Structured credit

Structured Products Europe Awards 2007

A relatively strong performance during the credit crisis, combined with one of the most impressive growth and innovation stories in the market gives BNP Paribas this year's credit award. Traditionally a very strong equity derivatives house, the bank entered the structured credit space in 1999 with single-tranche static deals. However, it was not until 2005 that BNP Paribas started to demonstrate market-leading expertise, when it launched Dynamo, a long credit constant proportion portfolio insurance (CPPI) product managed by Credit Agricole Asset Management. This established the bank as a leading credit CPPI provider and innovator, and its trajectory since then has been solidly upwards. Dynamo sold more than $900 million and was followed, in April 2006, by Axiom, another credit CPPI product, which garnered more than $500 million of business. This was the first time that a credit deal had been syndicated.

The success story continued into this year with the launch of the bank's latest CPPI product, called Azur, which sold $510 million in May. The notes, which are linked to a credit portfolio managed by Axa Investment Managers, are designed to allow the manager to switch in and out of different assets and asset classes with the aim of harnessing both market beta and dynamic alpha. Axa has the discretion to populate the underlying reference portfolio with a range of positions, from long and short plays on single-name credit default swaps (CDSs) and CDS indexes to emerging markets exposures, duration strategies, and long positions on asset-backed securities (ABSs), leveraged loans and bonds. Since launch, Axa has wisely kept clear of the ABS market, and BNP Paribas says the rest of the portfolio has held up well. Indeed, if anything the credit volatility has presented good opportunities for generating alpha.

The bank refers to its version of credit CPPI products as dynamic proportion portfolio notes (DPPN). While CPPI strategy aims to maximise exposure to a portfolio while providing capital protection at maturity, the DPPN technique entrusts the outside manager with the management of the overall exposure within limits set by BNP Paribas.

The Azur notes provide full principal protection, and the bank says investors can expect 350 basis point returns above Euribor rates for the 10-year capitalisation version of the notes, which pays performance at maturity - it can also be accessed as a distribution note, where the payout is realised through a Euribor-plus coupon.

So how did the bank manage during the credit crisis? "We did third-party distribution deals in the heat of the crisis," says Joe Lovrics, the bank's London-based head of structured credit sales. "We've taken no losses and no write-downs, we're profitable across the entire credit business - we have doubled our profitability in the last two years."

Of course, the credit crunch did affect some of the products that BNP Paribas planned to issue this year. Notably, its structured credit team put together a constant proportion debt obligation (CPDO) in collaboration with fixed-income manager Pimco, which was famously critical of the early CPDO deals that hit the market last year. In December, Pimco managing director Bill Gross put out a well-publicised warning about the viability of the then CPDO structure. "Increasing multiples of leverage beyond 15 times near current yields spreads cannot maintain either a AAA rating and/or the 200 basis points in yield spread that have made this derivative so attractive," said Gross, adding that the increasing use of leverage "appears to have run out of its magical ability to increase returns".

BNP Paribas thought it could take the concept further. "When CPDOs were being done in the first half of this year, we believed it wasn't justifiable to pay a manager for an index-based CPDO. We thought the best way to extract value from the manager was to do a bespoke deal," says Lovrics, adding that its product was put together on the basis that it would start from a relatively low leverage level, which would then be increased as credit spreads widened.

When the credit crisis hit the markets, the product was put on hold, where it remains for now. However, BNP Paribas' ability to convince the most sceptical of fixed-income managers, Pimco, of the viability of a CPDO product speaks highly of its structuring skills. It also demonstrates the banks determination to take concepts that have already caught on in the market and take them to a new level of sophistication. BNP Paribas may not have the biggest credit book among its peers, but it does have one of the most dynamic and innovative structuring businesses around.

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