Will Banks Mark ABS To The Citadel-E*Trade Market?

Posted by John Carney, Nov 29, 2007, 11:19am

As has now been widely reported, Citadel has swooped down into E*Trade's coffers and delivered the internet bank and brokerage $2.5 billion in cash. Investors seem to like this deal, pushing up E*Trade's share price in early morning trading.

The lads and lasses at DealBook have a bit of a laugh this morning in a post titled "We're From Citadel, and We're Here To Help." They run through the now familiar litany of Citadel's quick asset purchases from distressed financial firms: Amaranth, Sowood, Sentinel. It would be tempting to describe these as bailouts by Citadel--indeed, DealBook reports that Citadel founder Ken Griffin pitches the deals as "helping" the troubled firms--except that each of the firms subject to Citadel's attention went on to sink even further. Citadel's help often seems to be a prelude to the ash-heap of financial history. E*Trade investors may want to take note: when Ken Griffin is on the phone, you are probably in more trouble than you think.

As part of the deal, Citadel is paying $800 million for asset backed securities that had a book value of $3 billion. That's close to a 74% haircut for E*Trade. It's worth paying attention to the possibly the secondary effects of this sale, which may be even more profound than most have acknowledged. The market for asset backed securities is one of those severely stricken in the credit crunch, and this trade is one of the few large, publicly announced sales of these assets in recent weeks. Surely those banks and brokerages which have been claiming to be adjusting their valuations to market realities will have to take a second look at their valuations in light of this 74% discount.

We're not exactly going to hold our collective breath waiting for the banks to mark their ABS portfolios down by two-thirds. If we listen close enough we can already hear them whispering in their conference rooms that E*trade's was a "firesale" and does not reflect underlying market fundamentals. Which makes us wonder whether they are truly confused about the difference between marking-to-model and marking-to-market.

We’re From Citadel, and We’re Here to Help [DealBook]

E*Trade to Get $2.55 Billion Cash Boost From Citadel [Bloomberg]

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Comments

Posted by the accountant, Nov 29, 2007 12:14PM

hear your moral outrage bubbling just under the surface there john, but i doubt citadel will be so helpful as to dislose what it payed on individual securities in the ETFC book so yes you are right not to expect anyone to mark to a headline price transacted on "CDOs" - not all are created equal. that would be like adjusting the value of your PA based on the price of "stock"

or would you support any institution writing up the value of subprime mezz CDOs already written to zero based on the aggregate mark to ETFC book that is 2/3 prime 1st lien? just a thought.

Posted by the mortgage guy, Nov 29, 2007 12:19PM

i doubt that the citadel purchase is likely to trigger the price discovery event you reference.

they bought a portfolio. where citadel marks the securities is its own business; where e-trade marked them is its shareholders problem.

Posted by alreadyburnt, Nov 29, 2007 12:21PM

John-Most banks are already there. Obviously Etrade needed the cash but it might be Citadel thats left to mark those assets down further.

Posted by , Nov 29, 2007 12:27PM

the accountant: finally someone setting the record straight on CDOs and marking. People don't understand what is being written down. This stuff is not worthless, each CDO is different in terms of structure and collateral type. It's crazy what's going on in the CDO/CLO market now, pure panic out there with anything that has been securitized.

Posted by not mortgage guy, Nov 29, 2007 12:50PM

mortgage guy clearly u dont understand the rules of FAS 157 & FAS 159. New legislation takes emphasis away from model & entry point pricing and moves it towards last trade pricing

Posted by John Carney, Nov 29, 2007 12:59PM

Exactly, 12:50.

Although there is a lot of wiggle room in FAS 157, firms are not permitted to ignore information about market prices for assets that is reasonably available without undue cost and effort. Here we've got the price of an ABS portfolio sold for a 74% discount. The banks are required to take this in account. This doesn't mean they have to market every asset backed security they own down 74%--as others have said, not all asset backed securities are made equal--but they cannot pretend this very public sale didn't happen.

Posted by ian, Nov 29, 2007 1:17PM

To be fair, ETrade's portfolio was particularly shitty and may not be representative of everything else out there, as it was stuffed with second lien loans that will likely end up being very close to worthless.

Posted by the accountant, Nov 29, 2007 1:19PM

what is certain is that citadel did price each security and did not bid on this portfolio as a blind pool. similarly, banks are required to evaluate each position on its own merits. so they cannot pretend this sale didnt happen as you say but really what data is there to apply to marking an individual position unless you have at least some idea of the pool characteristics. please excuse me if i am getting my jargon confused but you know what i am driving at. we are coming from an environment where many of these things are quoted 0/0 so arguably, it is not a stretch to say if anything this liquidity is a positive sign

dislaimer: i am not a real accountant.

Posted by anon4life, Nov 29, 2007 1:38PM

It should also be noted that Citadel's purchase of the ABS portfolio is but one piece of a larger transaction, which includes an equity stake, a seat on the board, etc. and so disentangling the "market" value on these securities from the information that is publicly available right now is an exercise in futility. Even if Citadel revealed what and how it priced the individual securities in the portfolio, how much it paid probably can't be separated from a value perspective with the other parts of the deal.

Disclaimer: I am not a real accountant, but I play on on TV.

Posted by , Nov 29, 2007 1:38PM

ironically, as i was typing this i did just receive a portfolio sheet with markets at 0/0 at least half the issues

Posted by the accountant, Nov 29, 2007 1:43PM

anyway heck of a deal there, getting paid 12.5% coupon and get all the equity for FREE (yes CIG pays $0 for the equity)

holy cow

Posted by mortgage guy, Nov 29, 2007 1:45PM

not-mortg., JC:

this was a portfolio wide transaction. It did not, based on what i am seeing or hearing in mkt. this morning, create what I'd call any prior reference points...no specific marks. in other words, nothing is clearing in the mkt. based on that trade.

yes, they may have to broadly consider it under FAS's 157/9, but with no specificity in terms of individual prices, I'm not sure it's the killer example. at least, it doesnt trigger the automatic remarking procedure that a trade in the specific security--or ratings downgrade--does.

my understanding of what FAS 157 was designed to combat is basically Askin's Granite funds redux...i.e. PM says "We're getting price discovery of X, but our marks should reflect x plus xxxx basis points, as the Street's marks [do not] reflect the brilliance of our model. therefore, we mark to our model [myth]."

in good faith,
mortgage guy.

Posted by wdp, Nov 29, 2007 3:12PM

remember that ETFC was into really crappy loans. 90% of the mortgage & home equity loans on their books were purchased from wholesalers (and, that's a $29 billion book so it ain't small). over 60% was originated in 2006/2007. and, there's a bunch of below 680 FICO loans in there. bottom line, if the ABS book CIG purchased looks anything like ETFC's loan book (it is almost certainly much worse), then the 74% haircut might be appropriate. but, don't automatically make it a read-through to other banks & brokers.

Posted by Ken Houghton, Nov 29, 2007 4:13PM

wdp: Fine. Take a 50% haircut on all CDOs that you can't get priced in the market.

This assumes that your portfolio, which includes some (but not that many) high FICO (no relation to foreclosure data) mortgages that were not originated in the past two years (i.e., after the bubble popped but before the hissing was clear).

GOOG closed last night at 666. if I offer to sell you 1,000 shares right now for $800 (short settle as if it were COD yesterday), are you buying? If not, please explain why not, without referencing the "market price."

Posted by , Nov 29, 2007 5:54PM

Apples & Oranges Ken,

GOOG is a level one asset.

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