Inside The Citigroup Leveraged Loan Asset Sale
A: A quick check up into creditville, a not so nice place to call home. I got an email from a UrbanDigs reader telling me about the Citigroup asset sale plans and saying that this is a sign of the bottom. He went on to say, if Citigroup unloads their bad assets, it will free up cash and lending environment will improve. I guess in theory this sounds logical, but my interpretation of the Citigroup plans is much different; they had NO CHOICE, must raise capital, and what they sold off is only 25% of their total leveraged loan portfolio which has nothing to do with toxic mortgage backed securities still held on their books!
When a bank or brokerage has to sell stock (whether it be common shares or preferred; hey WaMu how r u!), that is a BAD sign and a clear sign that the firm is in need of cash and fast! Sure, the bulls can spin anything to be a positive, and the knee jerk reaction will be a positive one since the alternative outcome is bankruptcy or forced sales of assets at very low prices (remember BofA's cash injection to CountryWide when shares were at $18, and rallied to $23 on the news?), but ultimately it will prove to be a sign that the firm is in trouble! Which is why they need the cash to begin with.
We are entering a period of time where fund-raising will be necessary on a grand scale. Get used to it. Last Friday it was Washington Mutual, today it is Citigroup. Lets understand what Citi really did.
Citigroup is selling off about $12 billion in leverage loan assets to a group of private equity firms. Now these assets are only 25% of one sector of assets that is hurting Citigroup; Citi's leverage loan portfolio has about $43 billion worth of assets. Leveraged loans are the asset class that Citigroup has as part of its stake in the LEVERAGED BUYOUTS business! This is not mortgage backed assets! Which brings me to the point that was raised many many times before. This is NOT a subprime problem! I wrote about cov-lite leveraged buyout deals being a future concern way way back in June of 2007, in my post titled, "Buyout Boom Brings Reason To Worry", as I started to focus content on the credit crisis:
My Point - Forward thinking. I am by no means an expert of leveraged buyouts, credit risk, derivative products, cdo/abx markets, etc.. However, it doesn't take an expert to see how the industry adapts to continue to be able to lend to support such massive buyouts in the private equity sector. I'll repeat this again --> Right now you are seeing an environment that is a result of years of ultra cheap money and tons of liquidity. What is yet to be seen is the effect of globally rising interest rates to levels we see today; that will take 1-2 years. For the near future, I don't think the end result will be that bad, in fact I think the environment will remain bullish for some time. However, red flags are waving for the years to come when we will be able to look back at how many of these massive buyouts were successful, and how many caused major problems to banks and other lenders.Well, Citigroup is selling off 1/4 of their leverage loan portfolio at a discount of 90 cents on the dollar. But the amazing thing is that they are giving a loan on this sale! Isn't that incredible! Citigroup is actually getting only a portion of the $12 billion in assets in cash, and is providing a loan for the rest of the sale to the group of private equity firms! This removes potential write-downs for 1/4th of their total leveraged loan asset holdings. It does not prevent write-downs on other debt holdings. According to Bloomberg:
A sale to the private equity firms would shield the bank from further declines in the value of the debt, said the person, who wouldn't be identified because negotiations are private. The loans are part of the $43 billion in financing that Citigroup agreed to provide for leveraged buyouts last year before credit markets froze and saddled the New York-based company with hard- to-sell assets.Now if we take a step back and look at this credit crisis and the problem of toxic waste on the books of banks and brokerages, this sale proves that the problem has spread to other debt classes; something I have discussed ad nausem on this site. The real problem areas continue to be subprime, alt-a, HELOC's, credit cards, COSI, COFI, option ARM's, commercial, and auto loans. This deal involved leverages loan assets, which was sold to private equity firms using, drum roll please, you guessed it....leverage! Citigroup, come on down, you are the next contestant on THE PRICE IS RIGHT!
"As a Citigroup investor you won't have to worry about more mark-to-market writedowns on these loans," said William B. Smith, senior portfolio manager at New York-based Smith Asset Management Inc., which oversees about $80 million, including about 66,000 Citigroup shares.
