GOIH Global Capital Markets:Citibank's Rapidly Deteriorating Situation

Citibank's Rapidly Deteriorating Situation
by Markham Lee

The hits just keep on coming for Citibank (C): first there was the $6.8 billion in Q3 write downs and losses, then the alleged “resignation” of their CEO and Monday’s announcement of $11 billion in additional write downs. If that wasn’t enough, there came Tuesday’s news that Citi has provided its SIVs with a $10 billion credit line due to funding issues and Wednesday’s news of a possible downgrade from Moody’s.
From Reuters:
Citigroup Inc which faces rising losses from the global credit crisis, said it provided $7.6 billion of financing to off-balance sheet investment funds that have had trouble funding themselves recently.
Citigroup said it has given the funds, known as structured investment vehicles, or SIVs, $10 billion of available financing, and the funds had drawn $7.6 billion of that financing as of Oct. 31.
The move, disclosed in a quarterly filing with regulators late on Monday, may add to investor concern about Citi's $83 billion of structured investment vehicles, which issue short- and medium-term debt to finance their acquisition of bank bonds, repackaged debt, and other securities...

…Citi said in its filing that its credit lines to the SIVs were done on "arms-length commercial terms," and that the bank has no plans to list the SIVs' assets on its own balance sheet…
…Citi has faced a series of problems in recent weeks. Over the weekend, its chief executive resigned and Citigroup revealed it may face $11 billion more in pre-tax write-downs this quarter for repackaged debt known as collateralized debt obligations…
..Those potential write-downs are on top of $6.8 billion of write-offs and losses already recorded in the third quarter.
The funding problems are likely to get worse if Moody’s does indeed cut the ratings on some of Citibank’s SIVs:
From Bloomberg:
Citigroup Inc. and HSBC Holdings Plc received warning of possible downgrades to their structured investment vehicles as Moody's Investors Service reviewed its ratings on $33 billion of debt.
SIV "debt ratings continue to be vulnerable to the unprecedented large and sustained declines in portfolio value combined with a prolonged inability to refinance maturing debt,'' Moody's said in a statement today...

... Citigroup, the largest U.S. bank by assets, said this week it provided $7.6 billion of financing to the SIVs it runs after they were unable to repay maturing debt. U.S. Treasury Secretary Henry Paulson is pushing for Wall Street to establish a fund by year-end to help SIVs avoid a fire sale of assets because of the contagion from record mortgage foreclosures.
Citigroup's Beta Finance Corp., Centauri Corp. and Dorada Corp., with combined assets of more than $50 billion, risk downgrades to their capital notes, debt that ranks below commercial paper. Moody's may also cut London-based HSBC's Cullinan Finance Ltd. capital notes.
So after reading the two articles, the following things immediately came to mind:
1) The combination of the $10s (if not hundreds of billions), the words “off balance sheet” and “no equity exposure”, make me nervous. Citibank can pretend it isn’t exposed to its SIVs, but I know a hobgoblin when I see one, especially when Citi isn’t exactly acting like a company that doesn’t have any exposure.

2) Citibank’s SIVs or perhaps “fiscal sieves” are in trouble and the super-conduit may not be able to save them. Even though balance sheet alchemy allows Citi to legally keep the SIVs off book, if the SIVs aren’t able to pay back the credit lines the situation turns into a loss for Citi, period. Eventually, these SPEs will come back to hurt Citi.

3) Can anyone really question Citibank’s participation in the super-conduit as anything more than an effort to avert disaster for its own troubled SIVs? Let’s not forget that Citibank led the way in pushing for the plan in the first place; it’s quite likely that their SIV problem is significantly larger than anyone outside of Citi realizes.

4) If the debt downgrade does happen, don’t be surprised if Citibank extends additional credit lines to its SIVs as their funding issues are only going to get markedly worse. However, due to the current credit market turmoil it won’t be easy for Citibank to just toss $10s of billions more down the SIV drain, something has to give.
5) All of Citibank’s statements regarding its exposure to CDOs, SIVs, future profitability, etc, need to be taken with a large grain of salt and heavily scrutinized. This is the same company that predicted a return to normalcy just a few weeks ago and then turned around and announced $11 billion worth of write-downs. $11 billion worth of losses didn’t magically appear over the course of a couple of weeks.

6) Does anyone remember when we were looking at around $20 billion worth of write downs heading into Q3 earnings season and it seemed like a really big deal? In fact, many financial scribes suggested that the Banks were just getting the write downs out of their “systems” and/or that there was a lot of exaggeration in that $20B number. Well, it’s only a couple of weeks later and it looks like Citibank will have nearly $18 billion in write downs on its own and Q4 isn’t even over yet. Considering the speed at which the lending loss problem is increasing (mortgage defaults, credit card defaults, et al), is it really a stretch to say that Citi could hit the $20B mark by the end of Q4?

7) Continuing on the theme of write downs: Merrill Lynch may have to write down another $10 billion in CDOs on top of the $7.9 billion they wrote down last quarter, and Morgan Stanley announced that they may have to write down $3.7 - $6 billion in subprime CDOs. How much longer before the U.S. Banking sector crosses the $60 billion mark in total write downs? How many $10s of billions of write-downs do we need to see before we at least accept that we have some sort of crisis or the very least a rather significant malaise infecting the financial sector? We may find ourselves looking at back on a mere $20 billion in write downs as a “better place”.
8) Finally, the larger issue is that Citibank has some very significant financial problems that didn’t just suddenly appear; instead the market conditions that allowed Citibank to hide these problems are no longer present. As a result, past “strength” has to be questioned and investors need to be wary of this stock because we just don’t know how bad things truly are.
Sources:
· Reuters: “Citigroup provided $7.6 bln to struggling SIVs” – Dan Burns, November 6, 2007
· Bloomberg: “Citigroup SIVs Risk Cut in $33 Billion Moody's Review” – Neil Unmack, November 7, 2007