The Citadel Discount: Armageddon Scenario For Three Banks

Posted by John Carney, Dec 04, 2007, 12:11pm

One reply to our insistence about this Citadel discount thing has been to call it an "Armageddon Scenario" that is simply too horrible to contemplate. An old friend just wrote to us that what's keeping the banks from marking down their CDO portfolios based on Citadel is not wishful thinking but sheer terror.

What are they afraid of? Well Peter Cohan has helpfully showed exactly what there is to fear. In a recent column on blogging stocks he says that the capital of three banks would be wiped out if that 27 cents on the dollar valuation was applied to their Level 3 assets and written off from their most recent capital levels.

So who are the three banks who are imperiled by the 27 cents? After the jump, check out Cohan's list.


* Morgan Stanley (NYSE: MS): -$29 B (subtract 73% of Morgan Stanley's Level 3 assets of $88 billion -- or $64 billion -- from its capital of $35 billion).

* Goldman Sachs (NYSE: GS): -$14 B (subtract 73% of Goldman's Level 3 assets of $72 billion -- or $53 billion -- from its capital of $39 billion).

* Bear Stearns (NYSE: BSC): -$2 B (subtract 73% of Bear's Level 3 assets of $20 billion -- or $15 billion from its capital of $13 billion).

Cohan includes lots of caveats in his post, so you should read the whole thing before massively shorting Goldman. But this is probably the most plausible explanation we've come across for why there is such adamant resistance to treating the Citadel discount as a pricing event.

Could Citadel's valuation of E*Trade's CDOs wipe out capital at three big banks? [Blogging Stocks]

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Posted in: Banks

Comments

Posted by Anonymosity, Dec 04, 2007 12:20PM

Armageddon a little tired of hearing about subprime.

Mike's anyone?

Posted by anonymous, Dec 04, 2007 12:26PM

Floor? Citadel made out like Bandits. ETFC might have well thrown in Herschel Walker as part of the deal.

Posted by DRD, Dec 04, 2007 12:37PM

Level 3 doesn't equal only subprime mortgages. All of the PE and other illiquid investments are also classified in this category, so the analysis is retarded at best.

Citi is the one who will get rocked, $43bn of super seniors unhedged

Posted by , Dec 04, 2007 12:40PM

banks are just trying to get out of this year and into the next without having to re-value any of it's L3 until January.

Good work if you can get it.....

Posted by , Dec 04, 2007 12:48PM

Does this only look at the long side of their long-short positions which may be on a net basis short?

I have no idea, I'm just asking

Posted by Dr. Evil, Dec 04, 2007 12:52PM

DRD,

Citi's super seniors (unhedged as they are) are by no means simmilar to ETFC's junk. There's a lot of stuff that has to blow up before super seniors even feel a pinch.

Posted by , Dec 04, 2007 12:54PM

Unrelated -

Anyone have any scoop on the canceled december issuances by Fannie & Freddie? How often to they cancel these? Do they usually give a reason?

Posted by series7.5, Dec 04, 2007 12:58PM

uh bear and MS both put out press releases in november stating the total ABS CDO exposure - not even close to this.

and goldman is short subprime, so, you know, nuts to you

plus these arent even the right numbers for L3 assets

Posted by , Dec 04, 2007 12:58PM

for MS

Posted by s75, Dec 04, 2007 1:00PM

12:54 i think its been pretty common over the past few years of not growing the portfolios

Posted by , Dec 04, 2007 1:02PM

theyve done it a few times. FNM didnt issue in aug, or may of last year either

Posted by , Dec 04, 2007 1:08PM

series 7.5

Please enlighten us to what those numbers "should" be....

PR releases by the actual banks do not count.
As they've demonstrated that they didn't see ANY problem with the failed strategy of rolling over paper FOREVER.

Posted by just me, Dec 04, 2007 1:10PM

who cares? they're all too big to fail - if they failed, the regulators simply change the rules and voila - suddenly AA ratings all around.

Posted by LLCJ, Dec 04, 2007 1:19PM

I bet we all look back on this and laugh one day.

Posted by Anonymous, Dec 04, 2007 1:20PM

More posts about ALF, less posts about level 3 asset holdings of banks please. Thank you.

