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http://www.bloomberg.com/apps/news?pid=20601109&sid=a1liVM3tG3aI&refer=home
and that is what they will admit to. they are insolvent.
Citigroup's $1.1 Trillion of Mysterious Assets Shadows Earnings
By Bradley Keoun
July 14 (Bloomberg) -- At an investor presentation in May, Citigroup
Inc. Chief Executive Officer Vikram Pandit said shrinking the bank's
$2.2 trillion balance sheet, the biggest in the U.S., was a
cornerstone of his turnaround plan.
Nowhere mentioned in the accompanying 66-page handout were the
additional $1.1 trillion of assets that New York-based Citigroup keeps
off its books: trusts to sell mortgage-backed securities, financing
vehicles to issue short-term debt and collateralized debt obligations,
or CDOs, to repackage bonds.
Now, as Citigroup prepares to announce second-quarter results July 18,
those off-balance-sheet assets, used by U.S. banks to expand lending
without tying up capital, are casting a shadow over earnings. Since
last September, at least $100 billion of assets have flooded back onto
Citigroup's balance sheet, accompanied by more than $7 billion of
losses.
``If you start adding up all the potential exposures, it's a huge
number,'' said Sam Golden, a former ombudsman for the U.S. Office of
the Comptroller of the Currency who now heads the financial-industry
practice for restructuring adviser Alvarez & Marsal in Houston. ``The
banks will say that it was disclosed. Investors are saying, `Yeah, but
it was cryptic. We really didn't know what you were telling us.'''
U.S. banks already are reeling from more than $165 billion of
writedowns and credit losses, so shareholders are wary of unknown
obligations that might force them to take responsibility for
additional troubled assets. The risks have become so obvious that
accounting officials are proposing new rules -- some of which
Citigroup opposes -- that would force many assets back onto balance
sheets.
On the Hook
Seven of the biggest U.S. banks, including Citigroup, are on the hook
for at least $300 billion of credit and liquidity guarantees for off-
balance-sheet loans and bonds, according to a June 30 re****t from
consulting firm RiskMetrics Group Inc. in Rockville, Maryland. Such
guarantees were remote when pledged as an inducement to bond buyers.
Now, the first year-over-year decline in housing prices since the
Great Depression and rising home-loan, commercial-mortgage and credit-
card delinquencies have begun to trigger them.
``You will rapidly realize what a farce these off-balance- sheet
things are,'' said Ladenburg Thalmann & Co. analyst Richard X. Bove.
``You could pick up a lot of loan losses with the stuff you're putting
back on.''
It's impossible to predict what the losses might be from off-the-books
assets or liabilities because disclosures are thin relative to what is
required for balance-sheet assets, said Neri Bukspan, chief accountant
for Standard & Poor's in New York.
``A lot of information tends to disappear or becomes second or third
class,'' Bukspan said.
Second-Quarter Loss
Citigroup has had to bail out at least nine investment funds in the
past year, including seven structured investment vehicles, or SIVs,
whose funding withered. The bank had to assume $45 billion of
securities from those SIVs, which are now included in the $400 billion
of on-balance-sheet assets Pandit says he's trying to unload in the
next three years.
The bank probably will re****t a second-quarter net loss of $3.7
billion later this week, according to the average estimate of seven
analysts surveyed by Bloomberg. A loss would be the company's third
straight and add to $15 billion of losses recorded during the previous
two quarters.
Citigroup plunged 69 percent in the past year in New York Stock
Exchange composite trading. It closed at $16.19 on July 11, down 52
percent from April 6, 1998, when Citicorp agreed to form the modern
company by merging with Sanford ``Sandy'' Weill's Travelers Group Inc.
JPMorgan, Merrill
JPMorgan Chase & Co., which has more than $400 billion of off-balance-
sheet assets, also re****ts second-quarter results this week. The New
York-based bank, the largest U.S. bank by market value, may say second-
quarter profit fell 55 percent to $1.9 billion, analysts estimate.
