By Jonathan Weil
October 24, 2007
SourceOct. 24 (Bloomberg) -- The more Citigroup Inc. says about its structured investment vehicles, or SIVs, the more questionable the bank's accounting for them is beginning to look.
On Oct. 19, Citigroup issued a one-page fact sheet about the seven SIVs it sponsors, all of which it keeps off the balance sheet. Among other things, the largest U.S. bank said it ``has no contractual obligation to provide liquidity facilities or guarantees to any of the Citi-advised SIVs.''
Okay, so it has no explicit obligation. That begs the question: Does Citigroup have any implicit obligation to protect SIV investors from losses? Citigroup isn't saying. It's a crucial question. If Citigroup is implicitly obligated to absorb most of the SIVs' losses, then the SIVs already should be on Citigroup's balance sheet, under the accounting rules.
Many big investors piled into SIVs as a way to juice returns during the years of cheap, easy credit. The funds typically borrowed short and bought long, issuing short-term commercial paper and investing the proceeds in assets with durations stretching several years, including mortgage-backed securities.
The strategy yielded nice spreads as long as SIV debt- holders remained confident about the credit quality of the funds' assets. When credit markets began seizing up in the summer, it left many SIVs unable to roll over their commercial paper. That has fueled concerns SIVs may have to dump assets at fire-sale prices, taking the broader markets down with them.
Implicit Obligation
Citigroup, the world's largest SIV sponsor, holds no equity in its SIVs. The SIVs raised capital by issuing notes to investors who agreed to bear the risk of the funds' ``first losses.''
The company has its reputation on the line, though. Citigroup organized, pitched and manages the SIVs it sponsors, creating expectations it would stand behind the funds and protect their investors. Those investors include money-market funds that bought the SIVs' commercial paper and themselves may have implicit obligations to keep their net asset values from falling below $1 a share.
In a Sept. 5 report, Henry Tabe, managing director of Moody's Corp.'s SIV-ratings team, said the ``blow to a bank's reputation that may be occasioned by a failure of an SIV may be more than the bank can tolerate.''
``Even where the bank does not invest in the capital, the relationship with capital note investors may be such that it behooves the bank to avoid losses to capital note investors to protect that relationship,'' Tabe said. Citigroup says its SIVs have about $80 billion in assets. It hasn't disclosed the size of their liabilities.
By the Book
Citigroup officials declined to discuss the bank's accounting analysis. In a statement, Citigroup said it ``is confident that it has accounted for the SIVs it sponsors on behalf of investor clients properly and in thorough accordance with all applicable rules and regulations.''
In its 2006 annual report, Citigroup classified its SIVs as ``variable-interest entities,'' or VIEs. That means they are covered under a 2003 set of rules by the Financial Accounting Standards Board called FASB Interpretation No. 46(R), as well as a related 2005 FASB paper on ``implicit variable interests.''
Under the rules, if a company is obligated to absorb a majority of a VIE's expected losses, it is deemed the entity's ``primary beneficiary'' and must consolidate the entity on its balance sheet. Such obligations can be ``explicit or implicit.'' VIEs used to be called special-purpose entities. The FASB issued FIN 46(R) in response to their abuses by Enron Corp.
``FIN 46(R) requires a company and the auditors to understand all the arrangements in the structures, both explicit and implicit, and also understand the design and intent behind those structures,'' FASB Chairman Robert Herz says. ``And if there's a party at risk for a majority of the expected losses, then that party has to consolidate.''
Treasury Help
Companies also must periodically reconsider if a VIE's primary beneficiary has changed. So, implicit guarantees ``must be taken into consideration both at the inception of the VIE and at specific reconsideration events -- like the rollover of commercial paper in an SIV,'' FASB member Tom Linsmeier says.
``If a bank sponsor in deteriorating credit markets feels it is necessary in order to protect its reputation to provide an implicit guarantee of additional support to a VIE, and that additional support would make it the party that is expected to absorb the majority of losses, then the bank sponsor should be consolidating the VIE,'' Linsmeier says. Linsmeier and Herz declined to comment on Citigroup specifically.
It's also possible for a VIE to have no primary beneficiary. That seems to be part of the attraction for banks looking to pony up money for the Master Liquidity Enhancement Conduit that Citigroup is trying to organize, with help from the U.S. Treasury Department.
The megafund would shore up SIVs by buying their assets and preventing fire-sales. Because no one bank would be at risk for a majority of any losses, no bank would have to consolidate the fund, which is looking to raise $60 billion or more.
So, the proposed cure for Citigroup's off-balance-sheet SIVs is more off-balance-sheet accounting. There's no surer sign that Citigroup is worried about its potential SIV losses.
To contact the writer of this column: Jonathan Weil in Boulder, Colorado, at
jweil6@bloomberg.netLast Updated: October 24, 2007 00:13 EDT