The Citadel Purchase: Spinning It As A Floor

Posted by John Carney, Dec 04, 2007, 11:29am

It took a few days but the deep discount Citadel got when it picked up E*Trade's CDO portfolio is now being spun as a hopeful sign. How does getting 27 cents on the dollar become a sign of hope? Here's how it works: you describe it as a "floor" and claim it shows that buyers are returning to the market.

Yesterday's Heard On The Street column in the Wall Street Journal took exactly this tact. "While seemingly low, the Citadel price might emerge as something of a market floor, at least for some of the investments involved. It also might signal that some investors are now willing to step in and make a market for these stalled securities," the HOTSpurs wrote.

When we raised the possibility that Citadel's purchase might be a major mark-to-market event we were barraged with critical emails and comments. According to our critics, the information about the types of CDOs purchased by Citadel was too vague to force other CDO holders to revisit their CDO evaluations. What's more, they told us, CDOs were too heterogeneous of an asset class for the sale of one mixed bag portfolio to provide any market price indicators for other CDOs.

The Journal nicely summed this point of view yesterday, writing that "On its own, the Citadel investment might not be much of a guide for deciding how much other firms' debt portfolios are worth, some investors warned. That is because the kinds of debt securities included in such a portfolio aren't always standardized and so may not be directly comparable to holdings at other firms."

Maybe we're missing something but we don't understand how both these things can be true. If the debt securities Citadel picked up are too non-standardized to provide downside price guidance, how can the purchase indicate a floor? In our simple view of things, the 27 cents on the dollar either tells us something or it doesn't. But we don't get how it provides re-assurance without giving mark-to-market price signals. This seems like more wishful thinking than actual analysis.

But then again, wishful thinking seems to be the dominant strategy of many CDO holders on Wall Street these days. So perhaps we should be surprised.

A CDO Floor of 27 Cents on the Dollar? [Wall Street Journal]

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Comments

Posted by Anonymosity, Dec 04, 2007 11:41AM

Mike's Hard Lemonade. The perfect hedge against subprime CDO exposure.

Posted by , Dec 04, 2007 11:46AM

whoever was first to make a purchase in the distressed credit area is automatically discounted as a one-off or whatever the banking industry decides to tell us until the next sale occurs that will basically make that one look like a great deal.......for ETFC.

banks ALWAYS tell us we're wrong because they can. Wait until about March of next year when .27 looks like a great price for the seller...

Seriously these are the same people (those who scoff at the price action of the deal) who said that it's all contained and were all "surprised" when home values did not continue the trajectory to the moon. They were also surprised that a 10% drop in home values could wipe out an entire hedge fund or two. Funny how leveraging a bad loan 20x has that sort of repercussions on an industry that is based on lying and deceiving the latest batch of money (i.e. Ponzi).

Good luck trying to spin the next sals as a "non-observable input"...

Posted by Dick, Dec 04, 2007 11:53AM

opinions are like assholes...You are right in your observation and I can't believe that anyone in the Markets doesn't see a price setting event. It's not like this is the pricing for the next 10 years, but a spot price...

Posted by WDE, Dec 04, 2007 12:03PM

The thing that's different in each of these securities is the underlying collateral. So, theoretically, this $0.27 on the buck shouldn't signify any sort of standard pricing level.

However, the one thing that is consistent in relation to all of these securities is that everyone who is long, doesn't have a clue what they're holding. And while you can accept the fact that all the underlying collateral is different, until somebody differentiate between a poor quality CDO and a high quality one based upon what's in it (because the rating agencies obviously f'ed that one up royally), I'm willing to accept $0.27 on the buck as not only a spot price, but also a floor, for a discussion point. However, if the next sale goes off at $0.21, the shift will be made.

Posted by , Dec 04, 2007 12:17PM

12:03 An even more important differentiator is the seniority within a given CDO of the claim on the payment stream from the underlying mortgages. The value of the CDO is very much dependent on how that payment stream has been sliced and allocated among CDOs. But you all (I hope) knew that.

Posted by , Dec 04, 2007 12:29PM

They are all different in a lot of aspects.

It's a like a used piece of shit car sold for $1000, and now you think every used car is a piece of shit worth somewhere around $1000.

There probably needs to be a lot more write downs. And this trade gives us insight into that, nothing more.
Furthermore, no way does it put a floor on anything. There are bigger 'pieces of shit used cars' out there that are worthless.

Posted by LowlyLawyer, Dec 04, 2007 12:30PM

If you can accept it as a floor, wouldn't the converse also be possible that it is a ceiling? If we know anything about CDOs it's that we have no clue what's in them or what their actual value is. I find it hard to believe that Sentinel just happens to employ the only people on Earth that can determine their actual value and negotiated the absolute minimum price they could pay because no one else has a clue.

I have to agree, if we all admit that we have no clue what is actually contained in any given CDO, or what it's underlying value is, then how can we determine this is a floor. Did it just so happen that the ETFC securities happened to be the worst CDO on the planet? I find it hard to believe ...

If you're going to use it as a standard for anything (i.e. a price floor on CDOs) ...

Posted by LowlyLawyer, Dec 04, 2007 12:36PM

I just realized I used "Sentinel" instead of "Citadel." Sorry for the stupidity, I need more sleep.

Posted by Mort Glickman, Dec 04, 2007 12:42PM

0 cents on the dollar is the floor..

Posted by Anominous, Dec 04, 2007 1:27PM

11:53 is right about it being a spot price.

One of the keys to understanding this mess is that the value of these securities depends on the future path of home prices. Once they started turning down, it became impossible to value/price RMBS and derived CDOs because we are in an unprecedented boom/bust scenario and no one knows what the future path of home prices is. True price discovery is impossible until we have clearly bottomed. Which is why I think we need a bail-out a la the Resolution Trust Co.

And, if we go down 30%+ as some predict, I suspect Citadel will not have gotten the bargain it thinks it has.

Posted by Anominous, Dec 04, 2007 1:32PM

11:53 is right about it being a spot price.

One of the keys to understanding this mess is that the value of these securities depends on the future path of home prices. Once they started turning down, it became impossible to value/price RMBS and derived CDOs because we are in an unprecedented boom/bust scenario and no one knows what the future path of home prices is. True price discovery is impossible until we have clearly bottomed. Which is why I think we need a bail-out a la the Resolution Trust Co.

And, if we go down 30%+ as some predict, I suspect Citadel will not have gotten the bargain it thinks it has.

Posted by just me, Dec 04, 2007 3:22PM

All these pompus assholes who argue endlessly what a mortgage is worth, what a piece of real estate is worth, will get a huge dildo in their butts once they see the value of their own co-ops falling. There are more co-ops going into foreclosure on the East Side than you think. A banker called me last week asking if i was interested in taking over a 400,000 mortgage on a building in the east 70s. If thats not a wakeup call, I dont know it is.

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