Ah what a world we live in. If this is a sign of anything positive, it would have to be that there are buyers out there taking on some forms of troubled debt; that helps. But in no way, shape, or form does this save Citigroup and in my humble opinion is a signal of the necessary capital raising efforts that will happen over the next few quarters; one could actually argue that the leveraged loan assets were the ONLY troubled assets Citi could find buyers for! Expect plenty more rounds of asset sales and fund raising efforts before the credit storm dies out; and at some point investors will realize that this is dragging along way longer than they expected.
Oh by the way, Citigroup is expected to write-down another $17 billion when they announce first quarter earnings (story via FinancialWeek). Yep, the end is clearly so close! We haven't even starting discussing the $40+ trillion worth of credit default swaps that are out there; which Warren Buffet described as Financial Industry's weapons of mass destruction!
NYSE: C current trading UP 1.1%, or $0.24
ADD ON @ 1:25PM: Mish's Blog references Minyanville's Mr. Practical's response (no source that I can find) to this mis-understood Citi $12 asset sale:
As investors bid up the Citigroup (C) stock price early on the news that the bank sold $12 billion of bad loans at not too much of a discount, perhaps they should look closer at the deal.
In order to get that price, C had to agree to indemnify the buyers of the first 20% of losses.
Citi obviously did the deal at this artificial price so that it would not have to mark down too significantly the rest of its portfolio. Not to let facts get in the way, but the price it sold the loans at, if you include the indemnification, is very poor. Risk is high and growing.
Posted by evan
Wed Apr 9th, 2008 11:13 AM
also of note:
Discover Buys Citigroup's Diners Club International
http://www.bloomberg.com/apps/news?pid=20601103&sid=a06N.xkDTpCY&refer=us
Posted by Noah
Wed Apr 9th, 2008 11:33 AM
thx evan! It seems that C cant sell the real bad stuff though!
Posted by g. nu
Wed Apr 9th, 2008 01:27 PM
Noah Rossenblatt, Your right you don't know anything about legeraged loans and the like.
Citi which may have had what you continue to call call toxic paper, do not understand CITI took a write down, a write down in excess of what was necessary. By taking the loss at year end 2007,
They now have a loss reserve on their books of $24 billion. It now looks like they will only use 10% of the loss reserve so they will be in a position to write up $22 of profit down the raod. In the meanwhile tghey get a check from the US treasury
for the taxes paid for the last 5 years about 15 billion which they can use as cost free capital.
Citi also has the support of the FEDERAL Reserve Bank behind them. Since the Fed announcement on March 17 Citi stock is up 40% and your friend is correct. Become more knowledgeable before shooting your mouth off with such grandiose bravado, might save you from idiot status.
as
Posted by Noah
Wed Apr 9th, 2008 02:00 PM
Are you kidding me? Do you know what CITI's holdings are worth? Do you know where marks are coming in for these loans? Do you work at CITI and have access to this information? Did they mark those loans down to zero?
What did CITI write down thus far? To me, they only written down CDO book! Now your saying excess profit! Your assuming everything was written down to zero! I know people very close to this situation, and you are smoking crack by your statement.
As per the runup rant, since the fed cut rates in mid September, CITI stock is down about 45% including your 40% short squeeze runup since March 17th's fed/bear elimination of systemic crisis bottom. So a quick bounce is part of your argument on the strength of the company and a bottom? Pleeease! Talk about idiot status!
They do NOT have 24B of loss reserves on their books assuming they write the loans they sold to zero! I ask you,l did cit writes these specific loans to zero? Can you confirm this? I know that they were not! Prove me wrong.
Posted by Noah
Wed Apr 9th, 2008 02:19 PM
let me clarify - CITI does not have 24B of loss reserves on their ENTIRE portfolio of holdings
Posted by Query1
Wed Apr 9th, 2008 03:48 PM
What are the chances that the CDS products will escape write-downs or worse? Soros in Bloomberg a few days ago is quoted as saying these markets may be the next crisis because they are regulated. There has been such a proliferation of these products that some estimate if 10% of these contracts "go bust", there will be $5 trillion dollars in losses somewhere in the financial system. And Merril around 3/19/08 sued XL Capital to enforce the obligation to pay on some of the swaps they bought. Where do we go from here?
