(originally published on December 8, 2007)
In a definite sign of further deterioration in the financial markets, Rabobank became the third European bank in just two weeks to bail out its troubled structured investment vehicle, Tango Finance, taking assets worth $7.6Bn onto its balance sheet. The SIV, co-managed with Citigroup, has already seen almost half of its assets sold since July due to non-availability of sufficient funding. The business metrics for SIVs have changed dramatically since summer and there is little chance for any SIV, even those holding good assets like Tango supposedly is, to secure any viable funding. Moody's is expected to downgrade $105Bn of debt sold by SIVs after determining the average net asset value of SIVs to have declined to 55% from 71% a month ago (a complete reversal from 102% in June!). Downgrades will only further complicate the problems for SIVs to obtain financing. European banks, largely not in favor of a Super-SIV style bailout package, are increasingly resorting to these confidence-building measures in an attempt to preserve their fledgling reputations.
On the other hand, US banks have steadfastly refused to consolidate their SIV assets into their balance sheets, preferring instead to go with a Super-SIV bailout package spearheaded by Citigroup. Citigroup, with as much as $66Bn worth of assets stuck in its SIVs, is right in the eye of the storm. Citi has already committed emergency funds to the tune of $10Bn to save its troubled SIVs. Eminent gurus like Greenspan and Buffett have gone on record suggesting that if SIV assets are never marked to market, banks may only be delaying their day of reckoning. With Citi likely to account for a big chunk of the SIV bailout, the entire exercise is essentially akin to lending money to itself.
Interestingly, Citadel's recent purchase of the banking assets of E*Trade Financial set a price on similar assets at around 26 cents to the dollar. With this transaction being one of the few observable trades of such assets in recent times, a quick back-of-the-hand calculation suggests a worst-case scenario of Citi suffering a further $26Bn in after tax write-offs, if its assets were valued similarly. Citi will be unable to survive this kind of an assault on its balance sheet, at least not with the company intact and in its current form. Citi cannot afford any more large write-downs because of the existing banking regulations and on account of being a public company.
Will the government then step in to bail out Citigroup as well? There is certainly a precedent in recent history of bailing out large US corporations ('too big to fail' hypothesis). Or will it be private buyers? Citi's battered portfolio will have an attractive lure to a private buyer if the credit markets do indeed normalize (its assets are surely worth more than 26 cents on a dollar in a better market). Any buyer will, however, surely extract his pound of flesh. Expect issuance of preferred convertible stock to the buyer carrying an irresistible coupon (a la Abu Dhabi's recent purchase of a 7% stake).
Jim Morrison (of The Doors fame) crooned way back in the 1960s : “When the music's over, turn out the lights”. While the SIV music has stopped playing, it is not yet time to turn out the lights!!
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