Tuesday, November 06, 2007

More mark to model

Exactly what will certified accountants say about the balance sheets of Citi, Merrill, et al. at the end of the year? We may need a modification of financial accounting rules that allows for error ranges and Monte Carlo simulation in the reported results :-)

Can anyone guess when financials as a group will be oversold and I can go bargain shopping? Anyone recommend a good ETF for this purpose? (IYF, IYG, VFH, ...)

Earlier I had heard about foreign banks (e.g., in Germany) as big buyers of toxic CDO tranches, but now I learn that our sophisticated investment banks are also on the hook! (Goldman, perhaps, excepted?)

WSJ: Citigroup Acknowledges
It Can Only Estimate Write-Offs

November 6, 2007

How much more will Citigroup Inc. and other banks end up having to write off? It's still anyone's guess. In a Citigroup conference call Monday, a day after the bank said it expects it might have to record losses of $8 billion to $11 billion this quarter, likely wiping out net profit, Chief Financial Officer Gary Crittenden acknowledged that these numbers are an estimate of the write-downs the bank may need to take on $55 billion in subprime securities and collateralized debt obligations. It "can't give any assurance" that the loss won't grow worse, or perhaps shrink, as the quarter progresses, he said.

Our reporters write that investors were especially unnerved by the fact that the big U.S. bank announced the additional write-downs just weeks after saying third-quarter losses due to the bank's subprime exposure would be $1.56 billion. The new, vastly bigger losses calls into question Citigroup's ability to measure its holdings, while sparking wider fears that the credit crunch is continuing unabated. Citigroup officials said it will take the bank until the middle of next year to iron out the mess created by the recent credit-market turmoil.

Investors voted with their pocket books, sending Citigroup shares down 6.2% in New York Monday after the bank said it will need much longer to dig itself out of a hole that has deepened dramatically in recent weeks. The steep share drop showed that any relief among investors' over Chief Executive Charles Prince's departure was quickly eclipsed by concerns about continuing losses the bank may face due to securities underpinned by subprime mortgages.

The crows come home to roost? Recall that financial firms have posted record profits in recent years, accounting for a larger and larger fraction of all S&P 500 earnings.

Will super senior tranches suffer losses, or are they merely suffering from contagion?

WSJ: Why Citi Struggles to Tally Losses Swelling Write-Downs Show Just How Fallible Pricing Models Can Be

November 5, 2007; Page C1

When the market for mortgage securities entered a meltdown over the summer, financial firms holding billions of dollars of hard-to-trade assets used mathematical pricing models that were heavily dependent on credit ratings. When the credit-rating firms began a massive downgrade campaign last month, firms such as Citigroup Inc. and Merrill Lynch & Co. saw the value of their holdings plummet.

Citigroup's struggles to put an exact number on its losses demonstrate just how fallible the models can be, and how serious the consequences. Last night, Citigroup said that the downgrades will result in a reduction of fourth-quarter net income of $5 billion to $7 billion. That follows a third quarter when Citigroup recorded mortgage-related write-downs of $2.2 billion, including losses on subprime securities and fixed-income trading.

The latest update, much of it involving securities linked to subprime mortgages, follows a revision made late last month by Merrill Lynch that increased third-quarter write-downs to $7.9 billion from an earlier estimate of about $4.5 billion for exposure to debt pools and subprime loans. As a result, analysts are beginning to see Merrill's big hit as less of an anomaly than originally thought.

"We estimate that there's over $10 billion of write-downs in the fourth quarter for the industry for banks and brokers," said analyst Mike Mayo, who covers financial firms for Deutsche Bank. Mr. Mayo said his estimate is based on exposure to debt pools and mortgage securities and includes Citigroup, Bear Stearns Cos., Morgan Stanley and Bank of America Corp. Citi's updated write-downs could be included in its coming quarterly filing with U.S. securities regulators.

The source of Citigroup's write-down is at least as significant as its size. The bank's estimate of its losses has changed so rapidly in large part because the models it used to value hard-to-trade securities relied heavily on credit ratings, according to people familiar with the models.

That made the bank highly vulnerable when, in October, ratings firms Moody's Investors Service and Standard & Poor's slashed, or put on watch for downgrade, the ratings on tens of billions of dollars in securities.

It is unlikely that Citigroup is alone. Ratings play a big role in valuation models used by many banks, investment funds and insurance companies. Meanwhile, the market for securities linked to subprime loans has deteriorated in recent weeks as defaults have confirmed some of analysts' most dire forecasts, increasing the likelihood of further ratings downgrades.

Citigroup's subprime exposure -- and source of its problems -- is found in two big buckets that together total $55 billion in its securities and banking unit, the bank said. The first bucket totals $11.7 billion, including securities tied to subprime loans that were being held, or warehoused, until they could be added to debt pools for investors. The second, totaling $43 billion, covers so-called super-senior securities.

These highly rated super-senior securities are portions of collateralized debt obligations, or CDOs. CDOs are repackaged pools of lower-rated securities backed by subprime loans into pieces with different levels of risk and return. Analysts estimate that $60 billion in such super-senior tranches are sitting on the books of banks, insurers and investment funds.

The troubles stem back to the heyday of the U.S. housing boom, when Citi became one of the biggest players in the lucrative world of CDOs backed by subprime-linked bonds. Overall, Citi was the second-largest underwriter of CDOs in 2006, doing $34 billion in deals, according to data provider Dealogic. ...


DB said...

The WSJ article today (C14) on Gisele Bundchen's demand to be paid in Euros carries the headline, "Mark to Supermodel".

Less clever but maybe also of interest to you, Steve, is the article on B1 about Forum, a sort of entrepreneurs' group therapy.

SJ said...

Mmm oversold financials. Reminds me of how jealous I was on all the people who snagged some early alibaba shares yesterday in Hong Kong...

Anonymous said...

It’s worse than you think. Even the top brass at the big C (our nations largest) don’t know how much toxic waste sub prime CDOs they’ve got on book, and off book in siv s. C is not nearly alone. Your idea about GS...it’s is very unlikely to be a safe haven and the list goes on and on and on. The problem takes on new proportions of fugly when you realize that the monolines (bond insurers) are way in over their heads. Counter party trust is in bad shape. This mess cascades into a true shit avalanche by summer 09 during the next round of mortgage re-sets. The Dollar is being deserted like lifeboats leaving the Titanic. (Look what the dollar did at 9pm on the forex market this evening... a brief period of free fall during a long down trend.) Make no mistake about it this doesn't end pretty. The fed has a grim choice...save the dollar and plunge the country into depression or support the economy...as it appears to be doing with lower interest rates... and generate hyperinflation and a dollar crash. Suggested reading, Nouriel Roubini blog and Calculated Risk.

best of luck to you Mr. Hsu...I very much appreciate your blog.

Mike Savoca

Anonymous said...

Regarding the previous post, a correction... and an addendum.

It should have been "Best of luck to you Dr. Hsu , not Mr. ( I beg your pardon) and

for your convenience the url for Nouriel Roubini


highly recommended.

Thanks again,
Mike Savoca

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