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Derivatives

Investment Fraternity Plans First Credit-Default Swap

Lutheran Brotherhood, a Minneapolis-based member-owned fraternal benefit society that provides investment services to its 1.2 million members, is planning to use single-name credit-default swaps for the first time next year for both hedging and investment. Steven Lee, portfolio manager, said it is too early to determine if Lutheran would look to buy or sell credit-default swaps. "We could potentially do either," he added. Several undisclosed investment banks are currently providing research on credit derivatives for Lutheran, but it has yet to decide on possible counterparties, Lee said. He added that Lutheran has used bond options in the past, but on a limited basis. "We decided to take a look at credit derivatives now basically because they're very available. A few years ago you couldn't get into it," he added. Lutheran sees credit derivatives as a way to tailor its risk and manage its credit.

Founded in 1917, the firm has USD27 billion in assets, most of which is in fixed-rate investment-grade bonds and mortgage loans.

Lee said the notional sizes it is looking at hedging and investing with credit derivatives would range between USD5-20 million. Lutheran started exploring credit-default swaps earlier this year, when it began to recognize the rapid growth of the market and the potential it held for capitalizing on the recent rise in "credit blowups," such as those in the telecommunications and technology sectors. Lutheran may use the swaps for shorting certain credits, but would primarily use the swaps for protection. "We see it as a way to protect our assets," Lee noted.

The firm is investigating how to legally incorporate credit-default swap trades within its insurance division. Lutheran is currently working out the details of a planned merger with Aid Association for Lutherans. The merger will unite the two largest fraternal insurance organizations in the U.S. "The merger is scheduled to be completed fully by the end of this year. At that point we're going to begin putting an investment strategy policy in place that will include entering single name credit-default swaps," Lee said.

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