"Though few investors realize it, banks such as Citigroup Inc. could find themselves burdened by affiliated investment vehicles that issue tens of billions of dollars in short-term debt known as commercial paper," the Wall Street Journal reports. The vehicles, known as conduits and SIVs, need not appear on a bank's balance sheet due to U.S. accounting laws, and may create an uncharted source of risk. Citigroup controls 25% of the SIV market, the Journal says; its holdings are nearly $100 billion. Citigroup's Centauri Corp. owns $21 billion in debt, yet is not mentioned in its 2006 annual filing. Conduits and SIVs are usually high-rated, short-term debt that offers a higher-yielding alternative to government debt. So far there have not been any reported problems at Citigroup: "Quite simply, portfolio quality is extremely high and we have no credit concerns about any of the constituent assets," Citi directors Paul Stephens and Richard Burrows said in a recent letter. However, there have been issuers who were not able to find buyers for their commercial paper. Banks that have stakes in the conduits provide "liquidity back-stops" -- a promise that the vehicles' IOUs will be paid when they come due if they can't be resold. The banks would not want to consolidate the vehicles because their balance sheet would balloon, which could hamper lending. Allowing conduits or SIVs to fail could decimate a bank's reputation. Due to a lack of investor interest in commercial paper, banks may be forced to lend conduits money, or take substantial losses. In Europe, similar vehicles have already run into trouble; UK bank HBOS was forced to lend to a SIV it partly owns.
Sources: Wall Street Journal, MarketWatch
Commentary: Modeling Forward Defaults: Top Five US Banks • Commercial Paper Slump Deepens, T-Bill Yields Fall - Seeking Alpha
Stocks/ETFs to watch: NYSE:C. Competitors: MER, BSC, GS. ETFs: IAI, PKW
Earnings call transcript: Citigroup Q2 2007
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