The MasterBlog: Credit Mess (cont): The $25bn Citi CDO liquidity put - and who else has one and All hail the return of mezz
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Friday, November 23, 2007

Credit Mess (cont): The $25bn Citi CDO liquidity put - and who else has one and All hail the return of mezz

A post from the FT on the credit mess and on the return of opportunities in the mezzanine market as companies struggle to stay afloat

The $25bn Citi CDO liquidity put - and who else has one

Doing the rounds is talk of a CDO "liquidity put" that has troubled Citi with billions in extra subprime exposure.
Speculation about the "liquidity put" kicked-off after an interview with Citi president Robert Rubin in Fortune magazine last week. Fortune recounts:
Citi started then to have ominous dealings with CDOs that carried a "liquidity put." Never heard of a liquidity put? Google will give you a few uninformative references. But it is testimony to the obscurity of this term that Rubin says he had never heard of liquidity puts until they started harassing Citi last summer.
Peter Cohan at BloggingStocks picked up and promptly made it a lead. Felix Salmon also has some questions. Firstly, why hasn't this got more coverage? And secondly, who else has these "liquidity puts"? Brad de Long wants answers too.
FT Alphaville noted Citi's massive growth in CDO exposure - bizarrely through the commercial paper market - when the bank reported its Q3s. You can read all the detail here, but in a nutshell, this is the mystery "liquidity put".
Back in early November, we didn't know them as "liquidity puts" - just "agreements" in the structuring of Citi's CDO deals.
Here's the deal:
Several CDOs were created by Citi in 2005 that borrowed from technology used in designing SIVs- another market in which Citi was a leader. The rationale was that a CDO which could issue short-term commercial debt (alongside its traditional issuance) would have access to a broader funding market and would be able to more dynamically manage its funding portfolio. To mitigate any CP rollover risk, Citi entered into a series of "agreements" which forced it to buy the CDO CP if no one else would. As Mr Rubin calls them, "liquidity puts".
And those CDO commercial paper "liquidity puts" forced a staggering $25bn increase in Citi's CDO exposure - at a time when the market was falling apart. Like Salmon, we're bemused as to why that notion hasn't been more widely reported.
And it may not just be a Citi problem.
It seems that Bank of America had similarly structured CDO deals in place. In their 10Q, viewable here, there's an admission that:
The Corporation is obligated under the written put options to provide funding to the CDOs by purchasing the commercial paper at predetermined contractual yields…
And as we understand things, those obligations forced BofA to buy $12bn of CDO CP from off balance sheet CDOs.

All hail the return of mezz

Being the piggy-in-the-middle can be uncomfortable, and hard work - but may also in the event prove rewarding.
So it seems for Intermediate Capital. The mezzanine specialist on Friday expressed the rare sentiment that credit market turmoil was looking very good for business.
John Manser, chairman, said, as he reported pre-tax profit up 33 per cent for the six months to September, that the credit ructions had generated "considerable opportunities" for mezz specialists such as ICG. Indeed, he added, the group's growth prospects have "materially improved" as a result. That's not a boast many companies will be making over the coming year.
Lex this week noted that the re-emergence of mezz financing is another sure sign that the credit party is over. Ranked between senior debt and equity, but often with some equity-like characteristics, mezz found itself out of favour in the liquidity heyday as investors instead opted for cheaper instruments, such as second lien debt and PIK notes.
And the "dramatic reversal" of trends seen in the first half of this year, say ICG, is only just beginning. The credit bubble has burst and "the world in which covenant lite, and indeed due diligence lite, had become the norm, has now changed and is unlikely to re-emerge in the foreseeable future."
Before July, banks and investment banks had been arranging and underwriting increasing amounts of debt for onward distribution to the institutional investors with, we thought, poor structures and no margin for safety. These banks, have found themselves left with many hundreds of millions of dollars and euros worth of risky debt. This, added to the warehouses they were building for CDO investors and the Structured Investment Vehicles (SIV), which they have now had to absorb on balance sheet or finance, has used up a massive amount of bank capacity and will limit activity in LBO markets in both Europe and North America.
ICG will need that activity to pick back up before they can cash in, though the group adds that they expect the deal flow in Asia-Pacific - which was largely isolated from the credit market excesses - to continue strongly.
The mezz providers won't have it all their own way, noted Lex. Deals reamin stuck in the €250m to €500m bracket and are taking much longer to put together. And as the deals get bigger, sponsors, having primed investors to expect lower returns, may opt to pump in more equity than pay up for mezz.
But hey - at least someone's found a silver lining. There's a distinct whiff of satisfaction around the statement, which notes that ICG warned that we were all in bubble territory back at their results in June.
In other words, we TOLD you so.

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