Citigroups ‘Capital’ Was All Casing, No Meat – Bloomberg, by Jonathan Weil

Citigroup has “very strong capital,” the bank kept saying.

Its capital was so strong that the New York-based lender yesterday was ironing out yet another federal bailout. One lesson here is: There’s something very wrong with the way Citigroup and the government measure capital.

To see why, let’s dig into just one portion of Citigroup’s capital that has been soaring in value this year. It’s called deferred-tax assets, or DTAs, which now make up a big part of Citigroup’s book value and Tier 1 regulatory capital.

You won’t see anything about these assets’ values in Citigroup’s third-quarter report to shareholders. The bank buried them on its balance sheet in a line called “other,” and it discloses them in its financial-statement footnotes only once a year. You can piece together how much the values had grown, though, from Citigroup’s filings with the Federal Reserve Board.

Deferred-tax assets typically consist of tax-deductible losses carried forward from prior periods, which companies can use to offset future tax bills. Under generally accepted accounting principles, such carryforwards are valuable only to companies that are profitable and paying income taxes.

To the extent a company doesn’t expect to use these assets, it’s supposed to record an offsetting valuation allowance to reduce their value. DTAs also can take the form of carrybacks, which let companies claim refunds of past taxes paid.

As of Sept. 30, Citigroup’s net DTAs were about $28.5 billion, after subtracting deferred-tax liabilities. That represented 29 percent of the bank’s common shareholder equity and a whopping 80 percent of tangible equity, which excludes goodwill and other intangible assets. On a gross basis, DTAs were even bigger; the bank hasn’t disclosed how much.

By comparison, Citigroup’s stock-market value finished last week at $20.5 billion. The longer Citigroup goes without chopping its DTAs, the more investors should be wary of any of its numbers.

So, in truth, Citigroup had little, if any, real capital, even if the values for all its toxic loans and mortgage-related investments had been accurate. Most of the above-listed items won’t help the bank absorb losses. Rather, they are the kinds of things that cry out for more capital.

The market cheered over the Citi bailout but I doubt it could handle BofA and Wells going back to the TARP trough in order to stay alive. If BofA or Wells were to suddenly find their share price under significant pressure as Citi did a couple of weeks ago it may unravel even quicker than Citi. These two banks are something to keep your eye on.  For some reason folks think Wells avoided all of this – just the opposite. My research and years of competing against them in the mortgage space proves just the opposite. Bank of America was the one that avoided it all. They only got screwed up by taking down Countrywide and Merrill. Wells was a mess going into their Wachovia buyout and adding Wachovia makes then not too much different than BofA.

After Citi, is Bank of America Next? Reuters by Elinor Comlay

NEW YORK (Reuters) – A government rescue plan has eased investors’ concerns about Citigroup Inc, but mines lurking in the balance sheets of rivals including Bank of America Corp could still tempt short-sellers.

Bank of America, the No. 3 U.S. bank by assets, has loaded up on mortgages as the world’s largest economy wrestles with the worst housing market since the Great Depression.

Analysts at independent research company CreditSights forecast that in a scenario where the commercial and residential real estate markets really tank beyond banks’ expectations, Bank of America would have a Tier-1 capital ratio of 7.15 percent.

The minimum that regulators seek to consider a bank “well capitalized” is 6 percent, but any ratio near or below 7 percent tends to spook investors.

Bank of America declined comment.

CreditSights also expressed concern about Wells Fargo & Co, which it said would have a Tier-1 capital ratio of 6.98 percent under its worst case scenario. Wells Fargo recently agreed to buy Wachovia Corp.

Under the same assumptions, and before the government’s latest investment, Citigroup would have a Tier-1 capital ratio of 8.64 percent.

Wells Fargo, based in San Francisco, declined to comment.

Lastly, Bill King my favorite market seer recently wrote this about the big one.

More Mr Mortgage Stories

• Mortgage Applications Likely Soared Last Week – But Not Really (3)
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• Mortgage Security Holder Stands-Up – Could Cost BofA $80 Billion (17)
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• Mr Mortgage: In-Depth Look at Mortgage Rates…5.5% Does Not Exist For Most (44)
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• Mortgage Rates Drop! It Does Not Mean What it Used to (67)
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• Fed Buying Agency MBS – Still No ‘Explicit’ Guaranty (14)
  Posted on November 26, 2008 11:24 AM

The Japanese experience looks to be the Fed and Treasury play book.  It is the lesser of all evils. Hey, if it only costs a decade or two but some point in the future the nation pulls out of this mess, then game won. Remember, even though we will be weak, everyone will likely remain much weaker.

