Collateralized debt obligation houses in Europe have set their sights on trading correlation on asset-backed securities and Deutsche Bank and SG CIB appear to be leading the race. SG has already placed some EUR250 million of single tranche ABS products linked to AAA asset-backeds and Deutsche Bank is readying trading both single-name credit-default swaps and tranches of ABS.
The upsurge in demand for asset-backed securities over the last year has prompted banks to issue more structured products, such as single-tranche investments referenced to ABS, according to financiers. Officials at Deutsche Bank declined comment.
Bertrand Fitoussi, the Paris-based head of the structured credit group at SG CIB, said client interest is high but the bank is limited in the amount of business it can do because it uses SG's balance sheet in every transaction. When Fitoussi's group delta hedges, it stores the underlying ABS on balance sheet and has to pay an internal charge for this.
Rivals said Deutsche Bank has an advantage over most players because the huge asset-backed securities portfolio its Winchester Capital Principal Finance unit has accumulated acts as a natural hedge to any correlation trades.
One of the largest hurdles is that each asset-backed security is unique; just because an issuer places multiple ABS does not mean all the deals are the same. "You are hedging the issue, not the issuer, and that's hard," noted one exotic credit derivatives trader. Fitoussi said because of this SG has structured only trades referenced to liquid and highly-rated ABS. The relatively small notional sizes also makes hedging the exposure harder because the underlying is less liquid and also limits the demand.
In addition, ABS has prepayment risk, which credit-default swaps referenced to corporates don't. Fitoussi said SG takes some of this risk and passes the rest to investors by tailoring the documentation to allow substitution if the ABS prepays. The last factor is more on the demand side. There is much more demand for generic Ford Motor Co. risk than there ever will be for a particular ABS and therefore liquidity will always be limited.
Bankers estimated it will take another six months before the market starts in earnest and even then it will start off slowly. This is because there are so many more moving parts to a deal referencing an asset-backed security compared with one on a corporate.
