If HSBC Can Bail Out Their SIV, Why Can’t Citigroup?

Below is a good discussion of the two of the competing ways SIVs can be dealt with: 1) bring the SIV on to your balance sheet the way HSBC did or 2) develop a big bank bail out fund or superfund (M-LEC) to purchase SIVs so they do not have to be liquidated. Text in bold is my emphasis. From Market Watch:

HBC Holdings' $35 billion bailout of its structured investment vehicles puts pressure on a group of rival banks that are working on a broader solution to one of the major sources of this year's global credit crisis.

HSBC said Monday that it's moving Cullinan Finance and Asscher Finance, two structured investment vehicles, or SIVs, onto its balance sheet to prevent forced sales of what it called "high-quality assets." Britain's largest bank by market value is providing up to $35 billion in funding, and its balance sheet will expand by $45 billion. The SIV market, a roughly $300 billion business, is at the center of the current credit crisis. The vehicles borrow money short term and use the cash to buy longer-term debt. The longer-term assets usually pay higher interest rates than the short-term debt, and money is made on the difference.

As defaults surged on subprime mortgages this year, confidence in these products wilted, and SIVs struggled to refinance short-term debt. That sparked concerns that the vehicles would be forced to sell hard-to-value assets like CDOs into illiquid markets at severely depressed prices. That, in turn, could damage the value of similar assets held by others, such as banks, brokers, hedge funds, insurers and pension funds.

On Oct. 15 B of A, Citigroup Inc., and J.P. Morgan Chase unveiled a joint plan to try to head off this potentially damaging scenario, under the guidance of the U.S. Treasury.

The three banks agreed to create a fund called the master liquidity enhancement conduit -- or M-LEC, popularly identified as a "superfund" -- that would buy some of the SIVs' highly rated assets. The plan, scheduled to be up and running by mid-January, could help SIVs avoid having to sell assets quickly to pay off their short-term debt, providing stability and liquidity to credit markets, the group explained.

But HSBC's decision to deal with its SIV problems alone shows M-LEC is being set up too late for some SIVs and the vehicles' bank sponsors.

"When the plans for M-LEC were outlined, the banks anticipated potential situations like the one HSBC is in," James Moss, managing director and head of Fitch's North America financial institutions group, said. "The intent is to create a solution for situations like this, but it's not in place yet, so HSBC was left to decide for itself."

It may also suggest that some banks would prefer to retain 100% control over the destiny of their SIVs and are wary of getting involved with M-LEC. That's a problem because the plan needs other banks to take part for it to be big enough to have an effect on the SIV market and broader credit markets, according to other experts.

"If this airplane gets off the ground, it will probably crash before it reaches its destination," said Joshua Rosner, a managing director at research firm Graham Fisher & Co. "I still don't believe it will get off the ground."

HSBC's move also puts pressure on Citigroup, Rosner added.

Citi created the first SIV in 1989, and it's now the largest bank sponsor of SIVs, with roughly $90 billion of exposure, according to Deutsche Bank data. If HSBC, the second-largest SIV sponsor, can bail out its vehicles alone, why hasn't Citi done the same thing?

"Whereas HSBC has the balance sheet to allow them to do this, Citigroup and Bank of America don't," Rosner said.

It's less dire than that, according to other experts, who say Citi and Bank of America just may not want to allocate so much capital to one area.

Fitch's Moss said Citi has the flexibility to take all of the SIVs it sponsors onto its balance sheet.
A spokeswoman for Citi declined to comment, while a spokesman for Bank of America didn't return a phone message left seeking comment.

Still, Citi shares have been hit hard in recent weeks by concerns about whether the bank has enough capital. Analysts at CIBC World Markets said in early November that Citi may have to raise more than $30 billion, whether by selling assets, slashing its dividend or a combination of measures.

Citi has already bought $7.6 billion of its SIVs' maturing short-term debt but said in a recent quarterly regulatory filing that such support would stop at $10 billion, Fitch noted.

"Any additional support may increase the likelihood of a downgrade as its capital ratios are already under pressure," the rating agency wrote in a Nov. 14 report on banks' exposures to the SIV market.

One reason M-LEC may be struggling is that the banks involved are attempting a delicate balancing act, Fitch's Moss and others said on Monday.

Publicly available details on the plan are scarce and haven't been finalized yet, so it's still unclear exactly what M-LEC will be or do.

At one extreme, M-LEC could be a vulture fund that buys only the best assets from SIVs and then unwinds once the liquidity crisis is over. This means it might make a big profit. But it may not solve the problem of SIVs being forced to sell the rest of their lower-quality holdings.

"As you liquidate the balance sheet of your entity, it takes on the consistency of concrete as the liquid securities are sold and the impaired credit quality/illiquid securities and the 'OK' credit quality/illiquid securities remain," Brad Hintz, an analyst at Bernstein Research explained.

"At some point, as you shrink your balance sheet, the only alternative is to attempt to sell the illiquid concrete -- that is where M-LEC may help," he added in an e-mail. "Perhaps M-LEC will take or finance the 'OK' credit quality/illiquid securities which helps -- but that doesn't solve the problem for the banks."

At the other extreme, M-LEC could be a bailout fund that will buy a lot of SIVs' assets. This may stabilize the broader credit markets, but may mean M-LEC and the three sponsoring banks are left with losses.

"They don't want to do this at a loss, but the issues being discussed are not just centered on profits," Moss said. "Getting broad stability sooner rather than later produces many more profit-making opportunities in so many markets for banks and that goes beyond just making M-LEC profitable."