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Over the worst months of the credit squall Citi was obligated to nearly double its exposure to subprime CDOs. “Agreements” meant the bank bought an extra $25bn of subprime CDO paper, at a time when the market for CDO debt was crashing.

In Citi’s 10-Q filing on Monday, which you can view here, the bank repeated its weekend disclosure of $43bn in CDO super senior debt “backed primarily by subprime collateral.” The crucial point being that most of that was made up of:

…approximately $25 billion in commercial paper principally secured by super senior tranches of high grade ABS CDOs.

Commercial paper (CP) is short term debt; carrying a typical maturity of 90 days. Citi declined to comment on the issuers of the debt, but did say said the debt was taken on “over the summer”.

Commercial paper might be more familiar to most as the Achilles heel of that other credit crunch protagonist, the SIV. But forget Citi’s SIVs. Trouble in the commercial paper market for CDOs is causing much more pain for Citi. Not only are CDOs loaded with subprime - unlike Citi’s SIVs - but the bank also has far more significant funding commitments to them.

FT Alphaville understands that Citi has numerous agreements in place with CDOs that force the bank, as arranger, to buy CDO commercial paper if they cannot place it. That unplaceable debt has totalled $25bn so far - but there could be more.

Deep down on page 73 of Citi’s 10-Q filing with the SEC on Monday, it says:

[Citi] may, along with other financial institutions, provide liquidity facilities, such as commercial paper backstop lines of credit to the VIEs. [Variable interest entities - off balance sheet vehicles Citi has an interest in].

The Company may be a party to derivative contracts with VIEs, may provide loss enhancement in the form of letters of credit and other guarantees to VIEs, may be the investment manager, and may also have an ownership interest in certain VIEs.

Most CDOs, of course, don’t normally issue CP. Traditionally, CDOs issue straight tranches of rated bonds. But Citi made CDOs issuing CP good business pre-crunch. You might say that commercial paper CDOs are a scion of the SIV world - using CP issuance to supplement their normal debt issues and create a more dynamic, flexible portfolio, benefiting from low yielding CP.

But also just like SIVs, CDOs need to keep refinancing that CP to pay off upcoming redemptions. But where they differ is that CP issuing CDOs mitigate that rollover risks by using their arranging banks’ as underwriters on all new CP issues. Whatever CP they can’t sell, agreements are in place as backup that ensure banks will buy.

And just like with SIV CP investors, over the summer, CDO CP buyers have dried up.
Money market funds - formerly among the biggest players in the CP markets - are loathe to touch anything containing MBS.

So Citi - unable to place CP on subprime CDOs it arranged as far back as 2005, - is having to buy it instead. Right when it can least afford to do so.

Crucially we should make clear that Citi isn’t necessarily being “forced” into buying that debt: not in the most literal sense of the word. The backstop “agreements” it has in place are not set in stone. It could have said no. But had it done so it may have seen CDOs default, or else a rush to sell assets to meet amortizing CP. In the event, that was evidently too ugly an option to countenance.

And Citi may only now be ruing that decision. Commercial paper is classed as “super senior” debt in CDOs, and had until October, held out as a secure tranche. But the contagion has spread right up the tree, and the rating agencies have shown now mercy for even the highest grades of debt. Super senior debt is far from secure.

Citi declined to comment.