swap-it-like-its-hot11They’rrrre baaack. It’s leveraged supersenior kids, but not as you know it. Specifically not as you know it because the new ones are not non-recourse on the leverage, so they have no gap risk for the seller. Now, there are some not-entirely-accurate statements going around about what is actually happening here, so let’s look.

How would you synthesize a leveraged supersenior position? Well, take the underlying CDO, and sell the junior for a fair price.
Then take the senior, put it in an SPV, and fund that vehicle by

(i) a lower tranche equal to the LSS investor’s initial investment and
(ii) an upper tranche which is wrapped by the LSS investor. The fair LSS coupon is then determined by the total carry available on the senior minus what an investor in the upper tranche would need for bearing the joint default risk of the LSS investor and the upper tranche of the senior tranche of the underlying loans.

The problem is that it is hard these days to find people who want to put up a lot of money in order not to earn very much on it. So the solution is to pay the super senior guy more, but then you need a trick to come up with the money.