long-term profitability and growth from Citicorp, which comprises its core franchise. Citi continues to make progress on its strategy and will continue to pursue opportunities within Citi Holdings that create the most value for stakeholders.

The answer should be “not much, or perhaps a little negatively” because the press release contains close to no information at all.  Here is Floyd Norris:

A few unanswered questions:

1. Who is the buyer?
2. Which card portfolios are being sold?
3. What is the price?
4. Is there a profit or loss?

A check of Citi’s last set of disclosures shows that Citi Holdings had $67.6 billion in such credit card portfolios in the second quarter, so this is a small part of that. Still, I can’t remember a deal announcement when a company said it had sold undisclosed assets to an undisclosed buyer for an undisclosed price, resulting in an undisclosed profit or loss.

Chris Kaufman at Reuters noted the same.

Now, to be fair, there is some information in the release if you have some context.  In January 2009 Citigroup separated “into Citicorp, housing its key banking business, and Citi Holdings, which included its brokerage, consumer finance, and troubled assets.”  In other words, Citi Holdings is the bucket holding “assets that Citigroup is trying to sell or wind down.”  The press release is a signal to the market that Citi has been able to offload some of those assets – it’s an attempt to speak of improved market conditions.  But the refusal to release any details suggests that they sold the portfolios at a deep discount to face value, which implies either that Citi was desperate for the cash (a negative signal) or that they think the portfolios were worth even less than they got for them, which doesn’t bode well for the rest of their credit card holdings (also a negative signal).  It’s unsurprising, then, that Citi were down 4.1% in afternoon trading after the release.

Some more information did emerge later on.  American Banker, citing “industry members with knowledge of the transaction,” reported:

The buyer was U.S. Bancorp, according to industry members with knowledge of the transaction, who identified the assets as the card portfolios for KeyCorp and Associated Banc-Corp, which Citi issues as an agent bank, and the affinity card for the American Dental Association.

But a spokeswoman for Citi, which only identified the portfolios as “North American partner credit card portfolios” in a press release, would not comment, identify the buyer, or elaborate on the release. U.S. Bancorp, Associated Bank and the American Dental Association did not return calls by press time; a spokesman for KeyCorp would not discuss the matter.

It’s tremendously frustrating that even this titbit of information needed to be extracted via a leak.  Did Maria Aspan — the author of the piece at American Banker — take somebody out for a beer?  Did the information come from somebody at Citigroup, Bancorp or one of the law firms that represent them?

In what seems perfectly designed to turn that furstration into anger, we then have other media outlets reporting this extra information unattributedHere‘s the Wall Street Journal:

Citigroup Inc. sold its interest in three North American credit-card portfolios to U.S. Bancorp of Minneapolis, continuing the New York bank’s effort to unload assets that aren’t considered to be a core part of its business, according to people familiar with the situation.


Citigroup announced the sale, but it didn’t identify the buyer or type of portfolio that was being sold. Representatives of U.S. Bancorp couldn’t be reached for comment.

That’s it.  There’s no mention of where they got Bancorp from at all.

It’s all whispers and rumours, friendships and acquaintences.  It’s no way for the market to get their information.

Here’s my it’ll-never-happen suggestion for improving banking regulation:

Any purchase or sale of assets representing more than 1% of a bank’s previous holdings in that asset class [in this case the sale represented 1.9% of Citi’s credit card holdings] must be accompanied by the immediate public release of information uniquely identifing the assets bought or sold and the agreed terms of the deal, including the price.  Identities of all parties involved must be publicly disclosed within 6 months of the transaction.

How to value toxic assets

There should really be a question mark at the end of that title.  As far as I can tell, no-one really knows.

I mentioned yesterday that the US government has just given a guarantee to Bank of America against losses in a collection of CDOs and other derrivatives that BofA and the US government agreed were currently worth US$81 billion (the headline guarantee is for $118 billion, but $37 billion of that is cash assets that are unlikely to lose value).

Last November the US government did the same thing for Citigroup, but the numbers there were much larger:  US$306 billion.

The deal with Bank of America is a better one because the $81 billion of toxic assets had to be bundled with $37 billion of cash that will almost certainly create a (small) profit to partially offset any losses.

Nevertheless there is a general question of how they arrived at those numbers given that the market for those assets has dried up:  nobody is buying or selling them, so there aren’t any market prices to use.

The problem is hardly unique to America.  From today’s FT:

[M]inisters and regulators are examining loans already on banks’ balance sheets, which are becoming more impaired as the economy deteriorates. Concern about the eventual size of losses on them is one reason British banks have recently reined in lending.

Final decisions are not expected imminently from the Treasury. But Mr Brown has spoken recently of the problem of “toxic assets” on balance sheets, raising speculation that a “bad bank” solution will be adopted.

