"They're Ba-ack!" - Citi Says Synthetic CDOs May Reach $100 Billion In 2017, 5x Increase In 2 Years

Tyler Durden's picture

35-year-old Jia Chen of Citibank probably has no idea where that title quote above came from.  That's because she was roughly 4 years old when Poltergeist II hit theaters back in 1986...

...that said, Citibank, as we noted a few weeks back, has every confidence that Jia is the perfect person to put in charge of once again making the bank into a powerhouse player in the Synthetic CDO market...perhaps because she was barely out of college when the same product nearly tanked the global financial system less than 10 years ago.

Be that as it may, Jia seems to be succeeding admirably in her mission to once again massively overlever the global financial system as Citibank reports that Synthetic CDO new issues are expected to exceed $100 billion this year, up 5x in just two years.  Per Bloomberg:

The comeback in complex credit derivatives blamed for exacerbating the global financial crisis is picking up pace.


That’s according to new research this week from Citigroup Inc., one of the biggest arrangers of so-called synthetic collateralized debt obligations. Sales of the products may jump to as much as $100 billion this year from about $20 billion in 2015, Citigroup analysts wrote in an Oct. 31 report.


While investors suffered billions of dollars in losses on similar bets a decade ago, the leverage offered by synthetic CDOs is luring back buyers in an era of low yields and dwindling volatility.


“It would seem as if the low spread-low vol environment, similar to back in 2006-2007 (when investors couldn’t get enough of levered synthetic tranches) has revived some interest in portfolio credit risk,” Citigroup analysts led by Aritra Banerjee wrote. “Investors may not have necessarily wanted to add leverage, but, simply put, they have had to, given the lack of alternatives.”


But don't worry too much about the ballooning risk associated with these products because Citibank says they've solved the problem that made them dangerous back in 2008 by reducing duration...and we all know that credit risk is equally to exactly 0 on the short end of the curve, right?

There are some key differences in today’s synthetic CDOs versus the pre-crisis vintage. Citigroup said it has created over 50 “full capital structure” deals in recent years, which vary from the single-tranche bespoke deals that dominated before and just after the crunch.


Such full capital structures -- which typically include junior, mezzanine, and senior tranches -- have historically proved harder to sell because banks must find buyers for all the pieces at once. Senior tranches are more insulated from potential losses but also come with lower yields -- one reason that banks created the infamous “leveraged super seniors” before the financial crisis.


New banking rules, including higher capital charges, have dented the market for single-tranche deals, according to Citigroup. While full-capital structures may reduce exposures for banks selling the deals, they effectively shift all of the risk to investors.


“Banks operating in the market now seek to buy protection from investors across the entire capital structure,” the Citigroup analysts said. “Once this is done, banks can fully hedge out their risk using single name and index positions, which is far less punitive from a capital perspective.”


Recent deals also have lower duration. Maturities of just two to three years compare with the 8.5-year average from 2000 to 2010, according to Citigroup. Long maturities spooked the market during the credit crisis, when leverage embedded in the products forced investors to book outsized losses on their positions.

For those who have forgotten how Synthetic CDOs work, below is a quick primer.  To summarize, you go out and find a bunch of suckers willing to backstop trillions of dollars worth of credit risk in return for a few bps in annual premium payments.  You then tranche out the risk being taken by the CDO investors so that those at the top can get a AAA-rating and, in return, tell their investors that they're taking no risk at all.  Those investors then lever up their capital another 10x so they can make 8% returns on a 'risk-free' investment...it's basically as safe as having you're own printing press from the U.S. Treasury.

Typically, these CDOs pool together about 100 different credit-default swaps tied to various companies, which are then sliced into varying levels of risk called tranches -- senior, mezzanine and equity. Over the life of a deal, which generally lasts two to three years, the swaps generate a steady stream of income for “long” investors (and are paid by “short” investors on the other side of the trade who want insurance against a potential default).


The equity tranche has the biggest risk of getting wiped out if losses from defaults exceed roughly 5 to 7 percent, and nets the highest returns.

Synthetic CDO


And guess who's buying?  If you guessed 20-something year old pension and insurance fund investors who were in middle school during the last financial crisis then you're absolutely right...congratulations.

Yet after years of rising markets, declining corporate defaults and tighter credit spreads, the trade is finally attracting greater interest. Increasingly, pension funds and endowments have become senior tranche investors in many of Citigroup’s synthetic CDOs. And because the CDOs are derivatives, they have small upfront costs and amplify returns.


