Derivatives Investors flock back to credit product blamed in financial crisis Greater safety seen in ‘synthetic’ CDOs backed by corporate debt rather than subprime mortgages Issuance of 'synthetic' CDOs is growing quickly
Joe Rennison in New York MAY 3, 2019
Investors are flocking back to a complex debt derivatives product blamed for amplifying losses in the financial crisis, reckoning that the securities are safer now that they are no longer backed by subprime mortgages.
The vehicles, known as "synthetic" CDOs, short for collateralised debt obligations, bundle together derivatives whose returns depend on the performance of bonds, loans and other debts — providing hedge funds and other investors another way to bet on the creditworthiness of corporate America.
In contrast to standard CDOs, which bundle the bonds and loans themselves, synthetic CDOs proved especially destabilising during the crisis because they allowed multiple bets on the same subprime mortgages.
Because the newer vintages are backed by corporate debts, rather than risky home loans, Wall Street banks and investors argue the chances of disaster have been dramatically reduced.
But not all critics agree. "It's almost beyond belief that the very same people that claimed to be expert risk managers, who almost blew up the world in 2008, are back with the very same products," said Dennis Kelleher, chief executive of advocacy group
https://www.ft.com/content/9c33cea0-6ceb-11e9-80c7-60ee53e6681d 05/05/19, 15=44 Pagina 1 di 3
Better Markets.
As soon as you think synthetic CDOs, you think of the financial crisis. It has taken investors some time to get over that
Peter Tchir, chief macro strategist at Academy Securities
The synthetic CDO market is far smaller than it was last decade. But it is growing. JPMorgan analysts estimate that the number of securities tied to an underlying credit index has risen 40 per cent this year, putting that portion of the synthetic CDO market on pace to surpass the $200bn traded in 2018.
Other, so-called "bespoke" deals are on course for between $50bn and $80bn of new issuance this year, said bankers.
"The volumes have grown nicely," said a CDO banker. "We have seen clients hiring people to focus on it. It's risen on the radar of a lot of investors."
The appeal of synthetic CDOs is that they offer investors higher returns than can be found in global bond markets, where the average yield stands at just 2 per cent and trillions of dollars in debt trades at negative yields.
By contrast, investors willing to take the first losses on the underlying credit derivatives can receive yields of about 10 per cent, traders say.
Structures also have changed to better reflect risk, bankers say. In bespoke deals, lower-rated, but higher-yielding, tranches make up a greater part of a typical deal, reducing the potential concentration of losses.
Hedge funds, rather than banks, have become the big buyers, accounting for more than 70 per cent of volume in the market. Banks are responsible for 10 per cent of volumes, down from more than 50 per cent five years ago, according to JPMorgan.
"As soon as you think synthetic CDOs, you think of the financial crisis. It has taken investors some time to get over that," said Peter Tchir, chief macro strategist at Academy Securities. "On a scale of one to 10, with one being very cautious and 10 being
https://www.ft.com/content/9c33cea0-6ceb-11e9-80c7-60ee53e6681d 05/05/19, 15=44 Pagina 2 di 3
very aggressive, this is only around a five."
Notable participants in the synthetic CDO market include Citigroup, BNP Paribas and Société Générale, while Barclays is looking to increase its presence in the market.
Citi said in a statement: "Our synthetic CDO business employs prudent risk and capital management, and is both compliant and efficient with current and proposed regulation. "
BNP Paribas, Barclays and SocGen declined to comment.
Investors are flocking back to a complex debt derivatives product blamed for amplifying losses in the financial crisis, reckoning that the securities are safer now that they are no longer backed by subprime mortgages.
The vehicles, known as "synthetic" CDOs, short for collateralised debt obligations, bundle together derivatives whose returns depend on the performance of bonds, loans and other debts — providing hedge funds and other investors another way to bet on the creditworthiness of corporate America.
In contrast to standard CDOs, which bundle the bonds and loans themselves, synthetic CDOs proved especially destabilising during the crisis because they allowed multiple bets on the same subprime mortgages.
Because the newer vintages are backed by corporate debts, rather than risky home loans, Wall Street banks and investors argue the chances of disaster have been dramatically reduced.
But not all critics agree. "It's almost beyond belief that the very same people that claimed to be expert risk managers, who almost blew up the world in 2008, are back with the very same products," said Dennis Kelleher, chief executive of advocacy group
https://www.ft.com/content/9c33cea0-6ceb-11e9-80c7-60ee53e6681d 05/05/19, 15=44 Pagina 1 di 3
Better Markets.
As soon as you think synthetic CDOs, you think of the financial crisis. It has taken investors some time to get over that
Peter Tchir, chief macro strategist at Academy Securities
The synthetic CDO market is far smaller than it was last decade. But it is growing. JPMorgan analysts estimate that the number of securities tied to an underlying credit index has risen 40 per cent this year, putting that portion of the synthetic CDO market on pace to surpass the $200bn traded in 2018.
Other, so-called "bespoke" deals are on course for between $50bn and $80bn of new issuance this year, said bankers.
"The volumes have grown nicely," said a CDO banker. "We have seen clients hiring people to focus on it. It's risen on the radar of a lot of investors."
The appeal of synthetic CDOs is that they offer investors higher returns than can be found in global bond markets, where the average yield stands at just 2 per cent and trillions of dollars in debt trades at negative yields.
By contrast, investors willing to take the first losses on the underlying credit derivatives can receive yields of about 10 per cent, traders say.
Structures also have changed to better reflect risk, bankers say. In bespoke deals, lower-rated, but higher-yielding, tranches make up a greater part of a typical deal, reducing the potential concentration of losses.
Hedge funds, rather than banks, have become the big buyers, accounting for more than 70 per cent of volume in the market. Banks are responsible for 10 per cent of volumes, down from more than 50 per cent five years ago, according to JPMorgan.
"As soon as you think synthetic CDOs, you think of the financial crisis. It has taken investors some time to get over that," said Peter Tchir, chief macro strategist at Academy Securities. "On a scale of one to 10, with one being very cautious and 10 being
https://www.ft.com/content/9c33cea0-6ceb-11e9-80c7-60ee53e6681d 05/05/19, 15=44 Pagina 2 di 3
very aggressive, this is only around a five."
Notable participants in the synthetic CDO market include Citigroup, BNP Paribas and Société Générale, while Barclays is looking to increase its presence in the market.
Citi said in a statement: "Our synthetic CDO business employs prudent risk and capital management, and is both compliant and efficient with current and proposed regulation. "
BNP Paribas, Barclays and SocGen declined to comment.
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