Posted by , Dec 04, 2007 1:35PM

um. thats total bs. since when does L3=subprime CDO exposure? utter nonsense.

Posted by , Dec 04, 2007 1:41PM

Poopies!!!!

Posted by LLCJ, Dec 04, 2007 1:42PM

Ok - so I bet one day I look back on this and laugh

Posted by anon, Dec 04, 2007 2:04PM

This is the most ridiculous post on the subject that I've read.

Level 3 is NOT EQUAL TO CDO exposure. Let's see, real estate, private equity, and other complex instruments are all in Level 3.

Find out who owns ACA crap, and when that (likely) goes bankrupt, you will see upon whom the next shoe drops.

Let's bring intelligence back to that discussion.

Posted by Ken Houghton, Dec 04, 2007 2:17PM

it's rather convenient to ignore that most of ETFC's holdings weren't L3 assets either, isn't it?

Please no ALF: YouTube is blocked here and I keep hitting "serious" links and getting the warning as if it were Vivid Entertainment or the 14th floor men's room at BSC. (You're in good company, btw; Bear used to block Paul McCartney's website.)

Posted by Ken Houghton, Dec 04, 2007 2:22PM

Also, 2:04 PM: If you really have to put Real Estate Holdings in your L3 ("instruments without a market valuation") assets, 27 cents on the dollar is probably generous.

Posted by , Dec 04, 2007 2:31PM

Anon-

None of it would be in L3 if it actually contained value.......

So there is the conundrum......the banks say they HAVE to put it there however as I've stated if it were not tranches of crap credit then it would be actualized in an area that has some real tangible value.

It would'nt be accounted for in that level if it had value.....

There's the intelligence that was missing from you're post.

Posted by , Dec 04, 2007 2:38PM

Abby Cohen also thinks the S&P is worth 14% return in '08 too

we're about due for David Malpass' latest optimistic scribe that allows Cayne to keep his job a little longer too.

So gobbling down the latest of what passes for transparency at any of these banks is worth about the same as the above information...

Posted by just me, Dec 04, 2007 2:40PM

PS to Anon @2.31 - you may not want to comment on others' intelligence if the correct spelling or word usage of 'your' escapes you.

Posted by Buster, Dec 04, 2007 2:44PM

I just took a dump that would probably qualify as an L3 at B of A.

Posted by Anal_yst, Dec 04, 2007 2:59PM

@ Buster - no way, thats def higher quality than L3 @ BofA.

@2:31 - are you retarded? Your argument, wait, lemme get this straight, is that if there is no market price for an asset then it implicitly has no value?

Please, I'm not even going to dignify this drivel with a response.

Posted by give it a rest, Dec 04, 2007 3:03PM

Questions Carney should review before writing on this topic again: Are there different levels of risk within the same CDO? What is the difference between a supersenior tranche and equity? Is there some hypothetical situation where these can trade at different dollar prices? Are there different assets that back CDOs? Has the recent experience been the same for, say, broadly syndicated loan deals versus ABS repacks? If the notion that there could possibly be differences within the CDO universe starts forming in your head—congratulations, you are on the right track. Then you should begin to ask yourself “Which one of these is worth 27 cents on the dollar.” (Hint: the answer is not “all of them”).

Posted by Anominous, Dec 04, 2007 3:03PM

Buster @2:44:

make the rounds in the men's room and repackage into a CDO....

Posted by , Dec 04, 2007 3:09PM

Where the hell is Larry Craig?

Posted by To The Hilt, Dec 04, 2007 3:12PM

What does any of this have to do with Mike's Hard Lemonade?

Posted by HAM'05, Dec 04, 2007 3:33PM

well said hilt

anyone visited the box? (its where blair and chuck were getting it on right before they banged in the limo)

i keep hearing they have midget tossing and live knife fights but no one in the circle of trust has visited to confirm...

