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Tuesday, 25 November 2008

More to Citi's SARP deal than meets the eye

Citigroup's debt issuance has been phenomenal but is also typical. It's SARP/TARP bail-out is supremely important as the benchmark model for all other Government support for banks in trouble who can now go into the same Citi booth. Citigroup's own statement on the matter says the $306bn of assets involved now carry a 20% risk weight. This means that the $27bn deal has boosted the effective collateral for those assets to $244.8bn. Citigroup's capital reserve is now 14.8%. But, the minimum reserve ratio under Basel rules is 8% minimum. Citigroup's normal aggregate risk weight for assets is 52.5% (4.2% reserve capital ratio to gross assets). Hence, if the deal applied to average collateralised assets, $8bn of capital would be freed up. But, in this case $16bn is freed up. Therefore, the collateral value attaching to the $306bn assets pre-deal was only $44.8bn i.e. the deal is worth $200bn surety or collateral equivalent to Citicorp. This means that $27bn invested profitably in Citigroup by the Government has generated 7.4 times that in benefit to the bank. The bank sees a total capital reserve benefit of $40bn , but actually it is worth 5 times that, plus, if in normal business conditions, this would mean the bank could grow its assets by up to $952bn more than it could otherwise, which is a very substantial boost worth two thirds of its total current assets! This amount is worth the total losses of all banks currently insured by the FDIC, between one third and one half of all expected US bank losses! This shows just how effective judicious investment by Government can be - something those ideologues who hand-wring about Government fiscal interventionism should take note of! There should too be no doubt that this is mightily profitable to taxpayers. For example, as an additional sweetener, Citi will issue warrants to the U.S. Treasury and the FDIC for about 254 million shares of the company's common stock at a strike price of $10.61 = $2.6bn i.e. a 10% bonus to Government. There are conditions attached. One is that the medium term beneits to Citigroup are not immediately enjoyed by ordinary shareholders, who for 3 years are limited to 1cent dividend when pref stock holders get 5% & 8%. Another condition calls on Citigroup to help distressed homeowners by modifying mortgage payment contracts to avoid foreclosures. This follows the FDIC plan effected at IndyMac Bank, a major failed S&L (Pasadena, CA) whereby borrowers pay interest rates of 3% only for 5 years or whatever does not exceed 38% of their pretax incomes. This will prevent foreclosures and borrowers in negative equity walking away, and pleases Congress across the aisle. Citi has to factor this in to its P/L. But, this also puts some kind of floor under sub-prime and defaulting prime risks. Yet, arguably, it was just such deals by FM&FM that dangerously hid the signals of actual defaults pre-2008 and artificially buoyed up confidence that it was ok to continue the ballooning mortgage sales at dangerously high loan to value ratios, but then who cares about such nuances when the crisis is now fully upon us? This Indymac scheme is being applied on a larger scale now by FM&FM and has a positive knock-on benefit to AIG's (also Government-owned) exposures too. FDIC Chairman Sheila Bair has been pressing Treasury to use $24bn from the $700bn TARP program to apply mortgage contract modifications nation-wide, but Paulson is opposed this. We may expect this will no longer be opposed? Note that opposing views in the USA are being generated by M&A investment bankers and lawyers would prefer a general solution based on bank mergers arguing that these would provide mutual writedowns and free up reserve capital and with tax rebates & liabilities plus smaller Government capital infusions be enough to pay for nearly $1 trillion in losses i.e. those expected of FDIC insured banks. I think this is wishful thinking on the part of those who are trying to stop the momentum of Government nationalisations, however temporary, and further Government Keynesian interventions to put a backstop on Recession's domino collapse. All this going on in the US seems however, much more intelligent and sophisticated than UK media views following Chancellor Darling's statement worth variously an interim £20-40bn GDP boost. Most newspaper comment is mired in ideological argument mainly pushed by the Conservative Party that opposed Government fiscal intervention by creating a spectre to be feared of the future tax burden, arguing that merely a monetarist response would suffice and that the National Debt and budget deficits are unprecedented or socialistic Tax & Spend, when in fact they are no more than on a par with the last Conservative Government's fiscal stance. In a vain attempt to dislodge Chancellor Darling off his plinth as Recession-battler, the Shadow Chancellor, Osborne, is being outrageously economical with the facts. When UK finance sector liabilities are 4xGDP, Corporate debt 1.5xGDP and Households 1.3xGDP while Gov Debt is only 0.4xGDP - why should anyone think the latter is more a fearful burden to taxpayers than the former added together (over 6xGDP). All have large offsetting assets and none more so than Government. A third of the National Debt is internal to Government and what's not counted is often profitably invested and netted off. Note, by the way, that the EU is in policy catch up. Its thinking is roughly worth currently a 1% GDP boost when I suspect 2.5% is nearer what's required, and what the US and UK are both aiming at. Both UK and EU authorities may wishto consider what FDIC is enabling next.
In an email from JP Morgan I learn of the importance of the FDIC's new liquidity guarantee program - the FDIC back in Oct introduced a new facility that would guarantee the debt of financials (banks, thrifts, etc) but it wasn’t until last Friday that the final rules of the program were released. As a result, financial firms will start to come to market w/FDIC-backed issues. According to the WSJ, Goldman will be the first financial to issue under the FDIC program (~$2-3bn) and press sources say demand has been strong (we should see it price sometime today). "In effect Goldman is issuing synthetic Treasury bonds, at a much higher yield than straight Treasury bonds". Financial institutions may use the program to issue $250 billion to $350 billion of debt. That could help financial institutions make a dent in the $233 billion of debt they have to repay or refinance over the next five quarters.
At the Barclays shareholder meeting, concerning how fear was causing liquidity to evaporate for financials, Marcus Agius, the chairman, said the stock market was so nervous about investing in banks in October that “a dangerous leak that we were having trouble raising money could have been terminal” and prompted any and all liquidity to rush away from the company. Central bank guarantees like the FDIC guarantee should take such risk off the table for financials to a large degree. That’s not to say financials are above water - just that the FDIC plan helps on the liabilities side of a bank's balance sheet, but many still have problems on the asset side (Citi's problem, having offloaded assets into the Fed facility).

1 comment:

Mberenis said...

Consumers are going to be bailed out too! The bailout is causing lenders to practically give away money. You would be surprised at how much cheap and in some cases "free" money is going around out there.

Bailouts for Everyone