A bull ate my valuation.
Case for the prosecution, Mr Mike Mayo:
Citi prices its CDOs at 53 cents on the dollar. (MER 22 cents)
The decision about raising new capital may be closer than we previously thought.
Writedown: $7bn
And Mr William Tanona:
Citi prices its CDOs at 55 cents on the dollar. (MER 22 cents)
They would struggle to obtain their prices in the marketplace.
Writedown: $16.2bn to bring in line with MER.
Citi’s excuse case for the defence
Gary Crittenden, Citi CFO:
The securities are of higher credit quality [because they were created between 2003 and 2005]
Also…
People close to the company said that the bulk of its CDOs dated to years prior to 2005 - before the onset of the housing crisis. As a result, they said that Citi was comfortable valuing them at current levels.
The flaw - from Merrill’s Monday announcement:
[On aggregate US super senior ABS CDO exposures]… the majority of which comprises older vintage collateral - 2005 and earlier.
__________
Citi is in a bit of a bind. As in fact, are all the big banks with CDO holdings. Hitherto, writedowns and valuations have been based on a mark-to-model approach: a valuation method necessitated under accounting rules because no observable market price for the securities in question is available.
Has Merrill undone that by providing a market price? Sean Egan of Egan-Jones certainly thinks so. In today’s Times he calls it a “watershed moment”.
Yves Smith though, is keen to point out the nuances in the market which rather cloud an easy read across from MER’s numbers:
A reason that Citi and others might legitimately have CDOs that could e marked higher (or lower) is that the structure of each deal is custom, and there is a very high degree of variability among deals. Since each is pretty much sui generis, Merrill’s trade can only be used as a mark in a very general sense. While it does call valuations of, say, 50 cents on the dollar and higher very seriously into question, there is still a good deal of artwork in determining what the Merrill sale means for other firms.
For one thing, much of Citi’s exposure to super-senior ABS CDO positions is one step further removed than Merrill’s. Around $24bn of Citi’s $39.5bn outstanding position (June 30 valuation) is through commercial paper. Citi provided liquidity puts of that value to off-balance sheet conduits it created and loaded with super-seniors to lever-up returns. In fact though, that should only make Citi’s valuation all the more insecure. It’s another layer of leverage, not protection.
The underlying excuse - that the CDOs are of a pre-2005 vintage, is equally suspect. It’s true that post-2005 vintages of RMBS are suffering the greatest losses, but the rot is eating backwards. The fact remains that all mortgage-backed CDOs of this decade have been mispriced. Any post-2003 CDO certainly so, since that’s when rating agencies significantly lowered many of the diversity criteria which had prevented earlier deals achieving triple As.
Super-senior CDO positions are toxic. Forget not that Merrill didn’t just take paper writedowns, it sold out at 22 cents on the dollar. It took a realised loss. As capital pressures increase along with the threat of dilutive equity issues, other banks, Citi foremost among them, will surely have to sell those large CDO positions.