The banks have the same game plan, which is why they are not lending.  They know that if they rein in the lending, de-lever and raise cash the firm will be around 10-years from now.  When the storm passes they can poke their heads out and rebuild.  At least they are in business. This same strategy is being deployed at the smart hedgefunds and has been for some time – just live to fight another day.

The shame is that since Subprime started blowing a gasket in Dec 2006 through just a few months ago, the company line was to deny this problem existed and call it ‘contained’.  For a year and a half I was reading very smart people warning of this very outcome. But they were all called ‘alarmists and fear mongers’.  Heck, Peter Schiff was laughed off CNBC more times than I can count. Nouriel Roubini was called a quack until very recently.

There was plenty that could have been done to prevent it from going this far over the past year and a half.  Now it is likely too late and all of us are going to pay for this for a long, long time. This is depressing – no pun intended. -Best Mr Mortgage

Fed Commits $800 Billion More to Unfreeze Lending

By Scott Lanman and Dawn Kopecki

Nov. 25 (Bloomberg) — The Federal Reserve took two new steps to unfreeze credit for homebuyers, consumers and small businesses, committing up to $800 billion.

The central bank will purchase as much as $600 billion of debt issued or backed by government-chartered housing-finance companies. It will also set up a $200 billion program to support consumer and small-business loans, the Fed said in statements today in Washington.

With today’s announcement, the central bank is starting to use some of the unorthodox policy tools that Chairman Ben S. Bernanke outlined as a Fed governor six years ago. Policy makers hope the initiatives will bring down the interest rates on mortgages and consumer loans, offsetting the withdrawal of private-sector financing.

“They’re trying to put funds into the system, trying to unfreeze these markets,” said William Poole, the former St. Louis Fed president, in an interview with Bloomberg Television. “Clearly, the Fed and the Treasury are beginning to take a large amount of credit risk.”

The Fed will purchase up to $100 billion in direct debt of Fannie Mae, Freddie Mac and Federal Home Loan Banks after the yield premiums on those securities jumped. It will also buy up to $500 billion of mortgage-backed securities issued by Fannie, Freddie and Ginnie Mae, a government agency that insures bonds.

Source: Bloomberg – Fed Commits $800 Billion More to Unfreeze Lending

QUANTITATIVE EASING

From Wikipedia, the free encyclopedia

Quantitative easing was a tool of monetary policy that the Bank of Japan used to fight deflation in the early 2000s.

The BOJ had been maintaining short-term interest rates at close to their minimum attainable zero values since 1999. More recently, the BOJ has also been flooding commercial banks with excess liquidity to promote private lending, leaving commercial banks with large stocks of excess reserves, and therefore little risk of a liquidity shortage.^[1]

The BOJ accomplished this by buying much more government bonds than would be required to set the interest rate to zero. It also bought asset-backed securities, equities and extended the terms of its commercial paper purchasing operation. ^[2]

Actual email I received today…

An urgent message to GM owners

“You made the right choice when you put your confidence in General Motors, and we appreciate your past support. I want to assure you that we are making our best vehicles ever, and we have exciting plans for the future. But we need your help now. Simply put, we need you to join us to let Congress know that a bridge loan to help U.S. automakers also helps strengthen the U.S. economy and preserve millions of American jobs.

Despite what you may be hearing, we are not asking Congress for a bailout but rather a loan that will be repaid.

The U.S. economy is at a crossroads due to the worldwide credit crisis, and all Americans are feeling the effects of the worst economic downturn in 75 years. Despite our successful efforts to restructure, reduce costs and enhance liquidity, U.S. auto sales rely on access to credit, which is all but frozen through traditional channels.

The consequences of the domestic auto industry collapsing would far exceed the $25 billion loan needed to bridge the current crisis. According to a recent study by the Center for Automotive Research:

• One in 10 American jobs depends on U.S. automakers
• Nearly 3 million jobs are at immediate risk
• U.S. personal income could be reduced by $150 billion
• The tax revenue lost over 3 years would be more than $156 billion

Discussions are now underway in Washington, D.C., concerning loans to support U.S. carmakers. I am asking for your support in this vital effort by contacting your state representatives.

