Tuesday, November 6, 2007

Open Questions for Citi

I took a few minutes to review the Citi third quarter 10Q that was released today to much fanfare. I have four basic issues/questions, and I invite anyone to provide answers for them. Here goes:

1. An issue. I searched the document for “SIVs” and came up with 33 hits. I then searched the second quarter 10Q for “SIVs” and guess how many hits I got? Zero. Nada. Zilch. So I guess this wasn’t anything important, that is until it became something important. (I also searched for “structured investment vehicle” and got the same result.)

I looked at some of the footnotes and I have a headache and three questions. Here they are numbered my points 2-4:

2. “Citigroup has no contractual obligation to provide liquidity facilities or guarantees to any of the Citi-advised SIVs and does not own any equity positions in the SIVs. The SIVs have no direct exposure to U.S. sub-prime assets and have approximately $70 million of indirect exposure to subprime assets through CDOs which are AAA rated and carry credit enhancements. Approximately 98% of the SIVs’ assets are fully funded through the end of 2007. Beginning in July 2007, the SIVs which Citigroup advises sold more than $19 billion of SIV assets, bringing the combined assets of the Citigroup-advised SIVs to approximately $83 billion at September 30, 2007. See additional discussion on page 46.

“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.” From Citi's third quarter 2007 10Q pg. 7.

My question is, if “Citigroup has no contractual obligation to provide liquidity facilities or guarantees to any of the Citi advised SIVs…” then why does it provide “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.”? And, why wasn’t this $10 billion in liquidity facilities mentioned earlier? Sounds to me like Citi is not contractually obligated to provide the facility, and that means it can keep the SIV off of its balance sheet. But, in order to make the SIV work, someone has to backstop the liquidity, and guess who did that? Yup – Citi. Accounting hanky panky if you ask me. Of course this could all be perfectly legitimate according to the accounting rules, I guess. This could be a new facility, although why would Citi expose $10 billion into this market if it did not have to? If it isn’t new, then the question is why did “SIVs” not show up on the previous 10K? Is $10 billion in liquidity facilities to a managed entity immaterial? Was it lumped into that total “notional” exposure disclosure about VIEs (see below)?

3. Next up, the commercial paper question. From pg. 9 of the third quarter 10Q:

“ABS CDO Super Senior Exposures
Citi’s $43 billion in ABS CDO super senior exposures as of September 30, 2007 is backed primarily by sub-prime RMBS collateral. These exposures include approximately $25 billion in commercial paper principally secured by super senior tranches of high grade ABS CDOs …. Although the principal collateral underlying these super senior tranches is U.S. sub-prime RMBS, as noted above, these exposures represent the most senior tranches of the capital structure of the ABS CDOs.”

I want to point out the part that says “These exposures include approximately $25 billion in commercial paper principally secured by super senior tranches …….the principal collateral underlying these super senior tranches is U.S. sub-prime RMBS…” Looks like they had to purchase some of the commercial paper issued by those conduits. $25 billion of it, in fact. They don’t specifically tell us that’s where the commercial paper comes from. Guy Moszkowski - Merrill Lynch – Analyst asked the question on the conference call today. The answer he received from Gary Crittenden - Citigroup – CFO made no mention of conduits, only liquidity backstops for CDOs. I would like to know whether these were purchases of commercial paper from ABCP Conduits managed by Citi or not.

4. Finally, there is one other tidbit I would like to point out. Here is the disclosure I would like to know more about, from pg. 73 of the third quarter 10Q:

“As mentioned above, the Company may, along with other financial institutions, provide liquidity facilities, such as commercial paper backstop lines of credit to the VIEs. The Company may be a party to derivative contracts with VIEs, may provide loss enhancement in the form of letters of credit and other guarantees to VIEs, may be the investment manager, and may also have an ownership interest in certain VIEs. The Company’s maximum exposure to loss as a result of its involvement with VIEs that are not consolidated was $141 billion and $109 billion at September 30, 2007 and December 31, 2006, respectively. For this purpose, maximum exposure is considered to be the notional amounts of credit lines, guarantees, other credit support, and liquidity facilities, the notional amounts of credit default swaps and certain total return swaps, and the amount invested where Citigroup has an ownership interest in the VIEs. This maximum amount of exposure bears no relationship to the anticipated losses on these exposures.”

On its face this looks like a plain vanilla $141 billion no prob. But this amount was $91 billion at December 05, growing 19.8% in the ensuing twelve months to $109 billion at December 06. Since last September when this number was $93 billion, it has grown by 51.6% to $141 billion this September. In fact, in the three months since June 07 alone this number has grown by 29.4%, from $109 billion to $141 billion. I would like to know more about that number.

