Friday, December 14, 2007

Citigroup to Take $49B Worth of SIVs on to Their Balance Sheet

Citigroup decided to bring $49B in SIVs on to their balance sheet. This is going to cause problems with their Tier1 capital and possibly dividends. Does not mean that the big-bank bailout fund, formerly known as M-LEC is not going to proceed? Sounds to me like it couldn’t get off the ground. Text in bold is my emphasis. From the WSJ:

Citigroup Inc., bruised by mounting losses, is bailing out seven affiliated investment entities, bringing $49 billion in assets onto its balance sheet and further denting its depleted capital base.

The big New York bank said it would provide emergency support to the entities -- known as structured-investment vehicles -- if it can't find buyers for their short- and medium-term debt. SIVs, which often hold mortgage-backed securities, have come under intense scrutiny in the past several months as nervous investors have balked at buying the short-term debt known as commercial paper that provides critical funding to the vehicles.


While Citigroup's action may ease uncertainty about the future of its SIVs, it may be the death knell for an industrywide effort to create a rescue fund for the struggling vehicles.

Since September, Citigroup, B of A and J P Morgan Chase have been working to set up the fund, at the behest of the Treasury Department. But interest in the rescue fund has waned in recent weeks as several banks concluded they couldn't wait for it to get up and running, and decided to bail out their own SIVs.

Citigroup's decision to follow suit underscores how quickly Vikram Pandit, who was named Citigroup's chief executive Tuesday, is moving to tackle the many problems facing the bank. Just two days into his tenure, Mr. Pandit decided to reverse repeated assurances by Citigroup executives that the SIVs would stay off the bank's books.

The bank's action could help relieve some of the anxiety in credit markets by removing the threat that the SIVs would be forced into selling assets at fire-sale prices.

The depth of the mortgage and credit crises, and the risk to the economy, have stirred the Bush administration and Federal Reserve to action, but their efforts have had little success so far in thawing frozen credit markets. Helping to organize the so-called super-SIV rescue fund was one of Treasury Secretary Henry Paulson's first responses to the market turmoil, and was controversial from the start, with some critics saying it essentially represented a bailout for the SIV industry. The banks involved dismissed that notion, saying that it would merely provide one more option for SIVs that were in trouble.

Mr. Paulson's other major initiatives include an effort to prod mortgage-servicing companies to ease the terms of certain mortgages that would otherwise jump to much higher interest rates over the next year and an as-yet unsuccessful effort to persuade Congress to adopt changes in the Federal Housing Administration.

The Fed, meanwhile, has cut its target for short-term interest rates by a full percentage point since early August and this week launched, in concert with central banks in other countries, a new strategy to encourage banks to borrow more from the Fed and lend more readily to each other. . . .

. . . .Yesterday, Mr. Pandit also named the bank's finance chief to head a broad cost-cutting initiative that could result in the elimination of thousands of jobs. Many investors are hoping he takes more radical steps, including breaking up the financial conglomerate. . . . .

. . . . Citigroup's key Tier 1 capital ratio -- a gauge of the bank's ability to absorb huge losses -- stood at about 7.3% as of Sept. 30. Citigroup said that the SIV assets could reduce that ratio by another 16 basis points. That would push it even further below the company's internal target level of 7.5%, although it will remain above regulatory requirements.

To be sure, Citigroup remains fairly well-supplied with capital: federal regulators require a bank to have a Tier 1 ratio of 4%. A bank with a ratio of 6% or higher is considered to be well-capitalized.

While Citigroup said it still expects its capital levels to bounce back by next summer, its reduced capital ratio may put pressure on the bank to cut its dividend or take other steps to protect its capital position, such as bringing in another outside investor. A Citigroup spokeswoman declined to comment on possible dividend cuts or capital-raising plans. . . . .


. . . . Citigroup is the largest player in the SIV market, which was valued at about $350 billion at the start of the credit crunch. Just a few months ago, the bank was boasting to investors that its SIVs had nearly $100 billion in assets. "Citi's SIVs remain robust and their asset portfolios are performing well," said a letter from Paul Stephens and Richard Burrows, directors in Citigroup's London-based group that oversees the bank's SIVs.

Although the move will hurt Citigroup's capital ratios, it could take pressure off the wider commercial paper market. Until now, debt investors have feared that a fire-sale of assets held by SIVs would undercut prices for a host of debt instruments. That caused investors to demand higher rates from all kinds of financing vehicles that sell commercial paper. These vehicles, called conduits, provide much-needed financing to companies by purchasing assets such as receivables, credit card debt and auto loans.

Citigroup isn't pledging to immediately take assets off the hands of the seven SIVs it sponsors, but providing them with a backstop may give investors confidence that losses are less likely from commercial paper and medium-term notes issued by the vehicles. Indeed, Citigroup said that it expects the SIVs to continue selling assets, and it doesn't expect to have to make good on its pledge to provide funding.

Since the credit crunch began, SIVs have been forced to sell assets in order to pay off maturing debt. The vehicles, which were created to operate separately from the banks and stay off their balance sheets, issue short-term debt to investors and use the funds to buy higher-yielding assets. The business model only works if SIVs can keep issuing new debt as old borrowings come due, and it fell apart as the subprime mortgage meltdown accelerated this summer. . . . .

. . . . . Citigroup said the SIVs that it sponsors currently have $49 billion in assets, down from $66 billion two weeks ago and $87 billion in August. Like other banks, Citigroup has been selling assets to ease pressure on the vehicles. Already banks like HSBC Holdings PLC in the United Kingdom have taken similar actions to support their SIVs, further reducing the need for a super fund.

Citigroup's action leaves two major financial firms that haven't yet taken steps to restructure their SIV debt: Germany's Dresdner Bank, a unit of Allianz SE, and BMO Financial Group and its Bank of Montreal unit. Allianz said on Nov. 9 that there was no plan to bring assets held by Dresdner's SIV, K2 Corp., onto its balance sheet. A Bank of Montreal spokesman couldn't be reached for comment.

Citigroup's move is surprising because the bank made it clear in its most recent filing with the Securities and Exchange Commission that it had "no contractual obligation" to provide full support to any of its SIVs. In addition, Citigroup said it "will not take actions that will require the company to consolidate the SIVs." Citigroup previously had agreed to provide up to $10 billion as emergency support to its SIVS. The SIVS had drawn down $7.9 billion of that as of Sept. 30.

In making yesterday's decision, Citigroup cited recent moves by credit-rating agencies that threatened to make the SIV problem worse. Late last month, Moody's Investors Service downgraded or put on review debt totaling $119 billion that was sold by SIVs. A Moody's report at the time spotlighted problems that Citigroup faced as Moody's downgraded or put on review for possible downgrade $64.9 billion issued by six Citigroup SIVs.

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