In another sign of a booming CDO market, a handful of credit derivative product companies (DPCs) are cropping up and offering credit enhancement products similar to those offered by monoline bond insurers.

In the last year, companies like Athilon Structured Investment Advisors are among those that have either launched or are looking to do so. Armed with triple-A credit ratings, they typically provide credit protection on the super senior tranches of CDOs. In that line of business, they regularly bump shoulders with traditional monoline bond insurers.

"The DPCs do present more competition," said one professional at a bond insurer. "For the last 12 months or so, their presence has gradually been felt."

Bermuda-based Primus Guaranty sees it too, even though the company specializes in single-name credit default swaps and would not compete directly with the new companies. Nevertheless, during its first-quarter conference call recently, Jasper Thomas, chief executive officer of Primus Guaranty, said company officials were aware of about eight to 10 separate groups that were in various stages of setting up credit derivative operating companies.

Undoubtedly, setting up a DPC is easier than establishing a reputable monoline bond insurer. Essentially, DPCs need rating agency backing, sophisticated risk modeling, financial backing and a very experienced team of professionals in credit swaps.

Assembling those components, however, is just a starting point to getting the swaps market to warm up to a DPC business, according to some professionals.

"On top-tier fund manager said it was four years before they felt completely satisfied that they had worked out the kinks in their credit derivatives trading operation," said Janet Tavakoli, president of Chicago-based Tavakoli Structured Finance.

Although some big-name bond insurance companies acknowledge that the credit enhancement business has become more competitive, some say that the new players have not done much to shake their confidence in their market positions, especially because the CDO business is growing by leaps and bounds. According to the International Swaps and Derivatives Association, the CDO market has reached a notional value of more than $17 trillion. With so much business to be had, market players say there is plenty of room for the DPCs and the well-established bond insurers.

The increasing presence of DPCs validates Primus Guaranty's business model, said Thomas, who added that after the company completed its IPO in 2004, senior management was convinced that it was only a matter of time before other credit default products came onto the market, given the benefits of the structure.

Established players point out that the credit swaps market is large enough for the established players and the upstarts. If all the groups currently in the development stage became operational, their combined market share would represent a small slice, about 1%, of the overall credit swap market, said Thomas.

"Our estimation is that two or three may be operational within the next 12 months," he said, "most of the new companies are focused on an investment strategy built around selling protection on highly rated tranches, not single-name credit swaps."

Some large bond insurers share the sentiment.

"Certainly they are in the business areas we cover," said one source. But, he added: "There is a lot of volume right now - more than enough for them to satisfy their appetite and allow us to be selective."

And although establishing a DPC is less taxing than establishing a reputable monoline bond insurance company, building credit platforms, raising capital and securing triple-A ratings are still significant hurdles, said Thomas.

"In the esoteric space, they are not a factor," said Dan Bevill, a managing director of structured credit at Assured Guaranty, who specializes in unusual securitizations. "The truly funky deals are going to be done as a wrapped deal."

At any rate, the securitization market is at a benign point in its credit cycle, said one professional. Spreads are tight and competition for swap counter parties is robust. Some market players, however, predict an eventful season six to nine months from now, especially if the credit cycle becomes more volatile.

"I would choose the monolines," said Tavakoli. While some of the newer companies are sprouting up with a handful of close-knit professionals, "the monolines have a lot of depth on the bench. They have experience and have developed models and infrastructure."

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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