What Is a Bespoke Tranche Opportunity?

What Is a Bespoke Tranche Opportunity?

What Is a Bespoke Tranche Opportunity?

Bespoke tranche opportunities are a niche structured financial product that allows investors to buy a specific grouping of cash-producing assets in a CDO.

In many areas of knowledge, the rare and the arcane have little bearing on society in general. What wins on “Jeopardy!” does not often move the markets.

But in finance, the obscurities that are hidden from most can be disastrous. And one of those instruments, known as the Bespoke Tranche Opportunity, or BTO, is on the rise again as large investors seek returns in a low-interest market.

So investors must have at least a rudimentary grip on the Bespoke tranche opportunity, which looks like some of the financial instruments that played a disproportionate role in the 2008 financial crisis. This slowdown destroyed $ 9.8 trillion in state wealth. -United as house prices and investment accounts were beaten, and millions of people lost their homes and jobs.

The final seconds of the 2015 Oscar-winning film “The Big Short” is devoted to bespoke tranche opportunities, which are grimly described as just another name for debt collateral bonds or CDOs. These instruments are closely linked to the American real estate market, which helped plunge the United States into the Great Recession.

Here’s a quick look at this remote corner of Wall Street with a history of outsized economic influence:

  • What is a Bespoke tranche opportunity?
  • Benefits of tailor-made slice opportunities
  • Disadvantages of Custom Slice Opportunities
  • Conclusion: Take back the risk

What is a Bespoke tranche opportunity?

Bespoke Tranche Opportunities are a niche structured financial product that allows investors to purchase a specific group of cash-producing assets in a CDO. For example, suppose a sophisticated investor wanted to gain exposure to a BBB-rated mortgage pool in the Southwest or AAA-rated US auto loans group. In that case, they could use a Bespoke tranche opportunity to achieve this.

It makes sense when you break the term down: the “tailor-made” part refers to personalized personalization desired by an investor.

“A slice is, if you will, a slice of risk,” says Janet Tavakoli, president of Tavakoli Structured Finance LLC, a Chicago-based risk advisory firm for derivatives and structured finance. While CDOs will group all loans of a particular type, with a Bespoke tranche opportunity, “you are going to choose a specific tranche.”

As for the “opportunity” part of a Bespoke tranche opportunity?

Maybe it’s just a touch of poetic license. In any case, BTOs are not readily available to retail traders. They are created on an ad hoc basis for institutional investors.

“If you want to have AAA and AA rated assets, you would expect them to go to money market funds, some bank wallets, or people using them as collateral for another transaction,” Tavakoli said. BBB-rated loans could end up in fixed-income portfolios, while for “high-risk stuff,” you might expect hedge funds to stimulate demand, Tavakoli says.

Although the market is opaque, demand in recent years has been robust. In 2018, synthetic CDO trading volume exceeded $ 200 billion, according to a Reuters report. For some, this may echo the financial crisis, when banks were faced with cascading liabilities due to leveraged bets on loan pools gone awry, in some cases despite failing credit ratings and the Pound sterling.

The flip side of the bailouts that helped revitalize the US economy in 2008 and 2009 is the moral hazard problem – the phenomenon where bailed out or insured parties are consciously taking more risks. Today, many large banks are involved in the trading of bespoke tranche opportunities, including Citigroup Inc. (ticker: C), Deutsche Bank AG (DB), Goldman Sachs Group Inc. (GS), and JPMorgan Chase & Co. (JPM).

Benefits of tailor-made slice opportunities

A notable advantage for institutional investors seeking tailor-made tranche opportunities is the ability to reap higher returns, which is not readily available to fixed income investors in the low-interest-rate environment. ‘today. US Treasuries just don’t cut it for most yield-seeking investors at a time when the 10-year Treasury yield is near 1.3%.

Tavakoli points out another advantage of the Bespoke tranche opportunity: “There is always a market for them because people want to adapt their risk, and there is nothing wrong with that,” she says.

Another “pro” of these relatively unknown structured products – and this one goes both ways – is the ability to use leverage.

“If you want a bespoke slice made just for you, what made that easy was the derivatives,” Tavakoli said. “Derivatives are similar to the same idea but can provide more leverage. Instead of having an actual portfolio of assets, you can reference an imaginary portfolio of assets.”