Posted by Noah
Wed Apr 9th, 2008 04:17 PM
query1 - a big unknown. The counterparty risk that CDS brings to the structure of our financial system is huge. This is one reason why Bear was not allowed to go bankrupt, who would be on the hook for 10's of Billions owed to holders of CDS for Bear?
Everything is inter-related in this system. This is what scares Soros, Buffet, and scholars like Roubini, and many others. Honestly, no one knows how this will ultimately play out.
Posted by Steve
Wed Apr 9th, 2008 04:46 PM
The problems at Citigroup are far more serious than $12 billion in leveraged loans. We don't know what's in the loans they're selling, whether they're good leveraged loans (some M&A stuff) or mortgage-backed or what.
Citigroup's main problem is its business model, and that's what's going to have to change, and lead to massive layoffs. They've already virtually done away with Travelers - Salomon Brothers, now part of Smith Barney - because someone realized that insurance has very little to do with banking. Their problem now is, what are they? A US retail bank? If so, they don't look anything like their major competitors. An investment bank? Ditto. A brokerage? Ditto. An international retail bank? Ditto.
There is not a single bank that I can think of that tries to do what Citi is failing at. Maybe for a reason. It has very little US branch presence, it's a minor player in the international retail market except for Mexico. Their brokerage competes against Merrill Lynch and Morgan Stanley, which don't look anything like them.
I think they got into this mess partially because they don't know what they are. BofA's strategy has always been to be #1, #2, or #3 in any market; otherwise, get out of the market and redeploy the assets. JPMorgan's seems to be the same. HSBC has a large international retail banking presence, as does Santander. I just don't get Citi.
Which is why raising capital is just the beginning. Gaining a self-image is next, and more painful therapy.
Posted by Noah
Wed Apr 9th, 2008 04:50 PM
Steve - does CITI have the benefit of write-ups coming OR significantly more write-downs?
Is the 24B in loss reserves on the books of CITI ample enough to cover what is likely to occur in near term as more assets are marked to market, and write-downs announced? Unless of course housing miraculously reverses course starting now, and foreclosures/defaults do the same across all debt classes.
Im trying to see whether G.NU's argument holds water?
Posted by Steve
Wed Apr 9th, 2008 05:06 PM
I think the key to answering your write-up question is answered by Citigroup itself: "Citi’s CDO Super Senior sub-prime direct exposures are not subject to valuation based on observable transactions."
That totals about $29.3 billion unhedged. Who knows what's in it, what it's worth.
Eventually there may be write-ups. Maybe significant. But it won't help if they've already sold the instruments. And if it all gets written off, then $24 billion loan-loss reserve won't be nearly enough.
I honestly don't know, and Citibank isn't telling anybody. But that they are becoming the new Incredibly Shrinking Bank may speak for itself.
Posted by mike
Wed Apr 9th, 2008 06:57 PM
Citi is selling leveraged loans to PE shops for buyouts. This wasn't MBS paper. You can look at the write downs two ways:
1. They marked their portfolio to lower than where cash would sell, and took those losses in 2007 in order to book a windfall in 2009-2010 when/if the bond prices recover.
2. They're still f'd for I-banking profit for the foreseeable future.
I tend to think more #2, but it's possible they that markets recover. You still need to remember that the retail bank is WAY bigger in terms of their profit than the i-bank, it's margins are just slimmer.
RE: the leveraged loans, I don't understand why no one is discussing who bought them. Aren't these are the same guys that borrowed the money? With the seller financing, they're essentially financing a 10% rebate on their prior loan. It's almost like me buying an apartment with a $1 million mortgage, and 1 year later saying, you know that loan you made me that you can't sell? Well i'll buy it for $900k, but only if you finance $800k of the loan buyback. Sure I'm putting in a little more equity, but that's equity i'm receiving essentially for free. Where do I sign up for that kind deal?
That's what i see as the net effect of this whole thing. Even if it's apollo buying blackstone's loan, the PE shops can always trade them back and forth, but the net effect on the two general parties is the same.
