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The Bank-Loan Haircut

April 10, 2008
The Wall Street Journal


Banks, taking advantage of slightly improving debt markets, are shedding some of the risky loans and securities that have caused them so much trouble in recent months -- even if that means taking a big "haircut" on the price.

But it could be harder to move hundreds of billions of dollars more.

Citigroup Inc.'s move this week to sell $12 billion of leveraged loans and bonds to private-equity firms is a step toward relieving a problem facing banks and the broader economy: With the "securitization" markets that have allowed them to package and sell loans all but shut, banks have a large amount of corporate, mortgage and other loans that they never intended to hold.

That eats into the capital cushions they maintain against unexpected losses, and leaves them with little capacity to make new loans -- a problem that is starving even well-qualified borrowers of the money they need to buy cars, homes and even companies. Citigroup is in talks to sell the debt at just below 90 cents on the dollar.

Another factor that could breathe some life into the long-dormant market for risky corporate loans is the Federal Reserve. As part of its wide-ranging efforts to make cash more readily available in the financial system, the Federal Reserve Bank of New York recently created new lending facilities for Wall Street firms. The Fed has been accepting some "investment-grade" securities backed by hard-to-sell debt as collateral for loans.

As a result, some banks are moving to bundle risky corporate loans into instruments known as collateralized loan obligations for use with the Fed. Last month, $13.4 billion in CLOs were created, Morgan Stanley said in a report Wednesday. It isn't clear how much the Fed has taken on. A Fed spokesman declined to comment on its collateral arrangements.

As banks seek ways to get rid of the unwanted loans, they are raising hopes that the credit crunch won't continue with the same ferocity much longer.

"These small psychological steps bring confidence back into the market and bring value back," says Chip MacDonald, a partner with law firm Jones Day who specializes in banking.

Ratings company Standard & Poor's said Wednesday that a completed sale of the Citigroup loans would signal that stress in the credit markets is decreasing, and possibly free up Citigroup's balance sheet to make more new loans. In Switzerland, UBS AG has formed a so-called workout group to move troubled mortgage investments off its books. On Wednesday, investment bank Goldman Sachs Group Inc. sold $500 million of Chrysler Automotive debt left over from that company's sale to a private-equity firm last summer, according to a person familiar with the matter.

A Citigroup spokesman declined to comment. The buyers of the bank's $12 billion portfolio of loans and bonds include Apollo Management LP, TPG and Blackstone Group, according to people familiar with the situation. The bank is trying to complete the deal by the time it reports earnings on April 18.

But to make the deals work, banks will have to help fund them, and that will mean balance sheets will remain full. Citigroup is loaning the buyers about $9 billion for the purchase of a portfolio that largely includes less-risky pieces of corporate debt, according to a person familiar with the situation. Among the solutions that banks are pursuing: the sale of big portfolios of loans, attempts to sell smaller blocks, and the formation of so-called workout structures that could be sold to outside investors. Central banks and regulators ultimately could be forced to coordinate a broader bailout structure that would own loans and securities until maturities are reached.

Even if more deals happen, the relief might be short-lived.

As banks pile into the market to sell loans or securities, they could drive down prices -- a situation that would cause further losses and could bring a quick halt to the sales. Goldman Sachs, for example, sold the Chrysler debt for about 63 cents on the dollar to an investor group that included some hedge funds, according to the person familiar with the matter. That is well below the average value of loans used in corporate buyouts, which stood at a six-week high of 90.14 cents on the dollar this week, according to a Standard & Poor's index. A Goldman spokesman declined to comment.

Meanwhile, billions of dollars in consumer loans and securities are building up on banks' balance sheets. Over the past five years, assets on the balance sheets of the 10 largest U.S. and European banks doubled to €15 trillion ($24 trillion) the International Monetary Fund said this week. Commercial and industrial loans on the books of U.S. commercial banks are up 20% in the past year to $1.4 trillion, while real-estate loans are up about 6% to $3.7 trillion, according to the Federal Reserve. Some of the commercial-loan growth is the result of banks lending to middle-market companies that continue to be seen as good credit risks.

Securitization markets -- where loans and other assets are packaged and sold to investors -- aren't likely to provide an outlet for those assets soon. Last month, global asset-backed securitizations totaled $24.8 billion, up from the previous month but down 81% from a year earlier. Mortgage deals have performed worse.

Securitizations of home loans totaled $19 billion in March, compared with $218.6 billion in March 2007, when the U.S. housing market began its sharp decline, according to data research firm Dealogic.

Even the most highly rated securities aren't finding many buyers. "To unclog the system, you need to find a place to sell triple-A securities," says Karsten Moller, senior managing director at the Securities Industry and Financial Markets Association, a trade group. "Right now, every time somebody sells a decent block of those securities, the price drops."

The repercussions of the clogged financial markets are visible around the world, including in the United Kingdom housing market. In a report issued Wednesday, Credit Suisse Group estimated that a third of the U.K.'s mortgage availability disappeared in just the past two weeks.Efforts are under way to restart the securitization market. One goal is to make debt sales more transparent.

Still, Mr. Moller, based in London, figures the market may not reopen until the second half, at the earliest.

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