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The office space that had been rented on the 33rd floor of 250 Yonge Street to hold all the legal documents required to implement the ABCP restructuring. Articling student Daniel Mahler with Goodmans LLP is surrounded by files as he checks his email. Pictures taken on Jan.12/09Tibor Kolley/The Globe and Mail

Mention the words leveraged super senior tranche to most people and their eyes will glaze over. But to anyone who was involved in the messy Canadian asset-backed commercial paper (ABCP) crisis, the derivatives are the last thing they ever want to see again.

Yet here they are, as Euromoney reports that Citigroup Inc. is trying to sell the first leveraged super senior (LSS) tranche of a synthetic collateralized default obligation (CDO) since the crisis. Just reading that sentence should give an inkling of the complexity of the product, and in the wake of the crisis, investors shunned such credit derivatives.

Leveraged super senior deals are a form of synthetic debt, built to try to create yield.

The idea was to raise money from investors, and then sell a bunch of credit protection in the credit default swap market. The money from investors would be pledged as collateral against the CDS trades. In return, the counterparties to the CDS would pay a stream of premiums to the sellers. That would create the yield for the original investors. At some set point in the future, the trade would unwind and everyone could go on their merry way.

Canadian non-bank ABCP creators took money from investors and used LSS trades to create the income to pay the yield on the ABCP notes. The setups were called conduits, as they were simply structures through which money passed.

(There's a good chart of the inside workings of the ABCP conduits in Figure 7 of this report.)

The "super senior" name comes from the fact that the credit protection was sold against very senior bonds, and payouts would only be triggered if a large number of the bonds went bad.

The leverage comes from the fact that the income stream is pretty small, because the credits are supposedly so safe. So the structures are levered up to enable a bigger income stream.

That was all well and good, except for the triggers built in, as Euromoney points out. There was a mechanism by which a widening of credit spreads on the bonds in the basket could trigger calls for more collateral. That's exactly what happened in the crisis, and what left Canadian ABCP conduits insolvent. There was no way they could meet the calls for more collateral.

As Euromoney points out, Citi has tried to change the structure to eliminate that risk. Still, given the massive headaches created by LSS the last time around, it's hard to see too much traction.

Then again, many other credit products have made strong comebacks, so maybe the market's memory is short enough to allow LSS to return, too.

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