Ridiculous. Steve Schwarzman & co aren't worth a bazillion dollars because they're not greedy.
Posted by Noah
Wed Apr 9th, 2008 09:15 PM
yea Steve I am with you. The write UPS theme is hot on the street now, but I do not think its anywhere close to being a near term reality. How will asset prices do when/if recession gets real nasty? All those other debt classes will start to be pressured.
Its just not the time to start to talk bottom yet. I'd rather wait, see the extent of the damage, the severity of this, how things change, how tax code is affected, etc. until making more concrete bets.
Posted by Noah
Thu Apr 10th, 2008 09:29 AM
G.NU - where are you? No response afer trashing me for shouting my mouth off? My response is up?
But if thats not enough, see what Mish thinks about and then tell him he is shouting his mouth off.
http://globaleconomicanalysis.blogspot.com/2008/04/ponzi-financing-at-citigroup.html
"Citigroup is cash strapped. To raise cash it has agreed to sell $12 billion worth of leveraged loans it was holding at a reported 90 cents on the dollar. Earlier today in Less Than Meets The Eye at Citigroup, Goldman I noted that in order for Citigroup to get a price of $12 billion for the loan portfolio it sold, it had to agree to indemnify the buyers of the first 20% of losses. Tonight more details are emerging."
"Citi is financing much of the sale itself, according to a person familiar with the deal. It is lending some money to the private equity firms, which will combine it with some of their own money to purchase the debt.
Essentially, Citigroup is re-lending money, but on different terms. The new loans are obligations of the private equity firms, and Citi is selling the original loans to the firms at somewhere around 90 cents on the dollar."
--I always welcome comments, but if your going to throw out insults, at least have solid reasoning to back it up.
Posted by Query1
Thu Apr 10th, 2008 10:43 AM
If Citi is financing a 10% rebate to seel leveraged loans at a 90% discount, roughly speaking, isn't their price below what CDS market is showing for these loans? If so, is the Citi sale a "price discovery" event that would begin to put pressure on the leveraged loan market price and down we go?
Posted by Noah
Thu Apr 10th, 2008 11:14 AM
Query1 - well they are not selling at a 90% discount, they are selling at a 10% discount, 90 cents on the dollar. They need to raise capital, and before cutting dividend or issuing common stock or selling preferred's which dilute, they are looking to off load some troubled assets from their balance sheet.
It should be a price discover event, but remember, firms can move hard to trade assets to Level 3 on their books, and they have been:
http://online.wsj.com/article/SB120775467750601847.html?mod=googlenews_wsj
There is a concerted effort NOT to find out price discovery for these assets as that will hurt everyone. The argument is that eventually it will come out, so many think they are simply delaying the inevitable especially if housing continues to fall and other debt defaults continue to rise affecting the securities held.
Posted by Adam Steele
Fri Apr 11th, 2008 03:42 AM
I appreciate you taking such pains to simplify and elucidate a complex topic, in terms that even a layman like me can understand. I respect the opinions presented here. However I would like to say something too.
Innovation creates wealth and I see immense wealth being destroyed as a result of bets that I can't really understand. I could have understood insurance bets, bets of productive value, risk taking for purposes of industry. What I don't understand is the huge amount of bets placed on speculative vehicles without regard to prudential standards.
As individual trader's we are expected to follow the prudential rules of 2% loss limit for individual trades and 6% limit for all open positions. We are expected to take risks only up to the limit of our cash margins and those square-off orders consequent to the positions.
Why do these mega corporations have debt to equity ratios of 30:1, 20:1. What makes their debts so superior? If as I understand it, their policy makers donot understand the entire picture of their exposures and the implications on thier P/L picture; does'nt this provide a strong case for de-complexification. What the h** was the use of those rating agencies? I'd like to bet they were paid 30 pieces of silver to put and retain strong ratings (AAHaHa) on thie debts.
Why should these people not be expected to take responsibility by getting their parachutes cut-off?
They have damaged the wealth of generations of ordinary people who were not smart enough to sell their residential homes in Jan 2007 and were actually dumb enough to repay their loans partially or fully.