More On SIVs: Citigroup's Purchase Its SIVs' Commercial Paper

Earlier this month, I wrote this post regarding SIV ownership. In that piece, I wrote,

"If a commercial bank, such as Citigroup, were to voluntarily offer to take back the commercial paper issued by an SIV which it created and operates, or simply absorb the SIV's balance sheet onto its own balance sheet, thus bringing it 'on balance sheet,' it could well be subject to lawsuits by some of its institutional investors.

By having structured SIVs as separate entities, companies like Citigroup specifically and legally sidestepped ownership of liabilities connected with the SIVs. To now assume those liabilities, which might default if left alone on an SIV's balance sheet, would be effectively assume an obligation with no adequate offsetting benefit."

However, in today's Wall Street Journal, Citi is reported to have purchased $25B of its SIVs' commercial paper over the summer, in addition to $18B that it already held. This comes to a total of $43B of short-term SIV debt that Citigroup now holds to finance a reported $84B of CDOs in the SIVs.

To be honest, I hadn't thought about this particular scenario. It seems to me that by purchasing the debt of its own arms-length SIV, Citigroup is demonstrating, de facto, if not de jure, that it considers itself the ultimate owner of the SIV.

For example, if Citi had let the commercial paper go unsold, it probably would have triggered the default of the SIV, wiping out the equity-like 'senior note holders,' and dumping the CDO assets of the SIV onto the market.

But Citigroup's purchase of SIV debt begs the question,

"At what price did Citigroup buy the paper, and on what valuation assumptions?"

If Citi bought the commercial paper with the assumption that the assets were fully, and correctly, valued on the SIVs' books, then it perhaps overpaid, given the true risk of the vehicle, and its assets.

If Citi had been less involved, and more hard-nosed, might it not have paid less for, and demanded higher returns on the commercial paper? Of course, that would have necessitated a write-down or sale of some of the SIVs' CDOs, in order to preserve equality of assets and liabilities for the structured vehicles.

Granted, Citi has cleverly sidestepped legal actions which could be brought by its own shareholders for taking the SIVs onto its balance sheet, after having claimed them to be separate for so long.

However, as the Journal article details, there is now a debate over whether Citi's purchase of commercial paper from its own SIVs constitutes a "reconsideration event."

The term refers to conditions under which accounting determinations may be reversed, or changed, to reflect subsequent actions that change ownership of assets.

Citigroup claims its original SIV covenants, which obliged it to fund the vehicles by buying commercial paper which was unsalable in financial markets, obviates any reconsideration event.

However, other observers maintain that, as Citigroup's ownership of debt of the SIVs climbs, it effectively does own the vehicles, and, indirectly, the assets.

But, let's step outside the arcane world of interpreting accounting rules, and consider a common sense perspective.

If the SIV had been unable to roll over its commercial paper in the market at large, it could have attempted to sell some of its CDO assets to pay off the existing holders.

What if Citi had simply negotiated to buy said CDOs in a direct transaction? Whatever valuation it placed on the CDOs would be, of course crucial. If the SIV offered the CDOs and attracted no bids, or very low bids, and Citi stepped in with a higher bid, that would obviously constitute a bailout by the bank of the SIV.

It also would have been one way that Citi could effectively begin to bring the CDOs onto its own balance sheet, without technically repossessing the entire SIV.

But look at what we are describing. Whether Citi buys the SIVs' commercial paper, to prevent the SIVs from liquidating their CDO assets and becoming insolvent, or buys the SIVs' CDOs, in order to let the SIVs pay off their creditors and shrink their balance sheets, Citigroup is clearly giving their own SIVs special treatment.

Would they be doing this for, say, the SIV of another bank? Unlikely.

So just by Citigroup's own actions, especially if mandated by the SIVs' agreements that Citi buy any otherwise-unsold commercial paper, the bank pretty clearly behaves as if it owns the SIVs, and/or their assets and liabilities.

If you were to consider buying Citigroup stock, in light of this information, you'd be foolish not to assume Citi effectively owns the SIVs which it manages.

Despite the legal and accounting legerdemain, Citigroup's actions tell you all you need to know about who really owns its SIVs.

Contrary to what I believed in my prior posts, I would say, at least for Citigroup's SIVs, because of the new (to me) information regarding its requirement to supply commercial paper funding to its SIVs, that the bank owns those SIVs.