The prime minister has also said Britain is looking at different models. These include schemes whereby the government buys up bad assets in return for cash or government bonds; and schemes where banks keep the assets on their balance sheets but the government insures them against loss. The latter method was adopted by the US government this week to shore up Bank of America.

The Bank of England is moving towards the idea of a so-called bad bank, since private sales of bank assets are proving difficult or impossible. But it raises difficult questions: how should assets be valued; should gilts be issued for the purchases; or should money be created.

Mr Darling also notes that a US toxic asset relief scheme proved difficult to launch because of banks’ refusal to sell assets at a price ­acceptable to the government. Offering insurance against future losses on bad assets could prove more attractive.

“The other problem is that the banks haven’t asked us to do this yet,” said one government official. “We would be asking the banks to give us a load of crap and they’d say to us: ‘What are you going to pay us then?’”

The credit crisis will not end until we know which banks are solvent and which are not, and we won’t know that until we know the value of those CDOs.  Despite the fact that they can’t sell them, banks are loath to write them off completely.  Also from the FT today:

With speculation growing that the government will be forced to stage another bank rescue, the prime minister told the Financial Times he had been urging the banks for almost a year to write down their bad assets. “One of the necessary elements for the next stage is for people to have a clear understanding that bad assets have been written off,” he said.

Speaking amid mounting market concerns that banks face further heavy losses, Mr Brown said: “We have got to be clear that where we have got clearly bad assets, I expect them to be dealt with.”

Is it just me, or do you get impression that we’re watching a very expensive game of chicken here?

The (latest) bailout of Bank of America

Bank of America is being handed a butt-load of cash:

Bank of America will on Friday receive $20bn in fresh capital from the US government and a guarantee on most of a further $118bn of potential losses on toxic assets.

The emergency bail-out will help to cushion the blow from a deteriorating balance sheet at Merrill Lynch, the brokerage BoA acquired earlier this month.
The package is on top of the $25bn BoA received from Tarp funds last October, and underscores the depth of the financial difficulties affecting the world’s leading banks.

At this point, BofA has received US$45 billion in hard cash and – more importantly, to my mind – a guarantee against US$118 billion of CDOs and related assets that they hold, many of them from their takeover of Merrill Lynch.

I don’t really want to get into whether bailouts in general are worthwhile, or if this one in particular is worthwhile. What I want to rant about is the nature of this bailout and in particular, that guarantee.  It’s been done in a manner highly similar to the one given to Citigroup last year, so my criticism applies to that one as well.

Here is the joint Press Release from the US Federal Reserve, the US Treasury Department and the FDIC.

Here [pdf] is the term sheet for the deal with Bank of America.

The guarantee is against a pool of assets broken down as:

  • US$37 billion worth of cash assets
  • US$81 billion worth of derivatives (i.e. CDOs and other “troubled” assets)

Profits and losses for the pool will be treated as a whole. The fact that one third of the pool is cash (and cash equivalents) will have been insisted upon by the US government because they will almost surely generate at least a minor profit that will offset losses in the derivatives.

In the event of losses on the pool as a whole, BofA will take the first US$10 billion of losses; the US Government will take the next US$10 billion of losses; and any losses beyond that will be split 90/10: the US government will take 90% of them. That gives a theoretical maximum that the US government might be liable for as 10 + 90%*(118-20) = US$98.2 billion.  In all likelihood, though, the cash assets will hold or increase their value, so the maximum that the US government can realistically be imagined to be liable for is 10 + 90%*(81-20) = US$64.9 billion.

But kicker is this: There was no easy way for them to arrive at that number of $81 billion. The market for cash is massively liquid (prices are available because trades are occurring), so it is easy to value the cash assets. The market for CDOs, on the other hand, is (at least for the moment and for many of them, forever) gone. Unless I’m mistaken, there are no prices available to use in valuing them. Even if there were still a market, CDOs were always traded over-the- counter, meaning that details of prices and volumes were secret.

Instead, the figure of US$81 billion is “based on valuations agreed between [BoA] and the US [Government]” (that’s from the term sheet).

I want to see details of how they valued them.

When TARP was first envisaged and it was suggested that a reverse auction might take place, the rationale was for “price discovery” to take place. The idea – which is still a good one, even if reverse auctions are a bad way to achieve it – is that since nobody knows what the CDOs are really worth, confusion and fear reign and the market drys up. Since nobody can properly value banks’ assets, nobody can tell whether those banks are solvent or not.

The generalised inability to value CDOs remains, and will continue to remain, a core issue in the financial crisis.

Suppose that the true value of BoA’s CDOs is US$51 billion. At some point, we will collectively realise that fact. The market will become (at least semi-)liquid again and the prices will, at least approximately, reflect that value. But since the BoA and US government had agreed that they were worth US$81 billion, it will technically look like a $30 billion loss and so will trigger the US government handing $19 billion (= 10 + 90%*(30-20)) to BoA and unlike the $45 billion in direct capital injection, the government will get nothing in return for that money.

