Several Wall Street banks want to offer a toxic investment product for the first time since the financial crisis - even though it's the same one that caused the crash

the big short

  • Banks are rushing to sell investors synthetic collateralized debt obligations for the first time since the financial crisis, International Financing Review reported Friday.
  • The assets are related to those that fueled the financial industry's collapse and the Great Recession.
  • Money managers seeking high yields are eyeing the sale of collateralized synthetic obligations, which use pools of credit default swaps tied to corporate debt, instead of toxic sub-prime mortgages.
  • The financial turmoil fueled by synthetic CDOs was highlighted in Michael Lewis' bestselling novel "The Big Short," and the 2015 film adaptation of the same name.
  • Visit the Business Insider homepage for more stories.

Banks are rushing to offer investors synthetic collateralized debt obligations for the first time since the financial crisis, International Financing Review reported Friday.

Years of low interest rates have led wealth managers to sink cash into managed collateralized synthetic obligations, a kind of synthetic CDO that uses tranches of credit default swaps tied to corporate debt, according to IFR.

CDOs tied to risky sub-prime mortgages drove massive losses in the US financial sector 12 years ago. When the housing bubble burst, ratings agencies downgraded the CDOs and investment managers lost vast swaths of client cash.

The financial risk posed by synthetic CDOs was highlighted in Michael Lewis' bestselling novel "The Big Short," and the 2015 film adaptation of the same name.

Banks are planning to offer later-maturity, managed CSOs, which allow the assets' managers to swap credits in the underlying portfolio. Firms interested in selling the longer-dated CSOs include JPMorgan, Nomura, and BNP Paribas, IFR reported. Funds interested in the vehicles include Apollo Global Management and CQS.

"There's definitely a focus on getting the first transaction completed," Sukho Lee, an executive director in structured credit at Nomura, told IFR. "We're hoping that once we do a managed deal, the investor base can expand - the traditional [collateralized loan obligation] investors will look at CSOs too."

Citigroup is avoiding the longer-dated CSOs, sources told IFR, due to the later-maturity assets bringing greater risk to investors.

Synthetic CDOs linked to sub-prime mortgages haven't returned to financial markets since the Great Recession, yet CSO tranche trading reached $80 billion in 2018 and is still growing, IFR reported, citing data from Quantifi. The increase in popularity is likely linked to historically low interest rates around the world and vast amounts of negatively yielding debt, particularly in European markets.

Though banks are gearing up to offer the highly engineered products, a handful of obstacles stand in their way. One variable that's yet to be finalized is the cost of swapping credits in the managed CSO, as well as who will pay for the substitution, IFR reported. Regulatory costs for the complex deals could also cut into their returns and spoil investor interest.

"The question is whether they can get the hedge costs and potentially the increased regulatory costs to a level where it all makes sense economically," Astra Asset Management cofounder Christian Adler told IFR.

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