Merrill Lynch & Co., the third-biggest U.S. securities firm by market
value, also re****ts results this week. New York-based Merrill had to
buy about $4.9 billion of mortgage-linked assets last year from an off-
balance-sheet financing vehicle, resulting in a $170 million loss. It
may post a second-quarter loss of $1.56 billion after re****ting about
$14 billion of net losses in the previous three quarters, according to
a Bloomberg survey of 11 analysts.
``The riskiest assets we had, our CDOs, weren't even on our balance
sheet,'' Merrill Chief Executive Officer John Thain said on a June 11
conference call with investors. Merrill would have to provide $15
billion in financing for CDOs and related obligations under a ``severe
stress scenario,'' according to a Merrill regulatory filing published
in May.
VIEs, QSPEs
The Financial Accounting Standards Board, the five-member panel in
Norwalk, Connecticut, that sets U.S. accounting rules, voted
[=^]earlier[^=] this year to eliminate ``qualifying special- purpose
entities,'' or QSPEs, a category of off-balance sheet financing
exempted from tighter standards enacted following the collapse of U.S.
energy trader Enron Corp. FASB also plans to clamp down on ``variable
interest entities,'' or VIEs, that banks used when their vehicles
couldn't qualify as QSPEs. And it voted June 11 to force banks to
consolidate off-balance-sheet assets whenever an ``obligation to
absorb losses can potentially be significant.''
Banks are required to disclose their off-balance-sheet assets in
annual re****ts. According to Citigroup's most recent financial
statement, filed in May, the bank's $1.1 trillion of off-the-books
assets as of March 31 included $760 billion of QSPEs and $363 billion
of unconsolidated VIEs.
`Full Disclosure'
``Our quarterly financial re****t provides full disclosure of our off-
balance-sheet assets, including our maximum exposure to assets in
unconsolidated VIEs,'' Citigroup spokeswoman Shannon Bell said. That
figure was $141 billion as of March 31 and included funding
commitments and guarantees, company re****ts show.
To lose the full amount, all the assumed assets would have to be
written down to zero. The figure exceeds Citigroup's market value of
about $90 billion, which dropped more than $180 billion since the end
of 2006.
Citigroup's financial statement also says that about $517 billion of
the QSPEs are related to mortgage securities, and that they are
``primarily non-recourse,'' which means the risk of future credit
losses is transferred to purchasers.
Sharon Haas, an analyst at Fitch Ratings, said anyone who has studied
Citigroup's disclosures would be familiar with the off-balance-sheet
risks.
``A lot of these so-called off-balance-sheet exposures, there's no
mystery about this,'' Haas said. ``Whether they're on or off balance
sheet is frankly not as im****tant from an analytical perspective as
understanding the inherent nature of the businesses that they're
involved in.''
`Impractical' Rule
Pandit, 51, who replaced Charles O. ``Chuck'' Prince III as CEO in
December, said in a June 27 re****t posted on Citigroup's Web site that
regulatory reform must include ``public disclosures to investors about
pertinent risk and financial information that give the market a chance
to make informed judgments.''
The comments came after Robert Traficanti, Citigroup's deputy
controller, sent a letter to FASB Chairman Robert Herz on June 9
objecting to a provision that would force banks to reevaluate their
off-balance-sheet assets and liabilities every quarter. Citigroup has
more than 7,000 VIEs and more than 100 QSPEs, he wrote.
``We believe that this model is impractical from an operational
standpoint,'' Traficanti wrote. ``We would not be able to perform this
analysis given the resources we currently have. We would need to hire
many more accountants.''
Capital Concerns
Regulators may part ways with accounting overseers and grant banks a
waiver from having to raise capital against assets that have to be
consolidated on the balance sheet, said Tanya Azarchs, a managing
director at Standard & Poor's in New York.