Therefore, BofA had an enormous incentive to game the US government. No matter what they privately believed that their CDOs were worth, they would want to convince the Treasury that they were actually worth much more.

The US government isn’t entirely stupid, mind you. That’s why the first $10 billion in losses accrue to BoA. That means that for the money-for-nothing situation to occur, the agreed-upon valuation would need to be out by over $10 billion. On other hand, that means that instead of telling a little white lie, BoA has an incentive to tell a huge whopper of a bald-faced lie in convincing the Treasury.

That is why I want to see details on how they valued them.

Felix Salmon thinks that both Citigroup and Bank of America should be nationalised:

[N]either institution is capable of surviving in its present form much longer. [Hank Paulson and Tim Geithner] should embrace the inevitable and just nationalize the two banks.

[T]his isn’t a bank run: Citi and BofA aren’t suffering from liquidity problems. They have all the liquidity they need, thanks to the Fed. The problem is one of solvency: the equity markets simply don’t believe that the banks’ assets are worth more than their liabilities.

The problem being, as I explained above, that nobody knows what the assets are really worth and the market is simply assuming the worst as a precautionary measure.

I’m not yet convinced that they should be fully nationalised. I just don’t think that the government should put itself in a situation where it promises to give them money for nothing in the event that their private valuation turns out to be too high (i.e. the market is correct in believing that they’re worth bugger-all).

Barry Ritholtz wants to know why the heads of Citi and BoA are still there:

Like Citi, the B of A monies are a terrible deal for the taxpayer — not a lot of bang for the buck, and leaving the same people who created the mess in charge.

Organ transplant medicine understands certain truths: You do not give a healthy liver to a raging alcoholic, as they will only destroy the organ via their disease/bad judgment/lifestyle.

In this, I agree with him entirely.

Oops …

Well, what do you know?  The US government is (almost certainly) going to buy troubled assets after all, starting with those of Citigroup.  CalculatedRisk has been on top of it [1,2,3,4].  The last of those links contains the joint statement by the Treasury, Federal Reserve and FDIC:

As part of the agreement, Treasury and the Federal Deposit Insurance Corporation will provide protection against the possibility of unusually large losses on an asset pool of approximately $306 billion of loans and securities backed by residential and commercial real estate and other such assets, which will remain on Citigroup’s balance sheet. As a fee for this arrangement, Citigroup will issue preferred shares to the Treasury and FDIC. In addition and if necessary, the Federal Reserve stands ready to backstop residual risk in the asset pool through a non-recourse loan.

In addition, Treasury will invest $20 billion in Citigroup from the Troubled Asset Relief Program in exchange for preferred stock with an 8% dividend to the Treasury. Citigroup will comply with enhanced executive compensation restrictions and implement the FDIC’s mortgage modification program.

Here is a summary of the terms of the deal, with a fraction more detail:

Size: Up to $306 bn in assets to be guaranteed (based on valuation agreed upon between institution and USG).

Deductible: Institution absorbs all losses in portfolio up to $29 bn (in addition to existing reserves) Any losses in portfolio in excess of that amount are shared USG (90%) and institution (10%).

USG share will be allocated as follows:
UST (via TARP) second loss up to $5 bn;
FDIC takes the third loss up to $10 bn;

Financing: Federal Reserve funds remaining pool of assets with a non-recourse loan, subject to the institution’s 10% loss sharing, at a floating rate of OIS plus 300bp. Interest payments are with recourse to the institution.

A couple of points:

  • The US government isn’t immediately buying US$306 billion of crappy assets.  It’s guaranteeing that the value of them won’t fall too much further.  If they do, then they’ll buy ’em.  It will be interesting to see how much of this guarantee is actually called into force.
  • Notice that only US$20 billion is attributable to TARP, while the rest is entirely new.  That is presumably to make sure that the US government can continue to stand by it’s recent promise to not ask for congressional approval for the last US$350 billion available under that program.  On the other hand, I suppose it’s also likely that they want to keep the TARP money for direct capital infusions; that is, for actual money spent now rather than taking on risk.
  • To put the US$20 billion of new money into perspective, Citigroup’s market capitalisation as of Friday was US$20.5 billion.
  • It’s that “on valuation agreed upon between institution and USG” that troubles me.  Part of the reasoning given for TARP in the first place was for “price discovery” (through reverse auctions).  There was plenty of criticism of that policy, but the goal of discovering the true value of all of these assets is a noble one.  This bailout of Citi will now involve private negotiation between Citigroup and the US government to determine their value for the purposes of the guarantee.  That’s a bloody awful way to do it.