Synthetic CDOs Once Are Once Again In Demand Among Investors

Despite the damage attributed to them during the 2008 credit market crisis, synthetic collateralized debt obligations are once again in high demand among investors. The popularity of these risky investments, with their high returns and rock-bottom interest rates, are so high that even after being denounced by investors and a lot of lawmakers back in the day, now Morgan Stanley (MS) and JPMorgan Chase (JPM ) in London are among those seeking to package these instruments.

CDOs allow investors to bet on a basket of companies’ credit worthiness. While the basic version of these instruments pool bonds and give investors an opportunity to put their money in a portion of that pool, synthetic CDOs pool the insurance-like derivatives contracts on the bonds. These latest synthetic CDOs, like their counterparts that existed during the crisis, are cut up into varying levels of returns and risks, with investors wanting the highest returns likely buying portion with the greatest risk.

Granted, synthetic CDOs do somewhat spread the risk. Yet, also can increase the financial harm significantly if companies don’t make their debt payments.

The Wall Street Journal reports that a source in the know says that Morgan Stanley and JP Morgan are attempting to draw in even more investors, which the banks need enough of if they are to actually move forward with these latest synthetic CDOs. Due to rules now in place mandating that banks put aside huge quantities of capital against possible losses against such instruments, the two giants are not expected to invest in their deals.

What makes these newer CDOs different from their credit crisis-era ones? (An investor usually buys one of the (generally) six CDO slices.) One slice has been reportedly harder to sell because its yield is not enough. Also, buyers of the slices that aren’t as high risk would now likely receive more protection against possible losses than buyers of similar slices did several years ago.

Creditflux, a data provider, reports that during 2007, financial firms put out $634 billion of synthetic CDOs. In 2009, sales plummeted to $98 billion. While certain banks and hedge funds have been working together to put together private, small deals that have packaged derivatives into trades that are custom made, those deals were usually small and credit rating firms generally haven’t assessed them.

Another source says that there is now also a differently purposed CDO in development that Citigroup (C) Inc. is selling. This CDO uses derivatives linked to the bank’s loans portfolio and involves shipping companies outside the United States. The financial firm’s purported need to make room for new loans while being able to hold less capital to cushion possible shipping loan losses is said to be the motivation for the approximately $500 million deal (expected to bring in 13-15% in yearly yields). The WSJ says that investors of this type of CDO will be “on the hook” for certain losses, reports the WSJ.

Another security that investors seem to be hungry for these days are collateralized loan obligations. CLOs are tied to corporate debt, and to date, this year, over $35 billion of CLs have been sold in this country.

At Shepherd Smith Edwards and Kantas, LTD, LLP, we haven’t forgotten the massive losses investors took from synthetic CDOs during the 2008 financial crisis. We continue to represent investors that have suffered securities fraud losses linked to these investments. Contact our institutional investor fraud law firm today and ask for your free case evaluation.

One of Wall Street’s Riskiest Bets Returns, Wall Street Journal, June 4, 2013

Synthetic CDOs Making Comeback as Yields Juiced, Bloomberg, March 20, 2013

CreditFlux

More Blog Posts:
Bank of America Subpoenaed by Massachusetts Over Bryn Mawr CLO II Ltd. and LCM VII Ltd. CLOs that Cost Investors $150 Million, Stockbroker Fraud Blog, February 14, 2012

Standard & Poor’s Seeks Dismissal of DOJ Securities Fraud Lawsuit Over RMBS and CDO Ratings Issued During the Financial Crisis, Institutional Investor Securities Blog, May 9, 2013

Standard & Poor’s Misled Investors By Giving Synthetic Derivatives Its Highest Ratings, Rules Australian Federal Court, Institutional Investor Securities Blog, November 8, 2012