Capital Markets Engineering and Trading (CMET) expects to close its second transaction this week, a $200 million CLO-like hybrid called South Street Securities, which establishes a $15 billion repo trading desk for the benefit of Daiwa Securities.

CMET's structures combine characteristics of market value CDOs and SIVs. Unlike typical CDOs, the resulting vehicle is an operating company owned by CMET Financial Holdings. In this case, SSS will be an actively run the trading activities under head trader Jason Schuit.

This is CMET's second deal this year, and the firm is hoping to a third before 2005. The first deal, called Three Rivers Funding, closed in February, and its trading operations (repo) beginning in March.

CMET, established four years ago, is headed up by former Citibank bankers, including Murat Akgun and James Tabacchi.

The proceeds from the trading operation are passed into the deal as interest payments. While the senior notes are a natural triple-A, XLCA also participates in the transaction as a swap counterparty, in this case providing a credit default swap against the senior class.

Like the previous deal, HSBC purchased the triple-As, sized at $140 million. The deal also includes $20 million in triple-B rated junior notes and $40 million in equity investment.

The CMET transactions allow firms access to trading operations without the capital costs of running the desk. The treatment lowers the cost of capital (the notes approximate 1.33% of the South Street's trading capacity, for example), while regulatory capital requirements against a repo desk can typically range from 4% to 6%.

Risk considerations in rating these deals include repo counterparty risk - generally considered fairly low - and market value risk. As an operating vehicle, South Street moves in and out of positions over the yield curve in a way that statistically produces a reliable cashflow. Market value triggers are embedded in the deal, however, which could cause it to unwind if certain thresholds are breached, similar to market value CDOs.

Repo trading desks "generate revenue through establishing positive interest rate spreads between matching repo and reverse transactions, and taking advantage of differences in interest rates along the yield curve," said Cesar Crousillat, a vice president and senior analyst at Moody's Investors Service, which rated both of CMET's transactions.

CMET's use of CLO technology provides capital relief to trading operations and was originally envisioned by CMET's principles while at pre-merger Citibank. The team was exploring the idea of taking Citibank's entire fixed-income trading operations off-balance sheet, though the task fell by the wayside as post-merger Citigroup realigned its strategies.

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