Joshua Siegel is bringing back a version of one of the most toxic financial vehicles ever devised and arguing that this time it’s going to be different.
His StoneCastle Financial is among the funds that are reviving the collateralized debt obligation, or CDO.
CDOs stuffed with mortgages and their derivatives caused billions in losses around the world during the 2008 crisis. The CDO that StoneCastle put together is another kind. It’s backed by subordinated debt issued by about 35 community banks, some of them so small they don’t have credit ratings. Subordinated debt is paid off last in a bankruptcy, so issuers typically compensate buyers with higher yields than on other borrowings.
Citigroup Inc., which completed the $250 million deal for New York-based StoneCastle this month, calls it a collateralized loan obligation, but it’s a structured security that walks and talks like a CDO. Moody’s Investors Service plans to give it a rating of A3, six grades below Aaa, according to people with knowledge of the deal. Bank bonds rated A typically yield 2.5 percent. Through the wonders of financial engineering, StoneCastle’s Community Funding CLO yields 5.75 percent.
“A CDO is just another word for financing,” Siegel said in an e-mail. “What matters are what assets are being financed.”
This isn’t the first time Siegel pooled small-bank debt into a structured financial product. At Salomon Smith Barney in the late 1990s, he proposed bundling banks’ trust-preferred securities, a predecessor to subordinated debt, into so-called TruPS CDOs.
In a 2001 research report, Siegel divided the U.S. into five regions and wrote that the geographic diversity of the banks whose TruPS he used -- picking debt from different areas - - would make the CDOs safer.
Sales of new TruPS CDOs multiplied in the next seven years by a staggering 7,722 percent, rising to issuance of $60 billion by 2007, according to the Federal Reserve.
In all, Siegel said he put together about 13 TruPS CDOs. “There was a cult following,” he said.