Please take a few minutes to go to www.gmfactsandfiction.com, where we have made it easy for you to contact your U.S. senators and representatives. Just click on the “I’m a Concerned American” link under the “Mobilize Now” section, and enter your name and ZIP code to send a personalized e-mail stating your support for the U.S. automotive industry.

Let me assure you that General Motors has made dramatic improvements over the last 10 years. In fact, we are leading the industry with award-winning vehicles like the Chevrolet Malibu, Cadillac CTS, Buick Enclave, Pontiac G8, GMC Acadia, Chevy Tahoe Hybrid, Saturn AURA and more. We offer 18 models with an EPA estimated 30 MPG highway or better — more than Toyota or Honda. GM has 6 hybrids in market and 3 more by mid-2009. GM has closed the quality gap with the imports, and today we are putting our best quality vehicles on the road.

Please share this information with friends and family using the link on the site.

Thank you for helping keep our economy viable.

Sincerely,

Troy Clarke”

You should see what owners do before they leave. A few things I have seen is a) concrete flushed down the toilets b) dead racoons sheetrocked behind the walls c) all appliances, countertops and lighting fixtures removed d) all electrical and plumbing systems removed e) all windows removed.

This stuff can be high ticket and even though home sales are far lower in number than during the bubble years, the number of properties sold that need repair may be much greater.

The only thing I have yet to get my arms around is their credit exposure. They do a lot of financing and many who used credit to finance home improvement projects over the past few years will not feel like paying that debt given their home price is down 50%. If they lose their home to foreclosure, the same goes. While HD will have a ton of new business due to the foreclosure crisis, they may still have dues to pay due to past business. -Best Mr Mortgage

Home Depot Profit Falls But Beats Wall St View

* Q3 EPS of 45 cents vs. 39-cent estimate

* Stands by full-year profit forecast

* Steeper drop in full-year sales expected

* Stock rises 3 percent premarket (Adds analyst comment, byline)

Source: Reuters 10-18

Mish summed up the meeting below better than I could have so here ya go. If you want to read his full write-up, which I urge you do, here is the link.-Best Mr Mortgage

G-20 Top 10 Accomplishments

• 10: President Bush said “There was a common understanding that all of us should promote a pro-growth economic policy.”
• 09: U.K. Prime Minister Gordon Brown said “there is a clear determination on the part of world leaders in every continent to take necessary action to move economies out of this difficult period.”
• 08: The group agreed to not cap executive pay.
• 07: The group sang the praises of low interest rates.
• 06: The group will work on recommendations for enhancing disclosure while hinting it would allow the continuation of mark to fantasy accounting.
• 05: The group called for rating agencies to be registered even though rating agencies in the US are already sponsored by the SEC.
• 04: The group called for the creation of “supervisory colleges” who will not do anything thing but receive outrageous pay for sharing information one can easily find on Bloomberg.
• 03: Argentina, Australia, Brazil, China, India, Indonesia, South Korea, Mexico, Saudi Arabia, South Africa, and Turkey complained “the group of friends” otherwise known as the G-8 would not let them in whenever the G-8 got together to party. The above listed countries are saying to the G-8 “please don’t throw a party without us.”
• 02: The all inclusive group of 20 friends agreed to throw another party in April.
• 01: Drum roll please….. The number one accomplishment of the G20 meeting was to blame hedge funds and the buyers (not sellers) of poison apples for the financial crisis.

Top 5 Things G-20 Ignored

• 05: US Dollar Hegemony.
• 04: Micro-Mismanagement of interest rates by the Fed and Central Bankers.
• 03: Spending run rampant in US authorized by Congress. Same thing in other G-20 countries.
• 02: Of immediate concern is the Collapse of Trade, Letters of Credit, and Baltic Dry Shipping. Please see Yet More Trade Finance Worries (Not for the Fainthearted).
• 01: Fractional Reserve Lending run rampant, leverage, excessive credit creation, and unsound fiat currencies. In other words the G-20 ignored discussing the very cause of the problem we are now facing.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

One thing I found particularly interesting is how Buffet was ready to do a deal with Lehman during its crisis period. If he would have done so, he would have ended up with a big, fat ZERO.

