Prince resigns as Citi struggles

Charles Prince, CEO of US biggest bank Citi, resigned from his position as chairman and CEO on Sunday taking the responsibility for the business. He has been CEO of Citigroup for past four years. He has been replaced by Sir Win Bischof as interim CEO and Robert Rubin as chairman of Citi.

Managing an organization of the size of Citi is a very challenging task and Mr. Prince had worked hard to bring all the units of Citi under one umbrella. In the recent past Citigroup has done many mergers and acquisitions. In 1998 it has acquired of Salomon Inc., the successor of Salomon Brothers, the Investment bank which started the Mortgage Based Security (MBO).

Owing to the subprime crisis the rating agencies have downgraded many Collateralized Debt Obligations (CDO) and their mortgage securities. Because of this the valuations of these CDOs have fallen significantly and has impacted almost all banks which had exposure to mortgage based securities. In continuation to its earlier writedowns Citigroup Inc. has recently announced that its sub-prime writedowns may increase further to about $8b - $11b. Citi's total assets are about $2.3 trillion and is the world's largest bank by assets. Citi owns about $55b of subprime mortgage.

According to an estimate the total subprime mortgage based securities outstanding may be more than a trillion dollars.

About Citi:
200 million customer
100 countries
Domain: Consumer banking and credit, Investment banking, Securities brokerage, and Wealth management
Major Brands: Citibank, CitiFinancial, Primerica, Smith Barney, & Banamex

Merrill Lynch posts record losses in 93 years

The largest US brokerage Merrill Lynch had suffered worst quarter since its inception year 1914. The write-downs across CDOs and U.S. subprime mortgages were close to $7.9 billion. Earlier it had reported that this to be close to $4.5 billion. The net loss for the third quarter was $2.24 billion. Merrill's chief executive Stan O' Neal is under heavy pressure from board of directors over the handling of the crisis and is likely to resign.

This loss has made Merrill Lynch the biggest setback of the sub-prime crisis. Its losses were more than the combined losses of the rest of the US brokerage. Earlier Bear Stearns had to close two of its hedge funds and suffer $1.5 billion loss.

Merrill Lynch's reported a total net revenues of $577 million in the third quarter of 2007 which was down 94 percent from $9664 million in the second quarter of 2007 and $9833 million in the third quarter of 2006.

"Mortgage and leveraged finance-related write-downs in our FICC business depressed our financial performance for the quarter. In light of difficult credit markets and additional analysis by management during our quarter-end closing process, we re-examined our remaining CDO positions with more conservative assumptions. The result is a larger write-down of these assets than initially anticipated," said Stan O'Neal, chairman and chief executive officer. "We expect market conditions for subprime mortgage-related assets to continue to be uncertain and we are working to resolve the remaining impact from our positions," Mr. O'Neal continued. "Away from the mortgage-related areas, we continue to believe that secular trends in the global economy are favorable and that our businesses can perform well, as they have all year."

Source :Merrill Lynch Press Release

Securitization

This article tries to explain what is securitization. Lets consider what a bank does? A bank gives loans to its borrowers. If it is a small bank we call it as a sub originator and this small bank transfers these loan to a bigger bank which is called as originator. Now, this originator can sell off this loans to a trust and get money. And this trust sells of these loans in form of bonds to various bond holders

Now this trust collects money from the bondholders and gives it to Originator. And now this originator can lend of this money to more borrowers. Selling off the loans to a trust is known as Securitization.

Sub-prime crisis - Origin and Impact

The origins of this crisis can be traced from late 1990s, when the dotcom bubble started. After the crash of the dotcom bubble in 2000s most of the countries including US were facing economic recession. Interest rates were low during these periods and lending standards were not good. This led to the rise of another bubble in 2001 in the form of real estate. The prices of the real estate property sky rocketed during this period. There was a rat-race for buying houses and people were taking loans as it was very cheaply and easily available. Lending agencies used innovative products to attract customers. During 2004 through 2006, concepts like ‘teaser rates’ became popular in mortgages. These teaser rates (initial low interest rate) applied through varied time period, ranging from few months to couple of years depending on the mortgage creditworthiness. The thing which the borrowers forgot was that at the end of this freedom period the rates can rise rapidly, raising the minimum instalment to be paid out of their capacity. During this period lenders were so confident that they qualified borrowers only by their ability to pay the teaser rates.

One may trace the sub-prime crisis to the securitization – conversion of home mortgages into bonds. The man behind securitization was an Investment Banker of 'Salomon Brothers' - Lewis S. Ranieri. In 1980s Salomon launched Mortgage-Based Securities (MBS) – bonds with bundles of mortgages, bought from bank lenders, as collateral. For this, Salomon used a special purpose vehicle known as Collateralized Mortgage Obligation (CMO). Monthly instalment was used to pay the interest on these bonds. We will discuss about securitization separately.

Securitization had some negative implications on the mortgage standards. Since anyone can originate a loan and sell it to the Investments Banks, which package them and sell them as MBS, it lead to originators writing risky loans as they need not worry about the payback of loan. This problem was dealt by slicing MBS into tranches on the basis of the risk profile. These tranches which may have different maturity period were given ratings by credit rating agencies like S&P and Fitch. The most risky tranches were difficult to sell except for the hedge funds and some pension funds. These hedge funds were so eager to buy these securities that they didn’t care about the huge impending risk associated with these tranches and continued to invest in them.

With the collapse of the housing bubble in mid 2005 real property price declined so much that many owners holding became negative equity, mortgage debt became higher than the value of the property. During the housing bubble, many property owners used their property as collateral to raise money for consumer spending. With the crash of housing markets these lenders faced huge defaulter problem and were unable to recover their losses.

Aggravating the issue was the rising interest rates, coupled with the maturity of the freedom period of teaser rates, which increased the monthly payments. Many house owners felt incapable of meeting their financial liabilities and went bankrupt. Amongst the institutional players affected were the sub-prime lenders, banks, housing developers, and investors like hedge funds and pension funds. The impact was not limited only to US, as UK’s leading subprime lender Northern Rock sought bankruptcy protection.