Lehman Brothers
Lehman’s steady but sure approach in CDOs and CDS is paying dividends
| Jim Ballentine |
Jim Ballentine, Lehman Brother’s global head of structured credit, told Euromoney last year: “In certain respects people are getting ahead of themselves, looking at structured products because they are structured products, rather than focusing on the value that these products are adding.” He looks smart now.
Lehman Brothers has been one of the more conservative credit derivatives houses. It has focused on doing the right things for its credit derivatives clients. If that has meant missing out on a few extra cents per share over the years, so be it. And it has protected the bank from the reputational risk that the likes of Barclays Capital and Bank of America have run selling synthetic structured credit products. Lehman Brothers’ refusal to get ahead of itself is one of the reasons that it is our credit derivatives house of the year.
That’s not to say that Lehman can’t handle complicated products. There is more to its credit derivatives capability than flow CDS business. “In our overall structured credit business, CDOs is front and centre and correlation trading is front and centre,” says Ballentine.
On managed CDOs, for instance, the bank is focused rather than fearful. “Our managed CDOs include cash and synthetic deals, and we bring deals that we live with for five, 10, or 15 years,” says Beth Starr, managing director, structured finance in New York. This brings high levels of repeat business from the best CDO managers. “We would turn away managers who are in the middle of the pack,” says Ballentine. “They go somewhere else where league table focus means they do the deal.”
Lehman is also responsive to investor demand. In the past six to nine months, high-yield synthetic CDOs have taken off. Lehman was the first house to structure a high-yield deal publicly rated by both Moody’s and Standard & Poor’s. It has also closed a unique deal in which 90% of the reference portfolio was CDX IG3 and 10% was a single-A rated tranche of a high-yield portfolio. Some $450 million of high-yield mezzanine CDO tranches has been issued under this programme.
“We work with lead investors and they help us choose the pool. They might buy up and down the capital structure, or buy one class and then we market to other investors to defray costs,” says Starr. “We look at things that appeal to a wide range of investors.”
One reason Lehman can take this approach is its understanding of the underlying assets. From the well-defined high-yield market to the more nebulous secondary high-grade loan market, it understands the arbitrage-driven economics of cash CDOs, the way that loan deliverable credit default swaps track the loan markets, how high-yield CDS trade (like bonds), and so on.
Lehman also has a strong CDO research and analytics franchise, with over 400 deals modelled and accessible to investors through LehmanLive.
Lehman has merged its cash and synthetics businesses and so overall flow trading has continued to grow. Lehman’s strategy is to be a top three house. “We want to be in the flow and capture market share, but not at the expense of overall profitability,” says senior vice-president Mike Carter. Between July 2004 and May 2005, Lehman traded over $500 million of recovery products. It is number one by market share in loan deliverable credit default swaps and is a top three dealer in high-yield CDS swaptions.
Lehman’s is a global practice. The bank offered the first CDO squared deal distributed into Australia and the largest ABS synthetic CDO executed in Asia. In 2004, the bank structured a multiple currency, multiple collateral deal based on European leveraged loans that it sold in Asia, the US and Europe.
That’s the only way to work these days. In May, European clients needed US sales coverage as the credit markets reacted to the GM and Ford downgrades. Appetite for different structured products shifts from region to region, often depending on how advanced the products are. “Around 75% of CDO squared issues were distributed in Europe, while high-yield deals are led by the US,” says Carter.
Similarly, index correlation products are bought and sold by global investors, creating global flows. Around 10 months ago, Lehman started making a bigger push into CDX options and tranches. Consistent with its aims, it is now a top three player by CDX volumes traded outright and in CDX options. At the end of April, Lehman’s 30-day average trading volume on CDX indices was approaching $1.9 billion a day. “At the beginning of this year, the figure was about $400 million a day,” says Carter. “So our volumes are up around five times.”
While that partly reflects the increased use of CDX indices by clients, the increase in Lehman’s cashflow volumes – from around $600 million a day to $1 billion a day – shows how it is growing its trading business. Through making two-way markets in various names, Lehman provides around $4 billion of liquidity to the market at any one time. It was the first dealer in Europe to trade the seven-year part of the curve, boosting the pricing of the term structure.
