Credit Structuring Grows As Banks Customize Products
By ERIK PORTANGER, Staff Reporter of THE WALL STREET JOURNAL, Jan. 23, 2003

LONDON -- For Oldrich Masek III, a credit-risk guru at J.P. Morgan here, there are two typical reactions when he explains his job at dinner parties: blank stares or smiles and a swift change of subject.

"I usually try to avoid it," says Mr. Masek, co-head of the bank's credit-structuring team in Europe. "Or else I just tell them I work in finance."

Credit structuring involves the blending or repackaging of financial assets as a way to spread risks among institutions and give institutional investors new types of exposure to a wide array of markets. It may be obscure, but Mr. Masek's specialty is one of the hottest areas in banking.

Even as banks lay off equity researchers and mergers and acquisitions advisers, they are hiring more structured-credit specialists. J.P. Morgan says it now employs about 180 people in creating or selling these products world-wide, several times more than it did three years ago. Tim Watmough, whose London-based recruitment firm specializes in bankers with credit-structuring skills, says some of them with four to seven years experience are making as much as 500,000 ($808,503 or 753,920) a year, including bonuses. He describes such pay as "very favorable" in comparison with other areas of investment banking at the moment.

The demand is driven by fundamental changes in the markets over the past decade. Banks that once had billions of lending risk sitting on their balance sheets, for example, now routinely pass much of it on to an assortment of investors such as insurers and pension funds. These investors, meanwhile, are increasingly tapping the credit-derivatives market to get exposure to a dizzying array of new risks.

Higher Returns

The idea: to spread the impact of any market shocks, while generating higher returns for investors than those offered by more traditional financial products. For investment banks, the fees generated from this business can be several times as high as those from other areas, such as issuing bonds.

The market for structured credit had its origins in the late 1980s with securitization, which involves moving certain assets from a company into a new entity and selling highly rated bonds secured by these assets. For cash-strapped companies, this offered an alternative way to raise money when traditional lenders were becoming averse. "It brought liquidity into the system," says Mr. Masek, a 35-year-old American. "You had this whole industry revolving around doing funding trades for companies."

The first key turning point for the market came when bankers realized that instead of putting assets from one company into a special vehicle, they could include assets from dozens of companies. That led to the creation of new, highly diversified financial vehicles known as collateralized debt obligations, or CDOs.

A key challenge during this time was explaining the concept to clients and investors. Some didn't get it at all. Others tried to go too far. In one example, Mr. Masek was approached by a client who wanted to securitize future church donations. The idea never got off the ground.

CDOs began to take off in the mid-1990s when banks began using them to offload credit risk. This freed up extra capital that could be spent on more lucrative business areas. Then came so-called synthetic CDOs. Instead of holding physical assets, these new CDOs could be filled with derivative contracts that could offer exposure to an enormous menu of different credit risks. Because they could be assembled quickly and tailored to specific needs, synthetic CDOs were an immediate hit with investors. "It was like offering a gourmet meal to someone who had spent their life eating potatoes and beans," notes one London-based banker.

The boom in structured products has forced banks to sharpen their in-house risk-management systems. That is because banks usually have to take on credit risk to provide clients with the products they want.

Antoine Chausson, head of structuring at BNP Paribas in London, says BNPP has a team of 10 "exotic" traders who constantly monitor and balance credit risks held by the bank. Just one structured product could contain hundreds of different credits, each of which needs to be watched closely for changes in risk profiles. To complicate things further, there could be hundreds of products within the bank's portfolio, whose correlation to each other also needs to be adjusted on a daily basis.

"It's like running a currency book with 600 currencies," Mr. Chausson says. "That is the sort of magnitude."

But there are clear benefits. In late 2001, for example, BNPP had a client that wanted exposure to a range of asset-backed debt, such as credit cards and mortgages. But the client, a major financial institution, wanted to receive interest payments on specific dates -- all but impossible to achieve with this class of products. No such product existed, so the bank created it -- taking the irregular payments onto its books to be managed by its exotic traders, and guaranteeing regular payments to its client. Last week, it finalized its third example of this product -- earning hefty fees in the process.

Rapid Evolution

Recently, clients have been building more-defensive, less-leveraged portfolios of risk in preparation for a possible U.S.-led war with Iraq, says J.P. Morgan's Mr. Masek. "They're demanding higher-quality credits and structures that are less likely to be downgraded."

Mr. Masek believes the market will continue to evolve rapidly as companies become more complicated and face more kinds of risks that need to be managed. Hybrid products are already beginning to take off as investors seek to customize their risk portfolios. These allow a client, for example, to sell insurance against the risk of a Brazilian sovereign default, while using the proceeds to buy exposure to a European stock index -- all within a single product. Bankers expect the trend toward customization to gain momentum as investors become more comfortable with the concept.

Technology advances are also expected to drive change in the market, by providing the tools for banks and other companies to better assess their own risks. In a few years, Mr. Masek predicts, structured-credit products might even become available to individual investors if banks can develop ways of communicating more directly with such clients. "The products make sense, but the technology for tracking and communicating with retail investors isn't there yet," he notes. "You can't rely on retail sales forces to sell efficiently in this area."

Once that problem is solved, Mr. Masek hopes, people at dinner parties might even understand what he does for a living.


  1. Why does securitization add value?
  2. How does securitization provide added liquidity for firms?
  3. How would you  create synthetic CDOs?
  4. Why, do you think, did securitized church donations not work?
  5. "Recently, clients have been building more-defensive, less-leveraged portfolios of risk in preparation for a possible U.S.-led war with Iraq, says J.P. Morgan's Mr. Masek."  What sort of reactions might you see from firms (as opposed to individuals)?
  6. How might you create structured products for a multinational firm?