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Wall Street Revives Complex Derivative Trades Amid High Demand for Yield

Quiver Editor

Earlier this year, a hedge fund structured two trades worth $642 million, reminiscent of pre-2008 crisis transactions. Bayview Asset Management sold credit default swaps (CDS) to Huntington (HBAN) and Sofi (SOFI), then sold much of that risk to investors, according to Moody's reports and a source familiar with the transactions. This re-securitization echoes complex financial products blamed for exacerbating the 2008 crisis, highlighting a return of risky Wall Street practices in new forms. Demand for high-yielding products and the growth of shadow banking are fueling this trend, though experts say these trades now include more protections.

In the transactions, Bayview first sold CDS to Huntington and Sofi on portfolios of automobile and student loans worth $5.2 billion. Later, Bayview created bonds from the CDS and sold parts of the risk to other investors. These trades come with upfront cash requirements, which reduce counterparty risks. However, these structures may conceal issues in the banking system, making balance sheets appear healthier than they are. Experts like Jill Cetina from Texas A&M University warn that regulators should require more disclosure about credit risk transfers (CRTs) to better understand the risks involved.

Market Overview:
  • Bayview structured $642 million in re-securitized trades with Huntington and Sofi.
  • These trades are reminiscent of pre-2008 crisis financial products.
  • High demand for yield and shadow banking growth are driving this trend.
Key Points:
  • Bayview sold CDS on loan portfolios, then re-securitized the risk.
  • Upfront cash requirements now add more protections than pre-crisis trades.
  • Experts warn these structures may hide banking system problems.
Looking Ahead:
  • Regulators should require more disclosure on credit risk transfers (CRTs).
  • More such trades are expected as investors seek high-quality asset risks.
  • Current structures aim to mitigate counterparty risk with cash collateral and letters of credit.

The trades executed by Bayview involved selling CDS on loan portfolios to Huntington and Sofi, followed by re-securitizing and selling the risk to investors. This approach, though risky, includes safeguards like cash collateral accounts and letters of credit, which were not common before the 2008 crisis. Wells Fargo holds the cash collateral, and letters of credit from the Federal Home Loan Banks and Goldman Sachs back the transactions. Experts believe these structures could mask underlying problems in the banking system, despite their apparent robustness.

As more banks consider similar trades, industry analysts anticipate a rise in such re-securitized products. Scott Kenney from Columbia Threadneedle Investments notes that banks are motivated by capital optimization rather than asset problems, making these high-quality asset risks attractive to investors. However, the true test of these structures will come with a turn in the credit cycle, potentially revealing hidden risks that could impact financial stability.

About the Author

David Love is an editor at Quiver Quantitative, with a focus on global markets and breaking news. Prior to joining Quiver, David was the CEO of Winter Haven Capital.

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