``They really don't want to introduce any more instability into the
banking system,'' Azarchs said.
Mortgage-finance agencies Freddie Mac and Fannie Mae plunged to their
lowest in 17 years in New York trading last week, partly on concern
that off-the-books assets might swamp their capital.
James Lockhart, director of the Office of Federal Housing Enterprise
Oversight in Wa****ngton, said on July 8 that an ``accounting principle
should not drive a capital decision by a regulator.''
That doesn't mean regulators aren't paying attention. Examiners keep
offices inside the headquarters of large banks, and they have access
to non-public records that help them analyze off-balance-sheet risks,
said Bill Isaac, a former Federal Deposit Insurance Corp. chairman who
is now chairman of Secura Group, a consulting firm in Vienna,
Virginia.
What-If Scenarios
``The bank examiners are probably more thorough now and even skeptical
in looking at these things,'' Isaac said. ``They're probably doing
more what-if scenarios and stress tests. People thought there was a 1-
in-100 chance of something happening, and as we see now, it has
happened.''
Citigroup had $25 billion of ``liquidity puts'' -- a kind of guarantee
-- last year on off-balance-sheet ``commercial paper CDOs'' set up to
sell short-term debt known as commercial paper, according to the May
financial statement. In the second half of the year, after a surge in
market rates for the commercial paper, the bank had to preempt the
formal exercise of the guarantees by buying the debt, according to the
statement.
By the end of 2007, the full amount had been brought back on the
books. The assets had to be written down by $4.3 billion in the fourth
quarter and $3.1 billion in the first quarter. The remaining balance
stood at $16.8 billion as of March 31.
Failing SIVs
The commercial-paper CDO assets are in addition to the assets
Citigroup took over last December from its failing SIVs. In that case,
the bank didn't have a contractual guarantee; it intervened to cu****on
the losses for its clients. Citigroup had $212 million of losses
related to the SIVs in the first quarter, according to the financial
statement.
``People say they don't have any liquidity backstop, they don't have
any guarantee,'' said Russell Golden, the FASB's technical director.
``But then they act like they always had a guarantee.''
Murkier still are the $15 billion of assets Citigroup has had to
im****t this year from four off-balance-sheet hedge funds that
unraveled. They include the Old Lane hedge fund that Pandit helped
open in 2006. Citigroup bought Old Lane Partners LP last July for
about $800 million. Earlier this year, the bank said it would close
the fund because Pandit and other Old Lane founders had moved on to
management jobs at the bank.
Citigroup incor****ated about $9 billion of Old Lane assets into its
trading desk.
`Back to Roost'
``You had risks off the balance sheet that came back to roost,'' said
Marc Siegel, head of accounting research and analysis at RiskMetrics.
While Citigroup has more off-balance-sheet assets than its peers, it
isn't alone. Bank of America assumed about $6.6 billion of commercial
paper issued by off-balance-sheet CDOs last year. About $5 billion
related to ``written put options'' and $1.6 billion related to ``other
liquidity sup****t,'' according to the Charlotte, North Carolina-based
bank's financial statements.
Bank of America held $32.1 billion of VIEs on its balance sheet as of
March 31, compared with $22.4 billion at the end of 2006. It still has
$43.2 billion of VIEs off balance sheet.
JPMorgan has off-balance-sheet ``conduits'' with about $54 billion of
commercial paper outstanding, according to its first- quarter
financial statement. The bank says it is ``not obligated under any
agreement'' to buy the debt. Even so, the bank provided a chart
showing the impact if assets had been consolidated: First-quarter net
income would have been $2 billion instead of $2.4 billion.
``As soon as the cycle turned, all of these risks started to come
back, and companies weren't prepared,'' Siegel said. ``It wasn't
transparent to the investors what was going on.''
To contact the re****ter on this story: Bradley Keoun in New York at
bkeoun@[EMAIL PROTECTED]
Updated: July 13, 2008 19:01 EDT
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