A CIT CDO problem

July 14, 2009

CIT isn’t supposed to be a systemic threat, but a potential failure of a big lender, even if its customers are small and medium-sized businesses, is bound to shake up some corners of credit markets. That’s a rule, isn’t it?

The FT is reporting that the problem area is likely to be synthetic CDOs – the really fun structured products that are made up of sliced and diced credit default swaps referencing individual companies. But this time it looks like the losses just may be in investors’ heads.

From the FT:

A default by CIT, the troubled US commercial lender, could trigger widespread losses for investors in the $600bn market for synthetic collateralised debt obligations.

This is because it is the second most widely referenced company in synthetic CDOs after Volkswagen, with almost two-thirds of those rated by Standard & Poor’s in Europe including it in their portfolios of credit default swaps.

While many investors are already believed to have made writedowns against their CDO investments, analysts warn that a potential bankruptcy of CIT could have a psychological impact as a reminder of the potential systemic risk posed by structured credit products.

“We are likely to be reminded of the high concentration of risks in the CDO market as defaults rise in the coming months,” said Michael Hampden-Turner at Citigroup in London.

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