Toomre Capital Markets LLC

Real-Time Capital Markets -- Analytics, Visualization, Event Processing, and Intelligence

United States Treasury Hopes to Stabalize Citigroup

On Monday November 24th 2008, news emerged that the United States government has taken a stake in Citigroup that will amount to about 8% dilution to current stockholders through the issuance of $27 billion in preferred stock that will initially have a coupon rate of 8.00%. The terms of the total package are still somewhat murky. However, apparently for some $300 billion in identified assets primarily tied to mortgage assets, there has been some deal on how the waterfall of losses from those assets will be allocated.

Apparently Citigroup will stand in the first loss position for about 12% of these mortgage-related assets, which apparently (according to the Citigroup CFO [via CNBC]) were picked because they generally duplicate those assets held by many other financial institutions. [If this news report from CNBC is indeed true, does not this report suggest that the direct regulators and Treasury Department expect that other institutions with similar assets will be pressing their regulators and the Treasury Department for a similar “bail-out:?]

From the press releases to date, it is very unclear of how the term “loss” will be calculated. Does a loss mean a lower price than what Citigroup currently has an asset booked at on its books? And when was that “book price” last determined? (For September 30th public reporting or something more recent?) Or does it mean a lower price from wherever the current market price was last Friday November 21st 2008? Alternatively, it could mean that management has updated the “observable inputs” that it uses in its internal (and private) models to value “hard to value” assets (such as those included in the Level II and Level III categories according to the controversial accounting standard FASB 157).

Lower down in the “loss” waterfall (for these approximately $300 billion in assets) will be the Treasury Department, the FDIC and then ultimately the Federal Reserve. In insurance terms, there are various attachment points to these “loss” layers. From the perspective of Toomre Capital Markets LLC, these loss attachment points are akin to upper layer attachment points that many insurance companies transfer to reinsurers.

One of the key points with this bailout is the lack of transparency. Informed observers lack sufficient information needed to make probability of loss estimates. Hence, there will continue to be considerable rank (and in many cases uninformed) speculation about just how much loss each of the potential loss layers eventually will absorb. No doubt there also will be considerable political heat about just how much exposure the American tax-payer (i.e. “Main Street”) has to this bail-out of one of Wall Street’s largest institutions – Citigroup.

With this bailout of the one financial institution that truly is “too big to fail”, one has to wonder whether American tax-payers would have been far better off if back in mid-September Timothy Geithner, Hank Paulson and Ben Bernanke somehow would have found the wherewithal to prevent the bankruptcy of Lehman Brothers? (Or perhaps these regulatory officials realized that the marks of Mark Walsh and company on the commercial real estate and CMBS portfolios at Lehman Brothers were simply too aggressive and that any government investment/guarantee would result in immediate losses as those assets were marked down to a more reasonable estimate of the then current market value.)