Citigroup lost $15 million with UBS' 'crap' CDO blessed by S&P

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Carl Levin
Carl Levin

In just six months, Standard & Poor's AAA blessing for a slice of a $1.5 billion collateralized debt obligation cost Citigroup Inc. its $15 million investment.

The Vertical ABS 2007-1, a mezzanine cash flow structure built with asset-backed securities underwritten by UBS AG, is one of dozens of deals listed in the Justice Department's Feb. 4 lawsuit against S&P and its parent McGraw-Hill Cos. that received the ratings firm's highest AAA grade. Internal UBS emails referred to CDOs "as 'crap' at the same time that the bank was selling them," Senator Carl Levin said in an April 2010 subcommittee hearing on the causes and consequences of the financial crisis.

Federally insured Citigroup's Citibank unit bought into what was supposed to be the safest portion of the CDO, relying in part on S&P's assessment of the securities, according to the complaint. It lost the entire investment when the CDO defaulted on Oct. 19, 2007.

"Oh, well," S&P employee Bujiang Hu wrote in response to Moody's Investors Service's October 2007 downgrade of Vertical ABS CDO 2007-1, according to the Senate subcommittee report on the role of credit rating firms. "The cat is out of the bag."

The U.S. is accusing the world's largest credit rater of deliberately misstating the risks of mortgage bonds to keep its share of the booming business of repackaging home loans for sale as securities. The lawsuit seeks penalties that may amount to more than $5 billion, based on losses suffered by federally insured financial institutions.

Won't Perform

Ed Sweeney, an S&P spokesman, and Megan Stinson of UBS, both in New York, declined to comment.

"Don't see why we have to tolerate lack of cooperation" from UBS's James Yao, the UBS banker who asked S&P and Moody's to rate the CDO, an S&P analyst wrote in an email to colleagues, according to Levin and the subcommittee report. The deal's "likely not to perform."

In an April 5, 2007, email, an S&P analyst said the deal was closing the following Tuesday, "but our rated equity tranche (BBB) is failing in our cash flow modeling." After another employee tried "a lot of ways" to have the model pass, "unfortunately we are still failing" by one basis point, the analyst wrote. In a March email appended to the report the analyst wrote that Yao said S&P was "jeopardizing the deal."

Waterfall Mistake

The next day the analyst wrote the "model is passing now" after finding a "mistake in the waterfall modeling that was more punitive than necessary."

Vertical Capital, a New York-based CDO manager that oversaw more than $10 billion at the time, chose and supervised the assets "leveraging on the experience of its investment officers in the U.S. structured finance market," according to the January 2007 prospectus. Kem Blacker, a partner at Vertical Capital, declined to comment.

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