Citi: Financial Reverse Engineering

What do you have when the smartest guys in the room engineer a financial product so complex that it blows up? Even smarter guys that pick through the rubble and steal the diamonds. Genius creates alchemy and alchemy creates genius.

Bloomberg’s “Citigroup Aims to Stop TPG Fund From Stripping CDO” reports the tables have once again turned on Citigroup (C) under the law of unintended consequences. Citigroup has already written down roughly $118B in CDO losses according to Bloomberg’s calculations. Now TPG Credit, separate but associated with private equity firm TPG, has dived deep into the esoteric trust structures to cherry-pick some of the best CDO assets from the invalids.

TPG Credit has offered the preferred equity holders of Tropic CDO V and six other CDOs half of their original purchase for a consent agreement to sell specific bank trust preferreds at 5¢ on the dollar. Pay the CDO equity holders $23.5M for the right to buy $470.8M bank trust preferreds for $23.5M, total of 10¢ on the dollar. The CDO preferred equity holders are the first to take losses, so they are given the privilege of choosing which assets and when to sell.

Enough bank preferreds within the CDO have defaulted so that CDO equity holders have stopped receiving income and will soon be wiped out. At the same time higher tranche CDO note holders have seen the market value of their securities double in value recently. Citigroup claims that if the highest quality bank preferreds are sold, CDO equity holders will unfairly benefit at the expense of the highest level tranches (note holders).

I congratulate TPG Credit. CDOs were created with conflicting interest, giving each layer of capital risks and privileges. A purchaser of any tranche should be aware of the privileges or rights of all others in the capital structure. This is why retail investors should be far removed from any structured financial products.

Disclosure: Author is long C.

Comments

[al s:]

What is the exposure that C faces from TPG credit and how easily can this be replicated for C's big bag of CDOs.

Do you know how to say BLOOD BATH?

Oct 28 05:01 PM

[Fourpenny Guy:]

Citi is gradually being wound down and eviscerated as well...through selling profits, to losing personnel, pay, issuing shares, etc. Citi is done, and is not worth 97 billion....more like 15, or 90 cents based on pre-share issuance valuations....If they lose Bannamex, god help them. I say, the world is better off without Citi.

Oct 28 11:28 PM