Tuesday, April 26, 2011

Morning Call: Regulatory Arbitrage of the Day, Citigroup Edition

http://seekingalpha.com/article/264234-regulatory-arbitrage-of-the-day-citigroup-edition

During our morning calls we spend time analyzing a certain headline and dissecting it.  We addressed the following questions today to the article mentioned above:


Questions:

1. Briefly discuss what "Regulatory Arbitrage" in the title of this article means.
2. Briefly describe the background of Citi Holdings under Citigroup. Make sure you mention about the composite of its assets besides of other information.
3. What's the difference between the previous price on bond when Citigroup pumped those assets into Citi Holding and today's price on those assets?
4. Why does Citigroup have to explain the action to regulators?
5. Why avoiding higher capital requirements of BASEL III could be the reason for Citigroup to persuade regulators to let them take the action? Shouldn't regulators be glad to see tougher rules implemented in today's situation?
6. Like the article says, "the asset itself hasn't changed", so what has changed besides the bond price that made Citigroup the do this?
7. Do you think the bond price will go down in short-term (say 3 month)? Why?
 
A very brief outline of what each of us stated to the questions above is listed below.  This certainly isn't the complete description of our call:
 
1. Briefly discuss what "Regulatory Arbitrage" in the title of this article means.

Different from arbitraging from the price difference on option or commodities, the arbitrage here means that Citigroup is able to play with the numbers on its balance sheet by reclassifying some of its bad assets that was separated out as part of Citi Holdings.

The way it would do this is to move the original available-for-sale securities, whose prices were required to mark to market, to held-to-maturity in order to avoid price marked down. Now when it sees the prices came up and possibly exceeding the price in 2008, it wants to mark the price up again.  



2. Briefly describe the background of Citi Holdings under Citigroup. Make sure you mention about the composite of its assets besides of other information.

According to its 10-K, Citigroup currently operates via two primary business segments: Citicorp, consisting of Citi’s Regional Consumer Banking businesses and Institutional Clients Group; and Citi Holdings, made up of Citi’s Brokerage and Asset Management, Local Consumer Lending businesses, and a Special Asset Pool. Citi Holdings contains businesses and portfolios of assets that Citigroup has determined are not central to its core businesses.

Brokerage and Asset Management (BAM), which constituted approximately 8% of Citi Holdings by assets as of December 31, 2010, consists of Citi’s global retail brokerage and asset management businesses.

Local Consumer Lending (LCL), which constituted approximately 70% of Citi Holdings by assets as of December 31, 2010, includes a portion of Citigroup’s North American mortgage business, retail partner cards, Western European cards and retail banking, CitiFinancial North America and other local Consumer finance businesses globally. At December 31, 2010, LCL had $252 billion of assets ($226 billion in North America). Approximately $129 billion of assets in LCL consisted of U.S. mortgages.

Special Asset Pool (SAP), which constituted approximately 22% of Citi Holdings by assets as of December 31, 2010, is a portfolio of securities, loans and other assets that Citigroup intends to actively reduce over time through asset sales and portfolio run-off.

http://www.citigroup.com/citi/press/2009/090116b.htm

3. What's the difference between the previous price on bond when Citigroup pumped those assets into Citi Holding and today's price on those assets?

Before the bond prices fell so in order to show a profit, citi decided to hold them till maturity which meant they can record their value at par = $12.7billion. Later, the prices increased so Citi decided to hold them for sale(which also meant lower capital requirements) and the value of the same assets fell by a net of $946 million Gain - $1.7 billion losses = $754 million.
Hence, the assets decreased from 12.7 billion to 11.946 billion dollars in value!

4. Why does Citigroup have to explain the action to regulators?  

Banks can’t just oscillate back and forth between classifying assets. That defeats the whole point of classing assets as being held to maturity in the first place.

Citi cited the new Basel III requirements as the fundamental change which gave an excuse to switch classification. Basically, Citi need to explain to regulators because the capital requirements on these held-to-maturity assets were rather onerous and reclassification was requested to enable itself hold as much capital.

7. Do you think the bond price will go down in short-term (say 3 month)? Why?

Three months is a very short period to forcast or predict movements in the bond prices. However, bond prices tend to change when interest rate changes and they have a anverse relationship. The current level if interest rate is close to zero and it is more likely to stay this way for the upcoming three months resulting in bond prices not being changing due to interest rate change. Meanwhile, the market value of the bond prices could also change due to change in the economic condition or the credit rating of a prticular company such as higher credit default swaps. All of these factors are not likely to change within the upcoming three months. 

No comments:

Post a Comment