CDO expert comments on Citi’s report

Below is an e-mail I received from a friend who was manufacturing CDOs for a big bank until very recently. The guy knows his stuff and offered the following thoughts. To follow his thinking, you might want to open up the image in another window and toggle between that and his analysis.

My question to him was whether bigger writedowns are still to come from Citi and other banks. You’ll notice he comments about the havoc that will be caused if the “monolines” go under. Monolines are the insurers that back risky mortgage bonds, MBIA and Ambac. Take a look at their stock prices recently.

-RW

disclosure is very uneven. Really, the market wants each company’s full inventory out there. But companies won’t put that out for the same reason they won’t list all the stock positions they have on each desk- it puts them at a comparative disadvantage when they try to take on or put off risk. True, since EVERYONE KNOWS all the banks are trying to throw risk off, it probably matters less if they do this, but I think that the banks know that as soon as they disclose specific deals, the press will start picking apart the worst of them on front pages. Lots of banks have deals that Ralph Cioffi or Chris Ricciardi or someone else at risk of being in a high-profile lawsuit were in, and if they disclose these, they’ll be linked with those guys, even if they just bought the positions in the secondary market.

for fun, I looked at Citi’s 8K today: here are the money lines:

1) Write-downs of $17.4 billion, on sub-prime related direct exposures. These exposures on September 30, 2007 were comprised of approximately $11.7 billion of gross lending and structuring exposures and approximately $42.9 billion of net ABS CDO super senior exposures (ABS CDO super senior gross exposures of $53.4 billion). On December 31, 2007, sub-prime related direct exposures were comprised of approximately $8.0 billion of gross lending and structuring exposures and approximately $29.3 billion of net ABS CDO super senior exposures (ABS CDO super senior gross exposures of $39.8 billion). See detail in Schedule B on page 12.

Schedule B (if the image below doesn’t appear, try hitting refresh. If it still doesn’t work, go to sec.gov and pull up Citi’s most recent 8-K filing):

So what I see from this: it’s hard to know exactly how severe the writedowns are, because it is not clear that the assets were being held at par to start with. I’d say that given the breakdown of product types and assuming the the price of the mezzanines was already written down some, the numbers look like reasonable writedowns from what I remember. But you’ll see the ‘hedged exposure’ of 10.5B is treated solidly with a reserve of less than 1B: I imagine that is almost all held against monolines, and I would expect that the bonds they are written on are all crap, since Citi sold most of the better stuff’s Supersenior on the ABCP market. If the monolines go bad, I think you can expect at least another 5B of writedowns in CDOs alone, maybe more.

Furthermore, I’d imagine that the real impact of the monoline downgrades is in the muni and corporate bond markets, because those are their main businesses. No one is really looking there now. The banks won’t be the main people hurt there, but I wouldn’t even know how to quantify the loss of value. would be tremendous.

Anyways: favorite line from this chart: unsold ABS tranches: previously worth $2.7B, writedown of $2.6B, now worth $0.1B. Wow.

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