Perhaps this is why Goldman is having such a rough time lately – a Buffet deal does not automatically mean that everything is great.  Hearing this should make Buffet chaser investors proceed with caution. Not even Buffet has lived through a global crisis like the one that faces us today and everyone seems to be making the wrong move lately. -Best, Mr Mortgage

Source: Bloomberg – Fuld Solicited Buffett Offer CEO Could Refuse as Lehman Fizzled

Counter-Punching

This time around Fuld also reached out to Omaha billionaire Buffett, the man who had ridden to the rescue of Salomon Inc. in 1987, according to two people with knowledge of the approach. He asked investment banking chief Hugh “Skip” McGee, 49, to call David L. Sokol, chairman of Berkshire Hathaway-owned MidAmerican Energy Holdings Co., and see if Buffett might be interested in a stake in Lehman.

Spurning Buffett

The answer was yes, Sokol told McGee. So Fuld called the 78-year-old Buffett. Berkshire Hathaway would buy preferred shares that would pay a dividend of 9 percent and could be converted to common at the then-market price of $40, the people said. That was costlier than what other investors demanded, Fuld was told by associates, and he spurned the offer. A few days later, on April 1, Lehman sold $4 billion of convertible preferred stock to public investors with a 7.25 percent interest rate and a 32 percent conversion premium.

That meant those buying the convertibles were willing to pay one-third more than the market price for Lehman’s shares if and when they wanted to convert. Buffett was willing to pay only the going price at the time, which would have meant more dilution for existing shareholders. A spokeswoman for Buffett declined to comment.

Fuld had saved some money, yet he rebuffed a Buffett stake, considered to be corporate America’s Good Housekeeping seal of approval. Although that might have helped Lehman in the short run, it wouldn’t have solved the firm’s fundamental problem: Fuld needed to sell the entire mortgage-related portfolio at whatever price he could get and raise enough capital to cover the losses incurred in such a sale”

Instead of looking at sometimes artitrary indicators, just look at what’s going on in the real market. One will argue that ‘just by virtue of these deals going off at all means things are great’.  I say ‘no way!’  If Verizon, one of the strongest companies in the world, has to pay near 9% and MGM has to pay 14% for a loan using New York New York as collateral, I feel sorry for most corporate America.  Additionally, every week I see mortgage finance tighten and prgrams go away.

For some reason the markets think when we ‘come out of this’ everyone will open their eyes and it will be 2005 again. I think in a year or three when the global financial markets actually stabilize that most of us will not recogize it because it will be so much different than most of us have ever seen in our lifetimes. -Best, Mr Mortgage

Below is a great summary of the Verizon deal from one of my favorite new bloggers at Across the Curve:

November 3rd, 2008 3:35 pm

…10 year bond and a 30 year bond by Verizon. That very large telecom company with a reasonably pristine reputation issued 10 year notes and 30 year notes 4 7/8 percent above benchmark Treasury debt. The bonds carry 8 7/8 coupons in 10 years and 8.95 in 30 years. Each came 50 basis points to 60 basis points cheap to outstanding VZ debt.

I have asked this question before. If VZ has to pay nearly 9.00 percent to raise capital, what is the fate of a BBB industrial? I suspect they defer any attempts to raise funds. And for financials the world is so confused that for most the market is also closed.

So while the corporate market is manifesting some faint signs of improvement, a true rehabilitation is a distant prospect.

I would also offer the thought that if one can earn nearly 9.00 percent on a 10 year Verizon, why would anyone with a long term perspective charge into the equity.

Secondly, the MGM Subprime loan:

MGM MIRAGE Prices $750 Million in Senior Secured Notes

LAS VEGAS, Oct. 31 /PRNewswire-FirstCall/ — MGM MIRAGE (NYSE: MGM) announced today that it has priced a private offering of $750 million principal amount of 13% Senior Secured Notes due November 2013 at a price of 93.132%. The transaction is expected to close on November 14, 2008. The notes will rank as general senior obligations of MGM MIRAGE, will be guaranteed by substantially all of MGM MIRAGE subsidiaries, and will have a first priority security interest in the Company’s New York — New York Hotel & Casino.

