At the beginning of the year, a prophetic Salomon Smith Barney released a research piece titled "Mind the Gap - Between Secured and Unsecured," which, had an investor followed Salomon's advice, would have been one of the best plays of the year (See ASR 2/4/02). The idea - buying the triple-B rated classes of monoline-issued credit card ABS, while simultaneously buying credit-default swaps of the triple-B-rated parent, or shorting its debt - would have reaped substantial gains.

At the time, prior to the collapse of Adelphia, WorldCom and Tyco Inc., to name a few, the outlook for the economy was somewhat optimistic. Salomon researcher Mary Kane noted that there was "little spread difference" between the comparably rated ABS and corporate debt and theorized that "these narrow differentials will soon reverse course."

Using Capital One Bank as an example, by investing in both five-year triple-B credit card ABS and five-year credit default swaps, one could have cleared 645 basis points at one point on the option trade, which would have covered the roughly 160 basis point loss in Cap One's credit card subs.

In February, a credit-default swap for five-year Cap One unsecured paper would have cost 355 basis points, according to Creditex, Inc.'s PriceTracker, versus 140 basis points over Libor for Cap One triple-B card ABS. Currently Cap One five-year credit default swaps are quoted at 750 basis points, recovering from a level of 1000 on Aug. 7, just weeks after the announcement of the Memorandum of Understanding (MOU) with federal bank regulators. Triple-B credit card paper has remained wide and is currently quoted in the 300 basis point area over one-month Libor.

Had an investor purchased Cap One credit default protection in February at 355 basis points, he or she could have sold that protection at the going market price, locking in a profit of up to 645 basis points based on the Aug. 7 wide levels. Cap One 8.75% senior notes due 2007 were quoted last week at $0.80 on the dollar, yielding 15.25%, according to IFR Credit.

Back in February, then research director Peter DiMartino said that "Acute Enronitis," as he called it, "may have begun to infect investor sentiment" and the fallout "may soon be pushing investors out of corporate debt." As it turned out, the ABS market enjoyed crossover buying from the corporate sector throughout the summer as scandals plagued unsecured debt markets.

As predicted, the asset-backed investor was protected by the disproportionate widening seen in corporates versus ABS. In fact, using Cap One as an example, the 645 widening in default swaps outpaced the five-to-one ratio SSB had predicted, widening 64.5 basis points for each 10 basis points of widening in ABS.

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