One of these is a draft version of a third-quarter pre-earnings announcement Citigroup considered making in the credit-crunched October of 2007, in reference to its subprime exposure. The other is what actually went out.
Exhibit A :
We typically have sold the lowest rated tranches of the COOs and held on to most of the highest rated tranches where historically values have been stable. In July, however, actions by the rating agencies which involved methodology changes and downgrades of certain CDO tranches caused investors to suddenly pull back from the entire CDO market, resulting in a rapid decline in CDO values.
We typically have sold the lowest rated tranches of the CDOs and held onto most of the highest rated tranches, which historically have enjoyed more stable valuations. As the subprime problem spread across various security types, we started to see valuation declines even in the highest rated tranches.
We bring it up because on Thursday, the US SEC fined Citi $75m for misleading investors about the bank’s subprime exposure between July and October 2007. Instead of putting the figure at about $50bn, Citi, the SEC says, repeatedly told investors its exposure was ‘just’ $13bn.
For a large chunk of 2007, it turns out, the bank was neglecting to include its infamous super senior positions and liquidity puts in publicised estimates of its subprime exposure. So in its October Q3 pre-announcement, for instance, some $43bn of additional exposure was left out of the disclosed $13bn figure.
As for those two pre-announcement versions above — Exhibit A was the one Citi eventually went with. Alluding to losses in higher-rated tranches as the draft version did, ’twas thought by an unnamed Citi officer, might lead to some uncomfortable questions about super senior positions.
One reason Citi may not have felt the need to publish its super senior or liquidity put positions is that the bank generally considered to be quite safe, an idea alluded to in the SEC complaint. According to internal Citi documents, the default risk was thought to be “extremely small” at the time. Oops.
In fact they were considered so secure that Citi apparently thought nothing of making more of them.
The bank told investors on its July 20 Q2 earnings call that it had reduced its subprime exposure from the $24-26bn held at the end of 2006, to just $13bn. What it didn’t say was that part of the stated reduction came from Citi taking unsold lower-rated tranches of previously underwritten CDOs to create new ones, from which it could then retain the super senior tranches, according to the SEC.
And of course, as we now know, Citi wasn’t reporting its super senior holdings.
It wasn’t until November 4 that Citi finally outlined its full $55bn subprime exposure — including the $43bn from super seniors and liquidity puts. At the time, most of the market (FT Alphaville included) thought the massive jump in the bank’s super senior commitments was due to Citi reluctantly buying CDO commercial paper as the market tanked, in an effort to prop up the investments up.
That certainly appears to have been part of it.
Citi’s real subprime exposure grew from $38bn in April 2007 (super senior: $14.6bn, liquidity put: $23.2bn) to that $55bn November number ($18bn, $25bn, respectively), according to the SEC. And by mid-September 2007, Citi had bought that $25bn — or almost all — of the commercial paper backed by super senior tranches of subprime CDOs in anticipation of its liquidity puts being exercised.
But still, Citi’s subprime position appears to have largely stunk from the (2007) beginning.
Citi to pay $75m to settle SEC charges – FT
Citi’s super-safe CDOs? Puh-lease – FT Alphaville
Citi’s predicted $19bn CDO writedown – FT Alphaville, 2008
“Involuntary asset growth” and the beginnings of the “true” credit crunch in 2008 – FT Alphaville, 2008