Lastly, the Fed’s Senior Loan Officer Survey was released yesterday and showed severe contraction across the majority of lenders at the ‘Prime’ level. This is something that cannot be turned on a dime. The effects of this lending freeze even if banks started lending at a 2006 pace today would be felt for some time into the future:

From Mortgage News Daily – Nov 3rd, 2008

U.S. banks tightened lending standards for businesses at a record pace in the third quarter, according to the Federal Reserve’s July Senior Loan Officer Opinion Survey on Bank Lending Practices.

In the three months ending in October, a record 85% of banks tightened lending standards to businesses, up from 60% in July.

The survey showed 84.6% of firms with annual sales of $50 million or more raising standards and 14.5% indicating “considerable” tightening.

“What I fear is a sharp contraction in willingness to lend. That would suggest we’re now cutting into the muscles and bones,” said T.J. Marta, fixed income strategist at RBC Capital Markets, prior to the report’s release.

Demand was a key issue in the report with about half the banks surveyed reporting weaker demand for prime mortgages and less demand for commercial loans.

The survey showed that 70% of domestic banks raised standards for prime mortgages in the quarter after 75% reported doing the same in the previous quarter.

In the seven categories on willingness to lend and collateral requirements, none of the 55 banks surveyed reported easing standards. The top reasons for tighter standards were the uncertain economic outlook and reduced tolerance for risk.

The problems appear to be hitting the large banks hardest.

“Responses differed somewhat by bank size, with about 80 percent of the largest banks, but only 55 percent of the smaller banks, reporting tighter standards for prime borrowers,” the Fed said.

By Adam Button and edited by Sarah Sussman
�CEP News Ltd. 2008

“On the call, the last several weeks have been challenging for the co and its customers. It has seen a freeze up in spending around the world. It is seeing trends in U.S. business it has never before seen.” In September, worldwide processed volume growth was high single digits on a single currency, with the U.S. in low single digits. Notice that Americans are cutting back on travel… Co continues to control expenses in this environment. Co has instituted a hiring cap, watching spending with suppliers and contracts…”

Even though my hope was that the Treasury would not actually go out and overpay for toxic mortgage assets on the tax payers dime because it would have been a disaster, that was what was sold to the American public as the primary solution.  Apparently, only the law makers really thought that $700 billion was enough to go out and overpay for all of those big bad securities then sell them at a profit years down the road when they magically become worth something.

Initially, we were all told that if Treasury bought all the big, bad mortgage assets from the banks it would promote lending once again across all sectors. Even as Treasury changed the plan to capital injections immediately after passage, they sold it as the necessary step to promote lending.  Maybe it will, but not for a long time.

As feared, the banks look to be using the money for what I would use the money for if I were CEO of a bank – to acquire distressed banks for pennies on the dollar for their foot print and deposits. I would also use the money to plug holes in my own balance sheet and baton down the hatches so I am around several years out when the skies clear. The last thing a responsible CEO would do is start aggressively lending during the largest asset revaluation and de-leveraging period in history. Who cares about returns and share price at this point, its all about survival.

There is no doubt that the country would be far better off with 1500 strong banks instead of 8500 insolvent banks.  But the tax payer funding bank merger and acquisition activity without deploying some percentage of the TARP money towards much needed commercial and consumer credit will start riots.

In Europe they have the same problems with their bailouts.  But they added protocol up front and are now threatening to get in there to shake things up unless they open the coffers.

The French state has threatened to seize control of the country’s banks and fore top staffers unless they do their part to stabilise the economy by stepping up lending to companies in need.

The Telegraph: French Threatens to seize banks; German bail-out escalate

“The banks have got to open up credit to business: they have the means to do it,” said prime minister Francois Fillon, accusing lenders of hoarding cash. “We don’t think the banks are stepping up to task as necessary. We can withdraw the credit that we have extended to them under the state’s contract with the banks, and that will put them in difficulty. At that moment the question arises whether we should take an equity stake, change their managers, and assume control over their strategy.”

In Germany, HSH Nordbank – 59pc owned by the city of Hamburg and state of Schleswig-Holstein – rattled the markets yesterday by revealing that it would need €30bn in guarantees from Berlin’s €500bn stabilisation fund. It warned that further sums may be need`ed to meet capital adequacy ratios in the future.