I hope these questions are eventually answered. Meanwhile, I remain cynical. My opinion, of course.

If you read my October post, Hocus Poke-us, then you know that banks are marking some liabilities to market. That maneuver resulted in a pre-tax gain to Citi of $466 million in the third quarter. Here is the note from pg. 6:

“Market Value Gains Due to the Change in Citigroup Credit Spreads
SFAS 159 provides companies the ability to elect fair value accounting for many financial assets and liabilities. As part of Citigroup's adoption of this standard in the first quarter of 2007, the Company elected the fair value option on debt instruments that are provided to customers so that this debt and the associated assets the Company purchased to meet this liability are on the same fair value basis in earnings. At the end of the third quarter, $28.6 billion of debt related to customer products was classified as either short- or long-term debt on the Consolidated Balance Sheet. Under fair value accounting, we are required to use Citigroup credit spreads in determining the market value of any Citigroup liabilities for which the fair value option was elected, as well as for Citigroup trading liabilities such as derivatives. The inclusion of Citigroup credit spreads in valuing Citigroup’s liabilities gave rise to a pretax gain of $466 million in the third quarter of 2007 and is reflected in the Securities and Banking business.”

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ST said...

First let me observe that I'm no CPA. Given that, here's my opinion:

On 2. Observe that Citi's SEC filings are unaudited. The question you are raising seems to be whether Citi will be able to convince an auditor to sign off on its financials.

The only argument I can think of that they might get away with is that they have provided only a fraction of the financing for the SIVs and therefore have not taken action that will lead them to bear a majority of the losses in the SIV.

Accounting hanky-panky indeed.

On 3. IMO either Citi is holding it's own conduit's CP or the banks have put together a club to buy each other's conduit's CP. Don't know whether the latter would be legal. Maybe they're planning to use the telecom industry's justification: "When a government official says it's okay, I thought that meant it was legal." (Just kidding.)

On 4. Don't know anything about this, but thank you for posting it. Like you, I think it merits further explanation.

ST said...

This FT article indicates that Citibank has bought the commercial paper of its SIVs.

st said...

Sorry. Don't know how I got that link wrong. Let me try again:

This FT article indicates that Citibank has bought the commercial paper of its SIVs.

Palermo's Blog said...

ST - thanks for the link.

Lawrence D. Loeb said...

I tried posting this yesterday from my Berry, but the browser is apparently not able to work with blogger.


I actually participated in the Citicorp audit many years ago. Their auditors are on site throughout the year conducting interim testing and providing other audit related services. The quarterly releases (both press and SEC) are reviewed by the auditors. While this is not an audit, they do provide comments. Generally, the bank wouldn't issue statements that they believed would be changed in the audit.

If you look at the second newest post on my blog (blog.lawrencedloeb.com) you will find links to three white papers that were issued on October 3rd by the Center for Audit Quality and the related FASBs (and a Fitch report discussing the reporting guidelines). These white papers guide auditors on how certain items (including SIVs) should be reported given the recent market turmoil.

As for the credit lines, my understanding (from my research and conversations), is that SIVs are generally established with credit lines to bridge possible issues in the ABCP market (typically around 10% of assets). I don't believe that the reported credit lines were new, but they were considered worth reporting, separate from other contingent lines, because the SIV issue has been so in the news.

Under the CAQ white papers, it may be necessary to book exposures, even without being legally obligated to take on the assets. That would explain the comment that you were questioning.

It is unclear who's ABCP Citi owns, but it easily could be related to entities that they don't control (SIVs managed by others or other ABCP issuers - they're not all SIVs).

As I mentioned in a response to an earlier post, notional value is a misleading indicator.

As for the reporting of the current value of the debt, the FASB requires that companies, in cases where a liability is related to an asset that is also being marked to market, mark the debt to market so that the match between the positions is properly reflected (otherwise there might be artificial gains and losses).

I'm not sure if I addressed everything, but I hope this was helpful.

Shan Jin said...

DJ plunged 360 points today, stocks of major financial banks all dropped and dollar keeps making record low againt Euro. Do you think it's the beginning of the bear market? If so, how would Fed react to the market? Oil price is $98/barrel.

Palermo's Blog said...

Bull or bear? I am a bear, but I have been wrong plenty of times. I think the housing decline is a symptom of over-leverage in our financial system, and we need to de-leverage before we can get back to healthy growth. What makes bulls think the only systematically bad lending was in the subprime housing market? Many others, however, believe that strong export growth will offset economic weakness caused by the housing decline and the market will do better when the “soft landing” becomes clear. Soft landing or hard landing - I wish I had a crystal ball. Today the hard landing crowd won. Tomorrow? I’m watching the data like everyone else and staying cautious.

Regarding the FED, see my post here.

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