from anonymous
Another sick thing; Deutsche Bank who structured about 40% of this business and made about $500million off of the naive pension funds, is making another $150million off of the restructuring! They are giving it to the Canadian population twice! The bankers and lawyers involved are making a fortune for grabbing Rousseau by his privates.....
The vast majority of the non-bank Canadian ABCP market had nothing to do with the subprime crisis in the States. The reason it failed was that it was a tinderbox. The assets sold to conduits were always were worth less than the sale price. The manufacturing banks created them for 90cents and sold them for a dollar. Agreeing to buy them back if the Market disrupted. The language they agreed to with the Conduits and DBRS relied on a single word to keep the market disruption from ever being possible: they said ALL conduits must fail. Unfortunately the investors never saw this, as they bought paper from the conduits. This is racketeering and much worse than anything that went on in the States. Fortunately for those banks, the head of a Quebecois pension plan had his whole career to lose if it came out how stupid he was an dhow much he lost. Below is further background on this conspiracy to defraud Canadian short term investors. Maybe the regulators will learn to look out for such fraud going forward. Why Rousseau, DBRS, Deutsche Bank, are still permitted in Canada is a good question for the conspiracy theorists.
The Leveraged Super Senior Trade was invented around 2004. It was an idea to leverage the super senior tranche of a synthetic cdo. For some background: a synthetic CDO basically was like any CDO in that various tranches of risk and reward were created from underlying assets. CDOs can be seen as a financing structure for the "equity" holder. That is the investors taking the most risk were leveraging their investments in the underlying by issuing non-recourse debt in various tranches (these could be seen as attaching above the equity holder, successively).
In the late 90s, JP Morgan innovated the synthetic CDO whereby the financing element went away. That is, it look at a CDO as a risk sharing device, with the senior most holders having the least amount of default risk. Most or even ALL the underlying assets had to default for the Super senior holder to suffer a loss. the innovation that JP brought to thge market was that the underlying assets were no longer cash assets but were credit default swaps. The actual assets that the default swaps referenced, never left JP's books but were "synthetically" as individual CDS to the CDO. The CDO then issued notes to investors linked to various risk classes to hedge the CDS it sold to JP.
This structure was very successful and creating risk takers for CDS. Over time another innovation occured after the credit crisis of 2002, the single tranche CDO, to over coem the lack of equity and super senior investors in the market as a result of the crunch. In this structure, investment banks built a "correlation model" which allwoed them to value each tranche individually and then delta hedge the tranche. Most investors bought tranches rate A, AA, and AAA, but not the unrated equity or the low spread super senior.
As this business grew, hedge funds started taking the equity tranches to allow investment banks to remove their risk to the middle tranches and the models, but there were few super senior players. Even hedge funds would trade this because small spread movement could have big marked-to-market losses. This is because the notionals were huge.
A new product was created in 2004, the Leveraged Super Senior transaction which leveraged the spreads of super senior tranches so that typically AAA structured note investors could buy them. So if a $1billion CDO had a 0-5% equity tranche ($50mm), 5-15 mezzanine tranche ($100mm), and a super senior tranche of 15-100% ($850mm), the bank could sell a 10x levered $85mm super senior tranche. With single tranche technology, the investment banks just started selling the levered super senior tranche. Because they could use their derivative models to leverage the transaction 10X, if the fair spread was 10bps for the 85-100% and they paid 60bps, they made 40bps on the levered note. Investors loved it because it appeared to be very safe (it needed 15% losses on corporates, an unheard of number) and usually only de-levered if defaults exceeded a certain amount.
The problem was that by giving investors default-based leveraged, the investment banks were not hedging their mark-to-market risk. They had to wait for actual defaults to happen before the LSS notes de-levered, rather than spread widening. SO, the Investment Banks began to use spread based leveraging.
Deutsche Bank invented this structure. The problem with spread based leveraging was that it was much, much riskier, and no credible rating agency would put a rating on it. A, AA, AAA investors wouldn't ouch this toxic stuff, and the agencies knew better than to try to rate single tranche spread risk. Well, all except for one. One that was only credible in Canada, DBRS.
DBRS is pretty much an irrelevant agency except for the Canadian conduit market. By putting a rating on single tranche spread risk, DBRS allowed investors who used their rating to invest in full mark-to-market leveraged super senior tranches. The only investors who used their ratings were the Canadian Conduits.
Now their was one sticking point on selling LSS notes to Canadian conduits. They required liquidity language. Now most ratings agencies require strict liquidity language suggesting that if you sold paper to the conduit, you could have to take it back. This is fine if you are really just trying to get short term financing, but if you are trying to sell a risk transfer transaction like a single tranche CDO, you are not transferring risk if you might have to buy the paper back.
However, DBRS became a big rating agency in Canada for a reason. It had created a liquidity loophole. It said that only on a "market-disruption" must a liquidity provider buyback the notes. How did they define this market disruption? They let the individual liquidity providers define the "market disruption" and approved it or didn't. So for LSS, who were the liquidity providers? The investment banks that created the risk transfer notes! How could they sell a risk transfer note and provide liquidity (ie, not really transferring the risk)? They created market disruption language such that they were not really providing liquidity! The market disruption that Deutsche drafted and DBRS approved required ALL the conduits in Canada to fail. That is, even those backed by RBC, CIBC, etc. It required that ALL the Canadian banks would have to fail!
The brilliance of this arrangement was that now Deutsche Bank could sell billions of LSS notes with full risk transfer to the Canadian Conduits, book huge profits for this enormous risk transfer, and not have to worry about the notes coming back toi them, unless the nation of Canada collapsed!
How much? Well let say roughly $15billion CAD of notes. Not too shabby. they were levered 10X, so they represented $150billion of single CDO tranches. Or $150billion of risk transfered to the Canadian Conduits. Even better...they were not 15-100% tranches. They were on average 20-30% tranches. They represented a 10% slice of a $1.5 trillion CDS underlying the transactions.
Other banks jumped, and sold another $15billion or so. So the Canadian Conduit market had exposure to approximately $3 trillion of CDS. Canada became one of the largest CDS outlets in the world. Best of all, no one knew it. The conduits issued notes to investors and the conduits bought the LSS notes. This is why the I-banks kept all the transaction information confidential behind closed doors. You are talking about one of the greatest financial scandals on the planet. CDP alone was probably the biggest CDS player int he world, without knowing. Its $12billion of notes, represented $1.2 trillion of CDS. For which they got paid pennies. If they had given that kind of capacity to a smart hedge fund, the retirees of Quebec wouldn't have had to make any more contributions, they would have doubled their fund value! Because they invested with doing proper due diligence, they were scammed. Embarrassingly, one man's shame (the head of CDP) was allowed drive the investigation and settlement of these losses and a solution which allowed him to hide the losses.
Now, are they to blame or are the Investment Banks who created risk transfer transactions embedded in notes worth far less than par and then sold as par AAA DBRS rated notes to blame. In the US, they are figuring that out now with their Auction Rate deceit. When will Canada learn?
For more background on this scandalous business, see PIMCOs writeup from early 2007:
http://www.pimco.com/LeftNav/Global+Mar ... 5-2007.htm