She adds: “Instead of buying a certain asset, you can just use those assets as a benchmark.” Derivatives allow you to have a theoretical idea of ​​an asset to transfer the risk, says Tavakoli.

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Disadvantages of Custom Slice Opportunities

Unlike stocks or exchange-traded funds, which trade in large numbers every day, BTOs, as investments specifically designed for institutions, are not very liquid and can be difficult to value on a day-to-day basis. This illiquidity also makes them challenging to unload when you want to exit the trade.

“CDOs are extremely similar to custom wafers in that they are relatively illiquid and difficult to model their behavior in times of market stress,” said Lisa Fall, CEO of the Boston Security Token Exchange.

On top of that, BTOs are unregulated, which exacerbates the risk due to a lack of oversight. How to avoid blatant fraud or incorrect risk assessments? It remains an open problem.

“This is what happened during the financial crisis: unfortunately, some custom wafers that were sold as AAA were junk from the start.

There is also the systemic drawback of these instruments: “The main challenge with tailor-made tranche opportunities is that most market participants do not well understand the potential risks they pose to the financial system,” says Fall.

Are BTOs the New Threat to the Global Financial System?

Financial markets generate multiple investment opportunities, sometimes high risk, for the investor and the economy in general. A derivative product can lead to an imbalance in the world system. A situation already experienced in 2008 with the CDO ( Examples of Economic Bubble: 2008 Crisis and Fabricator Action ). However, the emergence of a new investment instrument similar to those already mentioned triggers the fear of a new chapter of the financial crisis.

Day by day, the market is in charge of generating new and attractive investment opportunities. However, not all the levels of risk and return that are implicit in it are striking. The low interest rates that the United States Federal Reserve (FED) has sustained since the crisis in 2008 have led investment banks to generate new instruments profitable enough for capitalists in search of large profits, regardless of whether they are related to old ones. Practices related to the erosion of the last global financial collapse.

In 2015, Bloomberg published a new investment instrument used by large financial firms called “Custom Tranche Opportunity” or Bespoke Tranche Opportunity (BTO), which allows the investor to buy a certain quantity or tranche. The highest quality of a package of credits placed by the financial institution is an instrument similar to the Collateralized Debt Obligations, also known as CDOs, which is the cause of one of the most significant financial crises in history.

What Is a Bespoke Tranche Opportunity?

This new instrument consists of a derivative that packages debts in different categories and allows investors to bet on what happens with their underlying loans. Unlike CDOs, in BTOs, most of the risk is indexed to the investor and less to the bank that sells them since it is this who requests the bank to build a risk instrument to buy it, assuming the consequences of a potential event of a risk. Non-payment Given this, it can be considered a risk instrument belonging to the family of derivatives at the center of the 2008 global crisis and amplified financial losses.

Despite the crisis already experienced, mainly caused by the already named CDOs, the financial product known as BTO is being backed by credits for financing studies. The purchase of vehicles, where, according to Goldman Sachs, a provider of this product and underwriter of Vehicle loans, of the total financing offered by the entity under this heading, 21% are subprime loans; that is, they have a level of default risk higher than the average of the rest of the loans.

Given this, the doubts that had about the financial regulation generated after the crisis multiplied. Even though at present the systematic risk is not so high, this instrument can create risks similar to those of 2008, since the deterioration in quality that the loans for study and acquisition of vehicles have presented, significant endorsements of the BTO, in the last few years, it is essential. Therefore, its control and regulation are necessary to avoid a future collapse.

In conclusion, it is unlikely that these structured products will have a scope similar to the 2008 crisis since they are considered more limited markets than mortgages. However, the risk indexed to BTOs is latent and even more so if the growing behavior of subprime loans is considered.

What is a Custom CDO? Characteristics

A custom CDO is a structured financial product, specifically, a secured debt obligation, that a dealer creates for a specific group of investors and tailors to their needs. The investor group typically buys a single tranche. The dealer retains the remaining tranches, who will generally try to protect himself against potential losses using other financial products such as credit derivatives. It is now more commonly known as a bespoke tranche or a bespoke tranche opportunity (BTO).

Traditionally, a secured debt obligation (CDO) bundles a collection of cash-flow-generating assets, such as mortgages, bonds, and other types of loans, and then repackages this portfolio into discrete sections called tranches. Custom CDOs can structure like traditional ones, grouping debt classes with income streams. Still, the term generally refers to synthetic CDOs that invest in credit default swaps (CDS) and are more customizable and nuanced.

