October 20, 2011 / 3:30 PM / 8 years ago

IFR-Derivatives trades moved in counterparty fears

By Christopher Whittal and Helene Durand

Oct 20 (IFR) - Since the beginning of September, large supranationals, agencies and corporate clients have been reassessing their counterparty credit exposures, to US investment banks in particular, as their credit default swaps have gapped out over the past couple of months.

“We’ve definitely seen some clients re-assigning business. When competitors’ CDS have gone dramatically wider, we’ve got calls from clients saying they might like to assign swaps to us and asking for quotes,” said one senior fixed income banker at a European bank.

“Clients are monitoring counterparty credit risk much more actively because many got so badly burnt post-Lehman in terms of the cost of moving their swaps around.”

Many banks’ CDS spreads have widened significantly during the past couple of months, with US investment banks being among the hardest hit.

In early October, CDS referencing Bank of America hit 456bp, CDS on Goldman Sachs reached 416bp, and CDS on Morgan Stanley were 584bp, according to Markit. CDS referencing all three institutions have since narrowed, but spreads remain more than twice as wide as levels at the start of August.

At the same time, clients now monitor dealers’ creditworthiness far more proactively. This is in part a hangover from Lehman Brothers, when even collateralised clients - which are theoretically insulated from counterparty credit risk - found it incredibly costly to move trades to other counterparties in the wake of the broker-dealer filing for Chapter 11 bankruptcy.

“Since Lehman, people are more prudent in managing their counterparty risk and look more proactively at what exposures they have to ensure they have a balanced portfolio,” explained one counterparty credit risk manager at a major institution.

“It hasn’t been anything like post-Lehman, when there was a stream of people moving away from some of the weaker players. But certainly people are being prudent, realising there are issues, and are looking to balance portfolios.”


Dealers say clients have become more sophisticated in terms of assessing counterparty credit risk, and will concentrate on dealers’ CDS levels as well as monitory a bank’s credit rating. One senior banker points to 300bp or 350bp as being a crucial threshold in terms of perceived creditworthiness.

Consequently, market participants are in disagreement over which institutions are being most actively shunned by clients. Some dealers highlighted Bank of America’s recent credit rating downgrade to Baa1 by Moody’s as significant, but the bank is by no means an outlier in terms of credit spreads.

One head of investment banking at a major institution indicated some clients were moving away from U.S. investment banks in general, and also pointed to French banks - which saw their CDS balloon in mid-September. Sources close to French banks denied seeing any such activity, though.

“We’ve not experienced clients moving away from us. On the contrary, we’ve seen more clients come to us as a result of our strong positioning in the equity derivatives markets,” said a source close to one French bank.

Sources at US investment banks also denied clients were moving away, stating trading volumes were flat or even up in some asset classes over the month.

“We have seen very little evidence of [clients assigning trades away from us],” added a senior banker at a US institution. “I’m not saying it’s zero, but it’s very minimal. In fact, it cuts both ways - we’ve also received novations from other banks.”

Senior bankers at more credit-worthy institutions insist clients are looking to re-assign swaps, but admit it is on a far smaller scale compared with the post-Lehman deluge.

They also highlight there is no open door policy in terms of the amount of risk they’re willing to take on. This is particularly true with regard to SSA clients that prefer to trade under one-way collateral agreements, which can be immensely costly for dealers.

“We have had a lot of people coming to us who are interested in assigning trades and we have completed some deals. We are looking at risk and exposures, and our own exposure as well - in this market we have to stay conservative. There will be more stuff coming to market, so we’re not in a rush to buy back risk,” said one head of rates at a major bank.

“Overall, I think [these types of scenarios] will accelerate the push towards central clearing [which reduces counterparty credit risk],” he added.

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