Credit-Linked Notes. Nick Johal. Thursday 4 th June 2015

Transcription

1 Credit-Linked Notes Nick Johal Thursday 4 th June 2015

2 Agenda Investing in Credit for DFMs issues and challenges What are the benefits of taking a synthetic credit exposure? What are the risks? Questions & Appendix 2

3 Investing in Credit Issues DFMs face Prospectus Directive Duration Liquidity Supply Retail Bonds Absolute Return/Strategic Bond Funds 3

4 Tailwinds for Credit Demographics Annuities changes and NISA Benign inflation environment Japanification of Europe Technicals 4

5 What are the benefits of taking a synthetic credit exposure? 5

6 Credit Linked Note (CLN) A credit linked note (CLN) is a form of funded credit derivative. It is structured as a security with an embedded credit default swap allowing the issuer to transfer a specific credit risk to credit investors. Synthetically, the risk profile is similar to being long the reference entity. On the Issue date, the investor buys the CLN at par value. As a note holder, he is entitled to receive the coupons linked to the credit risk of the underlying. At maturity; If no Credit Event has occurred since inception, the Notes are redeemed at par value on the maturity date. If a Credit Event has occurred since inception, the Notes are redeemed by paying the Recovery Value to the note holder. The investor bears a loss of {(1-R)*N]. In a worst case scenario, investors could lose their entire investment. Various iterations are possible e.g. Single name CLN The note is issued with protection sold on one reference entity Basket CLN The note is issued with protection sold on a basket of defined reference entities. First-To-Default baskets 6

7 Credit Linked Note (CLN) simple cashflows 100 CDS Ref Ref Investor Bank CDS Market Entity Entity CLN Spread 100 Funding Treasury desk 7

8 Transparent and easy to price CLN coupon = CDS spread + Swap rate + funding - cost SKYLN 8y CLN Coll 8y Swap rate (IRSB) 2.00 CDS Spread (CDX/CDSW) 1.00 Funding 0.05 Cost CLN coupon (%) 2.95 *priced 18/11/2014 8

9 Liquid, Flexible, Access Access Flexibility Economic Benefit Credit Coupon Type Positive Basis Duration Currency Costs vs Funds Denomination Priced at Par Curves CDS Liquidity QCB 9

10 Supply no longer an issue Format Debt Currency GBP Instrument Issuer SG Issuer (Secured) Settlement / Recovery American Cash settlement / Market Recovery** Collateral Any mixture of Gilts, Investment Grade Bonds or FTSE 100 Stocks* Payment Frequency Semi-Annual (30/360) Maturity 10/04/2022 Capital Protection Full capital at risk *If stocks posted an extra 10% haircut applied **As determined by the ISDA process Reference Entity Coupon pa S&P Moody's Fitch Reference Entity Coupon pa S&P Moody's Fitch Pfizer Inc 2.02% AA A1 A+ BHP Billiton Ltd 2.45% A+ A1 A+ Anheuser-Busch InBev NV 2.08% A A2 A Telefonica SA 2.45% BBB Baa2 BBB+ AstraZeneca PLC 2.10% AA- A2 A+ UPM-Kymmene OYJ 2.51% BB+ Ba1 nr Munich Re 2.10% nr Aa3 AA- SSE PLC 2.52% A- A3 A- Dixons Retail PLC 2.16% nr nr nr UniCredit SpA 2.60% BBB- Baa2 BBB+ British American Tobacco PLC 2.17% A- A3 A- Severn Trent PLC 2.61% BBB- Baa1 nr BT Group PLC 2.20% BBB nr BBB Tate & Lyle PLC 2.61% BBB Baa2 nr Next PLC 2.22% BBB Baa2 nr Rio Tinto PLC 2.62% A- A3 A- Lloyds Banking Group PLC 2.24% BBB A2 A ITV PLC 2.73% BBB- Baa3 nr National Grid PLC 2.24% A- Baa1 BBB Marks & Spencer Group PLC 2.77% BBB- nr BBB- Barclays PLC 2.25% BBB A3 A Firstgroup PLC 2.82% BBB- nr BBB- HSBC Holdings PLC 2.25% A Aa3 AA- United Utilities Group PLC 2.82% nr nr nr Rentokil Initial PLC 2.34% BBB nr nr Jaguar Land Rover Automotive 2.88% BB Ba2 BB- Royal Bank of Scotland Group P 2.34% BBB- Baa2 A British Airways PLC 2.93% BB Ba3 nr Sky PLC 2.35% BBB Baa2 BBB- Nokia OYJ 2.93% BB Ba2 BB Imperial Tobacco Group PLC 2.35% BBB Baa3 BBB Safeway Inc 2.95% B B2 nr Legal & General Group PLC 2.36% A A3 A J Sainsbury PLC 3.04% nr nr nr BP PLC 2.37% A A2 A Peugeot SA 3.20% B+ Ba3 B+ Prudential PLC 2.40% A+ A2 A+ Fiat SpA 3.30% nr nr BB- Standard Chartered PLC 2.41% A- A2 AA- Tesco PLC 3.34% BB+ Ba1 BBB- Vodafone Group PLC 2.41% A- Baa1 BBB+ Glencore PLC 3.38% BBB nr nr Lafarge SA 2.42% BB+ Ba1 BB+ Anglo American PLC 3.47% BBB Baa2 BBB Enel SpA 2.43% BBB Baa2 BBB+ Rallye SA 4.09% nr nr nr Royal & Sun Alliance Insurance 2.43% A A2 A- Ladbrokes PLC 4.13% BB Ba2 BB Renault SA 2.44% BB+ Ba1 BBB- ArcelorMittal 4.25% BB Ba1 BB+ 10

11 (CL01) 10y MKS fixed-floating CLN Issuer Currency Maturity SG Issuer GBP 10y Issue Price 100% Coupon Recovery Settlement s/a Market American 3.8% pa years 1 & 2 6m L + 125bps thereafter, paid UTD 11

12 Short Duration European HY Itraxx Europe Xover S23 Issuer Currency Maturity SG Issuer GBP long 5y Issue Price 100% Coupon s/a Recovery 0% Coupon = 6m L+3.8%*n/75 n = number of Ref Entities for which no Credit Event has occurred. Redemption = Par if no credit events Redemption = 100%-N/75 where N is the number of Credit Events 12

13 What are the risks? 13

14 Risks & Mitigants MTM/Basis risk Issuer risk Liquidity Transparency Quanto Collateral (for secured issues) 14

15 Questions & Appendix 15

16 Credit Derivatives - CDS basics Can be Cash or physically settled. If physically settled, additional complexity of CTD bond. 16

17 CDS Credit Event The Credit Risk of a Reference Entity (corporate or government) can be thought of as the risk that it will experience a Credit Event over a predefined time horizon. Definition of a Credit Event 1. Bankruptcy 2. Failure to pay 3. Restructuring (not applicable to US entities) 4. Repudiation & Moratorium (only for Sovereign entities) The definition of a Credit Event is standardised across all counterparties in the credit market as per the terms defined by International Swaps and Derivatives Association (ISDA) 17

18 Credit Indices Offer Liquidity, Tradability and Transparency Index components are selected by the Index sponsor based on specific criteria: liquidity, trading volumes, rating, etc. The rolls occur every six months for standardised contracts. itraxx Main Europe 125 European IG corporates itraxx Xover (Europe) 75 most liquid sub IG European names CDX North America 125 North American IG corporates 18

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