Tranches are parts of a grouped asset divided by specific characteristics. Different tranches of the CDO carry different degrees of risk, depending on the credit quality of the underlying asset. Therefore, each tranche has a different quarterly rate of return that corresponds to its risk profile.

Obviously, the higher the probability of default on the tranche holdings, the higher its profitability. The major rating agencies do not rate custom CDOs; the issuer carries solvency assessment and, to a certain extent, by market perception. Because these are complex and illiquid financial instruments, custom CDOs only trade over the counter (OTC).

Background on Custom CDOs

Like CDOs in general, custom CDOs have lost popularity due to their prominent role in the financial crisis that followed the housing bubble and the collapse of mortgages between 2007 and 2009. The creation of these products by Wall Street contributed to the massive failure of the market, eventual government bailout, and a lack of common sense. The products were highly structured investments that were difficult to understand, both for those who bought and sold them and difficult to value.

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What Is a Bespoke Tranche Opportunity?

What Is a Bespoke Tranche Opportunity
What Is a Bespoke Tranche Opportunity?

Despite this, CDOs are a valuable tool to transfer risk to willing parties and free up capital for other uses. Wall Street is always looking for ways to share risk and unlock capital. So since about 2016, the bespoke CDO has made a comeback. In its reincarnation, it is often called a bespoke stretch opportunity (BTO).

However, the rebrand hasn’t changed the tool itself, but there is presumably more scrutiny and due diligence on the pricing models. It hopes that investors will no longer have obligations that they do not understand correctly with these new products. 

BTOs worth $ 50 billion were sold in 2017.

Advantages of custom CDOs

The apparent advantage of a bespoke CDO is that the buyer can customize it. It is simply a tool that allows investors to target specific risk performance profiles for their investment strategies or hedging requirements. If an investor wants to make a big bet directed against the goat cheese industry, a distributor will create a custom CDO to do it for the right price. Still, these products are somewhat diversified since joint loans from, say, several goat cheese producers.

The second main benefit is the out-of-market returns they can provide. When credit markets are stable and fixed interest rates low, seeking investment income must dig deeper.

Cons of custom CDOs

The big downside is that there is typically little to no secondary market for custom CDOs. This lack of market hinders daily prices. It would help if you calculated the value based on complex theoretical financial models. Those models can make assumptions that turn out to be catastrophically wrong, costing the holder dearly and leaving him with a financial instrument that he cannot sell at any price. The more personalized the CDO, the less likely it is to attract another investor or investors.

Then there is the lack of transparency and liquidity that accompanies OTC transactions in general and these instruments in particular. As unregulated products, custom CDOs are still relatively high on the risk scale, more suitable for institutional investors, such as hedge funds, than for individuals.

A real-world example of custom CDOs

Citigroup is one of the leading distributors in bespoke CDOs, doing business worth the US $ 7 billion in 2016 alone. To increase transparency in what has “historically been an opaque market” – to quote Vikram Prasad Citi’s managing director of Correlation and Exotics Trading – the bank offers a standardized portfolio of credit default swaps. These are the assets that are generally used to build CDOs. It also makes the price structure of the CDO tranches visible on its customer portal, “publishing” the figures obtained by the tranches.


  • A bespoke CDO is a secured debt obligation that has been customized for the specific needs of a particular group of investors.
  • Shunned because of their massive role in the 2007-09 financial crisis, bespoke CDOs began to reappear in 2016 under the name of the bespoke tranche opportunity (BTOs).
  • Custom CDOs today are primarily used by hedge funds and other sophisticated institutional investors.

Conclusion: Take back the risk

While tailor-made tranche opportunities and secured debt securities have their place, there is a place for instruments that sophisticated investors can use to tailor risk returns. It returns to their liking – the effect of leverage, the unregulated nature of these investments, and the destructive potential for implosion make them highly risky “opportunities.”

Some lessons remain unexplored more than a dozen years after the most significant financial crisis the world has seen in decades.

“If you look at the financial crisis, instead of looking at the underlying portfolio, people just look at the ratings,” says Tavakoli. “And instead of doing due diligence and digging deeper, they said, ‘Well, it’s diverse. “But diversification hasn’t helped you. It was just a buzzword.

“We never solved a lot of our problems,” says Tavakoli.

What Is a Bespoke Tranche Opportunity?

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