Citi Found Itself Briefly Exposed to $400 Million Hit
Executives discovered a giant potential loss; money is recovered
A small London hedge-fund firm and a lapse in bank-risk controls caused a panic inside Citigroup Inc. in July, after its executives discovered a series of trades they estimated could cost the bank as much as $400 million, people familiar with internal discussions at the time said.
The concerns made a brief appearance in the bank’s second-quarter earnings released July 16 in which Citigroup said it had reserved $175 million stemming from “valuation adjustments related to certain financing transactions,” but the details otherwise have remained a mystery.
Citigroup clawed back all of the money at risk in the next three months. But the slip-up adds to a series of technology snafus at global banks and is reverberating inside the U.S. lender, which has worked to fix shortcomings in its systems and oversight.
“This is a systems problem,” said Janet Tavakoli, president of Chicago consulting firm Tavakoli Structured Finance Inc., adding that banks too often don’t adequately supervise their trading and financing activities with hedge-fund clients. “There’s a pattern where bankers are asking fewer questions in order to bring in more fees,” she said.
A Citigroup spokeswoman said the bank has no remaining exposure to the problem. “As soon as we detected this isolated issue through a regular review process, it was escalated to senior management, and we immediately put additional controls in place to prevent a similar event from occurring,” she said.
In June, Deutsche Bank AG accidentally transferred $6 billion to a hedge fund’s custody account, far more than intended, according to a person familiar with the matter. The bank got its money back.
In August, Bank of New York Mellon Corp. suffered a third-party software glitch that temporarily prevented the bank from accurately pricing more than 1,000 mutual funds and exchange-traded funds, causing headaches for asset managers. The bank apologized and has been analyzing the causes to prevent similar problems.
Citigroup’s problem was rooted in the bank’s prime-brokerage unit, which handles trades and extends loans to hedge funds while holding their assets. The trades in mostly bonds were made by LNG Capital LLP, a London hedge fund run by 52-year-old Louis N. Gargour and a Citigroup prime brokerage client since 2011, according to the people familiar with the matter.
LNG is a small fund, with about $150 million in assets. Most of its trades went through automated systems with infrequent human interaction on Citigroup’s part, the people said. On the dates LNG entered trades, Citigroup’s systems erroneously assigned higher than intended values to the bonds LNG held in its account, the people said.
According to the people, the systems got tripped up by expecting buy and sell orders to settle together, effectively canceling each other out. Instead, with some of the trades, which went on through May and June, one leg actually didn’t settle for weeks. As a result, Citigroup inadvertently kept extending credit to LNG, allowing it to buy about five times the value of securities as would have been allowed under normal risk limits, even as risks mounted for the bank.
An internal review flagged the issue in early July. Neil Warrender, a longtime operations and compliance consultant working for LNG, said that Citigroup “panicked” when it discovered the problem. LNG couldn’t immediately pay what Citigroup demanded, about $400 million, so Citigroup had to wait months for LNG to sell the positions, the people familiar with the matter said.
In announcing the $175 million reserve in July, Citigroup said it expected to recover all of the money.
Mr. Warrender said LNG simply made use of available financing. “If you put on trades and they don’t like them, they usually tell you right away,” he said. “LNG is a tiny company, and Citi is a giant company.”
Mr. Gargour said in an interview that LNG was operating “business as usual.” In a later email, he said his firm, like many hedge funds, has borrowed money from banks and was asked to reduce the leverage. He said LNG hasn’t caused any losses for Citigroup and said its trades “have on the whole been profitable.”
Citigroup has been reorganizing its prime brokerage business, which suffered significant losses in January when clients’ currency bets soured.
The positions that triggered the bank’s alarms, said Mr. Warrender, involved “not the most liquid bonds in the world.” A list reviewed by The Wall Street Journal shows bonds concentrated in companies connected with another private investment firm, Sapinda Holding BV, which has offices in London and Berlin.
The securities included debt and equities issued by agricultural and energy companies that are core holdings of Sapinda, as well as debt issued by Sapinda Invest Sarl, a Luxembourg-based investment vehicle, according to the list. A registered officer for Sapinda Invest said its beneficiary is the family trust of Lars Windhorst, a German businessman who is chairman of Sapinda Holding.
The trades involving the Sapinda-related bonds were the result of a new investment in LNG earlier this year, Mr. Warrender said. He said LNG’s contact for the investment was “through a family office,” which he said was Sapinda.
Ben Ullmann, an outside spokesman for Sapinda and Mr. Windhorst, said in an emailed statement, “Sapinda has no business relationship with LNG and no Sapinda affiliate has invested in LNG or received financing from LNG.”
Mr. Gargour said in an emailed statement, “LNG has no business relationship with Sapinda and no Sapinda affiliated entity has invested in LNG or has received financing from LNG.”
Citigroup has told LNG that its relationship is over, people familiar with the matter said. “We probably don’t want to work with them either,” Mr. Warrender said.