“There is a whole generation of people in finance who never knew or forgot what the problems were with synthetic CDOs,” said Janet Tavakoli, a 30-year veteran of the financial markets who runs a consulting firm and has written books on structured credit and CDOs. “Just as derivatives can lever up the upside, they can lever up the downside.”

Conclusion:  Seems like we're getting to that point in the cycle when it once again makes sense to "short everything that guy [or girl in this case] has touched."

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SloMoe's picture

Are they bringing back Hank Paulson and his containers?

38BWD22's picture



CDOs are as complicated as BTC!

yrad's picture

It's a CDO of a CDO. Or, a CDO "squared"

What's so complicated? 

YUNOSELL's picture

The market is getting wise to the latest dogshit wrapped in catshit so now they need some added complexity to generate new opaque fees to extract more wealth from the muppets.

Guess it will be time to start shorting the market soon.

VD's picture

they share certain-- um-- similarities; namely, the transaction volume of bitcoin over last 12months is, on average, unchanged. while price has gone up 10x.


it's a confidence game. videogame "coinz", toxic derivatives, etc.


Decay is Constant's picture

So where do I short bitcoin?

VD's picture

be very careful shorting the crypt0-ponzi. it's safer to buy dips if anything with tight stops. btc is Napster beta, but with inveterate Asian gamblers and "smart money" "investors" along w/ the 1% basement crypt0-muppetz.

Buckaroo Banzai's picture

Open an account at Kraken or Poloniex, they will let you short BTC, assuming there are sufficient coins in the exchange wallet that have been made available for shorting. Don't forget, it's impossible to naked short BitCoin, so if there are insufficient coins available you'll be SOL.

Good luck!

38BWD22's picture



Or sell some BTC for gold.

I did just that at BTC price of $6400 (from JM Bullion).  BTC now at $7280 or so.  My timing is typically imperfect.

Timing, bitchez!

BitchesBetterRecognize's picture

........ and notice how "strangely" the BTC has gone up parallel to the "wall street/Trump rally"....       

Racer's picture

When you have buyers who are price insensitive like central bwanksters and companies buying back shares then there is a great market for sick buckets of CDOs

taketheredpill's picture


Typically, these CDOs pool together about 100 different credit-default swaps tied to various companies, which are then sliced into varying levels of risk called tranches -- senior, mezzanine and equity. Over the life of a deal, which generally lasts two to three years, the swaps generate a steady stream of income for “long” investors (and are paid by “short” investors on the other side of the trade who want insurance against a potential default).


Salesman: "You're diversified by company, then industry, then geography, then you got over-collateralization and so on....so the only way you can get hurt is if all the credits implode at the same time.  And I've never seen that in my entire career"

Punter: "How long have you been doing this?"

Salesman: "Since 2010"

Punter: "Ok...well put me in for $20 million, if I get $10 I'll be happy"

Salesman: "Giddyup! Lunch next week?"





buzzsaw99's picture

when you tell a twentysomething pension fund manager that they need to earn 8% per year on aum while the 10Y sits at 2.4% there are going to be problems.  it is the no win scenario.  it matters not whether citi says they feel they are insulated because when it all blows to hell they are getting sued again without a doubt.

Versengetorix's picture

I sure am glad Chris Dodd and his pet homo, Barney Frank cleaned this up before they "retired."

Not if_ But When's picture

Barney Frank was the #1 super cheerleader for the totally corrupt, executive-pay-driven Fannie Mae (a major contributor to the crisis).    CPL593H

Versengetorix's picture

I am still amazed that Hollywood was ever allowed to Make the "Big Short."  It just told so many truths to the public.  I suspect NY knew all along that the public would never really want to get in the weeds.  They were right.

Jtrillian's picture

With central banks beginning to taper, this is the only way to keep the illusion going.  Banksters must figure enough time has passed that the plebs have forgotten what a CDO is.  

They're probably right. 

Elitist Trash's picture

Blue Horseshoe hates Citi

Games Without Frontiers's picture

And when all these leveraged bets go bad they will again say “we never could’ve seen this coming, now about that bailout......”

Drop-Hammer's picture

'Synthetic CDO's'?--  The jews create imaginary concepts/'financial products' and peddle them as reality.  They truly are Satan's children.