Banks band together to bring billions to credit market

Several major banks are working together to establish a multibillion-dollar investment fund intended to lessen the credit crunch by improving liquidity for mortgage securities and other investments.

The U.S. Department of Treasury facilitated discussions among the group of banks and investment managers, according to a Bank of America announcement today. Bank of America Corp., Citigroup Inc. and JP Morgan Chase & Co. are among the group of banks that are setting up the fund, which could be worth up to $100 billion, according to some reports.

Bloomberg reported that securities losses related to subprime mortgages led investors to retreat from high-risk assets, and structured investment vehicles that issued commercial paper to buy the securities “found they could no longer roll over the debt, forcing them to sell about $75 billion of their assets.”

The intended beneficiaries of the planned fund, according to the Bank of America announcement, are structured investment vehicles that have been hampered by problems in the subprime mortgage market.

SIVs borrow money using the commercial paper market and seek to profit from the difference between the short-term borrowing rate and long-term returns — they typically provide funds for mortgages and credit cards, among other products.

Commercial paper is a security issued by banks and corporations that is generally not used to finance long-term investments and has traditionally been regarded as a low-risk investment.

“Once established, (the new fund) will agree, for a set period of time, to purchase qualifying highly rated assets from certain existing structured investment vehicles that choose, in their sole discretion, to take advantage of this new source of liquidity,” Bank of America announced.

Treasury Department officials said in a statement today, “Treasury is pleased with the response by the private sector to enhance liquidity in the short-term credit markets. The joint efforts of domestic and international financial institutions, broker dealers and investors have resulted in a potential structure to improve liquidity in the asset-backed commercial paper markets. This proposal will complement other solutions investors and asset managers may utilize in committing and deploying capital to support more efficient markets.

“The department appreciates this global consortium’s cooperation during the last several weeks and their leadership in developing a market-based response to this situation. Such efforts help to foster orderly capital markets.”

The Bank of America announcement stated that “refinancing in the asset-backed commercial paper markets has been difficult despite the high-quality collateral underlying many of these securities,” and the objective of the planned fund “is to facilitate these re-financings and to complement other market-based solutions in supporting an orderly and efficient market environment.”

The fund, dubbed M-LEC for “single master liquidity enhancement conduit,” could be set up within 90 days, according to the bank announcement.

Also today, Citigroup Inc. reported net income of $2.38 billion in the third quarter, though its securities and banking revenues fell 44 percent “due to write-downs and losses related to dislocations in the mortgage-backed securities and credit markets.”

The company reported $1.56 billion in pre-tax losses, net of hedges, “on the value of subprime mortgage-backed securities warehoused for future collateralized debt obligation securitizations, CDO positions, and leverage loans warehoused for future collateralized loan obligation securitizations.”

Revenues grew 5 percent within Citigroup’s consumer lending division, based on growth in net interest revenues and net servicing revenues and the company’s acquisition of ABN AMRO Mortgage Group in March, according to the earnings report.

The company also reported higher credit costs and an $854 million pre-tax charge to increase loan loss reserves, and stated that the higher credit costs “were primarily driven by a weakening of leading credit indicators, including higher delinquencies in first and second mortgages, as well as trends in the macro-economic environment, and a change in estimate of loan losses.”

Charles Prince, Citigroup chairman and CEO, said in the earnings announcement, “This was a disappointing quarter, even in the context of the dislocations in the subprime mortgage and credit markets. Although we generated strong momentum in many of our franchises, our fixed-income results, along with higher credit costs in global consumer, led to significantly lower net income.”