No longer content to watch from the sidelines, big players have officially moved into the CDPC space -and some expect they'll come to dominate it, bringing a wave of liquidity with them. Marking the first entrance of a prominent structured credit market participant, Massachusetts Mutual Life Insurance Co., parent of asset manager Babson Capital Management, officially launched its CDPC Invicta Credit LLC. last week. Deutsche Bank and AXA Investment Managers are waiting for a rating for their CDPC, NewLands Financial, and Bear Stearns and AIG Investment Management are also rumored to be hanging in the wings.
The entrance of established structured finance players to the CDPC market brings to the Street a broader array of highly rated counterparties. The resulting ability to diversify counterparty risk is expected to bring an increasing amount of liquidity to the top of the capital structure, market participants said. "One of the things it would do is continue to contribute to better and better liquidity for senior tranches of ABS transactions," said Nik Khakee, a director at Standard & Poor's. And while it is more difficult to achieve a triple-A counterparty rating for ABS transactions, Invicta, which is currently able to operate in the corporate arena, is on that path.
Established structured finance players looking to get into the CDPC market say they are entering now, despite the tight spread environment, because the sector's pioneers - Primus Guaranty and Athelon - have validated it. And as CDPCs such as Primus have leveraged their resources to extend into the CDO sector, those currently in the market have the cost advantage of a built-in infrastructure. In fact, the ability to use existing resources to drum up additional fees is likely the impetus behind the CDPC craze, one source pointed out. Underscoring that point, Invicta only has three full-time employees. "It is hard for us to imagine that there is a more cost-effective way to do this," said Invicta President Ian Hawkins. Services not specific to the CDPC are provided through agreements with Babson and MassMutual, he added.
"We expect that the majority of CDPCs launched in the future will be sponsored by major financial institutions," Hawkins said. Rating agencies say they have as many as 20 CDPC proposals on deck, and at least in the case of S&P, about a quarter of them are backed by large corporate sponsors, Khakee stated. "I think that some firms have watched the initial companies and gotten a bit more comfortable with the structure, the income expectation and market acceptance," he said. Other appealing features of the companies include the fact that they are not required to mark their positions to market, have a wide range of leverage available, depending on the structure, and do not have to post a margin.
But not everyone is so bullish on CDPCs. "I think what we're going to find is that these guys are going to be scrambling for product," said derivatives expert Janet Tavakoli, president of consultancy Tavakoli Structured Finance. The path toward obtaining a triple-A rating is also a long and arduous one. Depending on the complexity of the proposal, business plan and availability of resources to execute it, a rating could take between five months and a year. The ratings are complex, melding together both corporate credit and structured finance ratings, an aspect that adds to the time-consuming nature of setting up such a vehicle, and one that leads to speculation as to how many will actually make it through the rating process. One source said he expects one or two this quarter.
CDPCs typically act as highly rated counterparties in credit default swaps, although their activities range from single-name swaps to an area that makes monoline insurers uncomfortable - selling protection for highly rated CDO tranches. The companies generally stay within triple-A rated territory because of the cost associated with carrying lower rated trades. Invicta's strategy as a synthetic buy-and-hold investor calls initially for writing protection on synthetic CDO backed by corporates, portions of CDOs and single-name RMBS.
Particularly in this environment, Invicta plans to stay in the triple-A and super senior areas, focusing on shorter maturities and higher ratings. It plans to solidify its ability to write protection on ABS CDOs and single-name RMBS by the end of the quarter.
CDPCs typically start up with about $500 million in equity capital. Primus, for example, was capitalized with about $600 million as of September. Deutsche has committed $125 million in equity to start up the NewLands CDPC, and the rest will be raised through debt financing. Primus was considered the first CDPC to enter the credit derivatives market when it opened in 2002.
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