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First-To-Default Appetite Sharpens On Sub-Prime Crisis
Total Securitization -- Institutional Investor News (April 10, 2007)

European interest in first-to-default baskets of U.S. financial companies with exposure to the U.S. sub-prime mortgage market is picking up. In first-to-default trades, investors sell protection on a basket of bonds--in this case on banks and financial companies--and pay the losses on any name that defaults during the life of the trade. First-to-defaults are simple structures that have been around for years, but interest in them has started picking up as investors look for new ways to play on the sub-prime fallout.

Tony Venutolo, global head of synthetic credit structuring at SG Corporate & Investment Banking in London, said the idea is that the market has overreacted to rising sub-prime defaults and delinquencies. Firms with sub-prime exposure, such as Bear Stearns, Countrywide Financial, HSBC, Lehman Brothers and Wells Fargo, have seen credit-default swap spreads blow out to multi-month wides. "It is attractive to sell protection on these names [at current levels]," Venutolo said. "This is usually done in first-to-default format."

Venutolo said he has had 10 to 15 enquiries from European prop desks and credit portfolio managers about first-to-defaults on U.S. banks in the last three weeks, from none last month. A typical five-year trade on a five-name basket of bank and financial companies pays 100-150 basis points over LIBOR. He declined to say how many trades have been structured. Jean de Lavalette, director in structured credit solutions at SG in New York, said he has not seen the same kind of interest from U.S. investors because they have natural exposure to the sub-prime market.

European investors, however, have been looking for ways to add exposure. UBS recently launched a constant proportion debt obligation referencing 50 banks and financial companies to take advantage of widening spreads. "I could see how [first-to-default] is a good trade," said one officials there, but declined comment on whether UBS is working on any deals.



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