Friday, November 9, 2007

Illiquid CP backed by subprime CDOs? Who would buy a thing like that... oh, right.

Nice Headline.

From FT Alphaville via the Risk-Over the Counter blog :

Very interesting post on the FT's Alphaville blog. Deep within Citi's recent 10-Q, the news that the bank bought $25 billion of CP issued by subprime CDOs.

Most CDOs, of course, don’t normally issue CP. Traditionally, CDOs issue straight tranches of rated bonds. But Citi made CDOs issuing CP good business pre-crunch. You might say that commercial paper CDOs are a scion of the SIV world - using CP issuance to supplement their normal debt issues and create a more dynamic, flexible portfolio, benefiting from low yielding CP.

But also just like SIVs, CDOs need to keep refinancing that CP to pay off upcoming redemptions. But where they differ is that CP issuing CDOs mitigate that rollover risks by using their arranging banks’ as underwriters on all new CP issues. Whatever CP they can’t sell, agreements are in place as backup that ensure banks will buy.

And just like with SIV CP investors, over the summer, CDO CP buyers have dried up.
Money market funds - formerly among the biggest players in the CP markets - are loathe to touch anything containing MBS.

So Citi - unable to place CP on subprime CDOs it arranged as far back as 2005 - is having to buy it instead. Right when it can least afford to do so.

Ouch. And, the writer reckons, this is waiting to go sour on Citi any moment now...