Posted by Brian, Dec 04, 2007 3:42PM

All of the back and forth about CDO misses the essential point about this transaction. CDOs were a minor part of the $3B book value of the portfolio that Citadel bought. They had already been written down significantly prior to the deal (by about 50% if memory serves) so they probably didn't account for much of the value in Citadel's calculation. Roughly 50% of the portfolio was prime, first lien RMBS rated AA or better. Even if you assigned all the value that Citadel paid to these securities, they are valued at 60 cents on the dollar. While we don't know the mix between AA and AAA or the geography, orginators, etc, it's a fair bet that most banks holding similar paper would find that haircut eye opening.

If that isn't enough to make you concerned about the quality of the banks' balance sheet, read the WSJ piece on Buffett's purchase of TXU paper and learn that senior bank loans for many LBO's are trading in the low 90's...think those prices were baked in last quarter - not a chance (and mind you none of these are even considered formally distress yet). Or if you are still feeling smug, take a look at the CMBX and see where those spreads are. Have you noticed that absorbtion and rents in CRE are rolling over? Do you know about the IOs in CRE deals and pricing based on rents three years out incorporating substantial rent increases. Anyone here want to make the case thta the midtown vacancy rate a year hence will be higher? Have you made any accomodation for that in your assessment of the banks?

The write downs are just getting started folks. The downside of a credit bubble is ugly. We are going to see that underwriting standards were dropped like pants in whorehouse in many asset classes beyond subprime.

Posted by HAM'05, Dec 04, 2007 3:45PM

BRIAN - you completely missed the point of my question

Posted by , Dec 04, 2007 3:48PM

Brian: I hate when people say "baked in". Otherwise, good post.

Posted by , Dec 04, 2007 3:49PM

HAM'05 will obviously not be going to the Morgan party tomorrow night

Posted by Anominous, Dec 04, 2007 3:55PM

for a second there I thought that Cohan guy actually got paid to invest money. clearly a tireless self-promoter however.

"false as to conclusion and riddled with errors" would be a charitable description of that post.

Carney, the reason you've gotten blowback on this one is not because everyone is denying how bad things are. We know how bad things are. It's because you are obviously wrong.

Posted by John Carney, Dec 04, 2007 5:44PM

It's not my contention that the Citadel discount means every CDO is worth 27 cents on the dollar. Rather that this price tell us something, and we'd all better start figuring out what.

If you claim your CDO portfolio is better than E*Trade's, I want to know why you think it's better and how much better. If E*Trade's was worth 27 cents on the dollar, is yours 32 cents? 45 cents? How did you get those numbers from the E*Trade price?

The point is we have an actual market price that is publicly available for these things, and we're supposed to be using these market prices to guide our estimations of value.

Posted by Anominous, Dec 04, 2007 5:52PM

you -can't- get the numbers from the E-trade price, as people have pointed out repeatedly. mark-to-market is done security by security and these securities and the tranches within them are heterogenous. read 3:03 repeatedly until it sinks in. the Citadel purchase indicates that the situation in re RMBS + CDOs is dire, but we already knew that.

Posted by One synapse clapping, Dec 04, 2007 7:03PM

Anominous, we may have known that, but that doesn't mean the dire state of affairs is remotely reflected in the carrying value of inventory net of hedge books. Of course the E-trade transaction doesn't infer pricing on individual deal collateral or tranches, but it can drive inputs for better mark-to-model estimates of the value of this monumental pile of toilet role, (even outside the mythical world where the models were actually built to mimic market pricing).

In any case and no matter how flawed, incorporating the new information in model pricing applying whatever assumptions required would certainly beat the laughable and transparently self-serving assumption of stale prices. Is it your contention that all the interest the pricing of that portfolio generated was uninformed? Talk about wishful thinking.

My man Carney has a point, although it's not likely to help him get his golden ring.

Posted by Holla Bitch, Dec 04, 2007 7:47PM

Eh yo, Brian put the smack down on this -lyrics my boy, lyrics.

Truth is Carney kinda pulled his own finger here, but hey guess what the entire room (CDO/ABS land)smells like John Mack's office as of 4:01pm market close today.

Yes Virginia, there is a Santa Clause, that fucker gave my bonus to Hugo Chavez and then skulled fucked my Spence girl, arrgghh I knew I should have stuck with my white paki from Jersey.

Wake me up when C trades $5 .

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