PrefBlog

The big news recently has been the Citigroup writedowns, ouster of the CEO and downgrade by Moody’s (to Aa2 from Aa1). Accrued Interest is experiencing deja vu … the search for sub-prime exposure after the writedowns is like the search for fishy accounting after Enron. Naked Capitalism points out that while both Merrill and Citi have taken huge write-downs, Citigroup has done nothing to reduce its exposure.

Nouriel Roubini thinks this is the tip of the iceberg (as does CreditSights) and pays particular attention to mark-to-make-believe accounting. Accrued Interest explains the rating volatility of CDOs with a simple model. Giovannini and Spaventa attribute the snowballing effects of the credit crunch to the information gap between investors and exposures and propose some solutions – most of which impose extemely onerous supervision. While none of the following elements is explicitly spelled out in their paper, or unequivocally endorsed, I interpret the remarks as proposing:

• licensing of mortgage brokers
• regulation of credit rating agencies and inspection of their models
• standardization of products traded over-the-counter
• increased disclosure of bank exposures under Basel II

The first three recommendations are inappropriate in the context of bank regulation. While these matters may well be desirable from other perspectives – and should be argued within the context of those perspectives – they have little to do with the regulation for the purpose of ensuring the stability of the banking system. Even the fourth suggestion is far too prescriptive for a free market: I suggest that the policy objective would be met by stating simply that any instrument for which the banks’ assigned credit profile cannot be verified due to material information not disclosed to the regulators should be charged to risk-weighted assets as if it were equity. This is sufficiently punitive that:

• the policy objective of encouraging transparency will be served
• the stability of the banking system will not be compromised by debt-rated securities that behave with, shall we say, greater volatility and less liquidity than most debt.

Meanwhile, Citigroup filed its third-quarter ’07 10-Q today, chock-full of interesting information!

The current lack of liquidity in the Asset-Backed Commercial Paper (ABCP) market and the resulting slowdown of the CP market for SIV-issued CP have put significant pressure on the ability of all SIVs, including the Citi-advised SIVs, to refinance maturing CP.

While Citigroup does not consolidate the assets of the SIVs, the Company has provided liquidity to the SIVs at arm’s-length commercial terms totaling $10 billion of committed liquidity, $7.6 billion of which has been drawn as of October 31, 2007. Citigroup will not take actions that will require the Company to consolidate the SIVs.

Master Liquidity Enhancing Conduit (M-LEC)

In October 2007, Citigroup, J.P. Morgan Chase and Bank of America initiated a plan to back a new fund, called the Master Liquidity Enhancing Conduit (M-LEC) that intends to buy assets from SIVs advised by Citigroup and other third party institutions. This is being done as part of an effort to avert the situation where the SIVs will be forced to liquidate significant amounts of mortgage-backed securities, resulting in a broad-based repricing of these assets in the market at steep discounts.

SIVs, including those advised by Citigroup, have experienced difficulties in refinancing maturing commercial paper and medium-term notes, due to reduced liquidity in the market for commercial paper.

Well! As far as I know, that’s the first official admission that the Citigroup SIVs are in enough trouble that they’re going to sell to Super-Conduit (MLEC), assuming that Super-Conduit ever gets off the ground! This may not be a death-blow to my thesis that Super-Conduit = Vulture, but it’s a pretty good hit!

In a similar development that I missed on its publication October 18, there is speculation that BMO has purchased $13-billion of its own ABCP.

Citigroup has previously announced:

Citi also announced that, while significant uncertainty continues to prevail in financial markets, it expects, taking into account maintaining its current dividend level, that its capital ratios will return within the range of targeted levels by the end of the second quarter of 2008. Accordingly, Citi has no plans to reduce its current dividend level. 

But Accrued Interest – a bond guy after my own heart – has looked at the various impairments of the various banks with the horror that only a bond guy who’s afraid he won’t get paid can muster and has made a modest proposal:

This leaves the surviving banks with better pricing power and/or ability to dictate lending terms. Overall, the long-term prospects for banks should be quite positive.However, in order to realize this long-term opportunities, banks must find a way to survive the current contagion with as much capital preserved as possible. Long-term shareholders appreciate this need for capital preservation. It would not serve shareholders interests to sell assets at fire-sale levels to raise capital. Nor would shareholders benefit from a bank being forced to issue new equity shares, particularly at a time when equity prices are weak.

There is one obvious way for banks to retain more capital: eliminate the dividend.

We shall see if any of them take him up on it!

A good day for prefs, with perpetuals resuming their upward trend of the past week … but splitShares went out of style today, with some large declines.

There were thirty-three other index-included $25.00-equivalent issues trading over 10,000 shares today.

This entry was posted on Tuesday, November 6th, 2007 at 11:18 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.