Citadel recently purchased E*Trade's portfolio of mortgage assets at 27 cents on the dollar. Before we get to the details of the transaction itself, let's amuse ourselves with a few of last week's blog headlines:
Could Citadel's valuation of E*Trade's CDOs wipe out capital at three big banks? (blogging stocks)
The Citadel Discount: Armageddon Scenario For Three Banks (dealbreaker)
The mark to Citadel and go to hell meme is thus established, albeit weakly. Schadenfreude dribbles from the keyboards of these authors......"OK, 6 weeks ago we had never even heard of level 3 assets, but now we know that they all are way toxic. TOXIC I tell ya! You're all dooooomed!"Why are they simply analysing the ABS part of the deal? E*Trade's SEC filing for the overall transaction with Citadel and its affiliate Wingate (go on, brave it out) notes the following components:
- a 1.7bn Springing Lien Note purchase in 2 parts
- 30.7m stock purchase
- the ABS portfolio purchase
- an Equities & Options Order Handling Agreement (Citadel gets some of E Trade's dealflow)
This agreement certainly states that Citadel paid $800m for around $3bn notional of ABS. Though out there in the fog, CalculatedRisk, the anonymous yet immaculate surveyor of all things housing, provides interested parties with some meat on the bones of the portfolio. This allows us to see how daft the 27% argument is: $1.3bn of the ABS notional is "AA or better prime residential first lien" product. The $800m purchase price implies that even if everything else is worth zero, these prime assets are worth just 62% of face value. Of course that is bunk; if a 70% original LTV mortgage being amply serviced by a wealthy professional is worth 62% of face, it implies that his home is worth less than half the purchase price. Grow up. Prime mortgage ABSs are not toxic CDOs. The so-called marks "validated" by this purchase are utterly spurious.
What is considerably more likely is that the $800m is just a balancing figure that Citadel paid for the ABS assets for agreeing to execute the larger E*Trade recapitalisation. It probably suits them to have the implied PnL on this ABS portfolio safe from the rest of the transaction. For all we know, the portfolio might be worth $2bn or more (somehow I doubt Ken Griffin will tell you). If this were the case, Citadel could lose $1bn on its direct E*Trade investment, but still be up overall.
Analysing the whole E*Trade transaction for value certainly falls into the category of "highly non-trivial", as my french derivative quant friends would say, but I have a hunch who had the upper hand in the negotiations. Do we think that prime housing collateral is suddenly worth less than 50% of its purchase price? Or do we really think that Citadel saw the most scared kitten in the basket, gave it a friendly smile then stomped on it with very large boots?
Finally, as to investment banks marking level 3 assets to 27 cents on the dollar? What those doomsday scenarios signify is that their proponents have voids where their brains should be, even if they have the ability to press buttons on a calculator.
2 Comments:
There's an awful lot of smart people on Wall Street. Some of them still have capital to play with, even. Some of them took a good look at the E*Trade assets. Many of them had a vested interest in forestalling the very sort of mark-to-market event that now appears to have happened.
A hypothetical higher bid for the assets... who would make it, and why then did it not materialize? Did these newfangled "springing lien" notes seal the deal (never heard of them before, have you?)
There are those who argue that even non-subprime is seriously impaired. Maybe 62 cents for prime isn't off the mark after all?
You're suggesting that the low figure for the ABS assets was compensation "for agreeing to execute the larger E*Trade recapitalisation". But I thought their brokerage business had been doing just fine? So if the ABS assets were actually worth more, perhaps a recapitalization wouldn't have been necessary in the first place. Or in other words, the very fact that the recapitalization was necessary is in itself an indication that the ABS assets weren't worth more.
Crash course alumnus...thank you for posting that link to the other side of the story. Herb Greenberg's article, plus the vast number of comments make sanguine reading indeed, even if you assume away the likely bias of the commenters. Maybe there is something in my psyche preventing me from seeing prime at 62, or wholesale (non-localised) 50% declines in real estate. But I still wouldn't use this as an excuse to mark IB's level 3 assets to 27% and declare them insolvent.
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