June 2001
Master chefs of the credit market
In the back parlours of the financial markets, where credit derivatives meet securitization, bankers are slicing and dicing credit to create a grand smorgasbord of investment products. The names of these delicacies are confusing, the recipes are closely guarded secrets and each firm has its own unique house style. But for firms and bankers with the requisite
know-how, there is plenty of money to be made. The top credit structurers – bankers with a background in quant, an understanding of credit and a flair for complex legal contracts – can name their price.
When credit spreads narrowed sharply in early May,
investors and issuers breathed a sigh of relief. But the rise in
corporate bond prices was not driven by a rally in equities or an
interest rate cut. A new and powerful force was at work in the
credit markets. "That tightening of credit spreads was driven
almost entirely by the credit derivatives market," says a senior
credit derivatives trader. "Banks have been buying massive amounts
of credit to cover short positions."
In the past, it was difficult to take a big short position in the
credit markets. That has now changed with the arrival of bulk
credit derivative trades known as portfolio swaps or synthetic CDOs
(collateralized debt obligations). By combining credit derivative
tools with the tranching techniques of securitization, banks can
sell large pools of credit without the need to transfer the assets
physically.
These trades were...
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