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Enron threatens double hit to credit tool market

The credit derivatives market faced a double threat from troubled US energy trader Enron on Thursday, leaving dealers divided on whether the rapid growth of the market might be at risk.

Enron's troubles impact the market through credit derivatives contracts written on the company, which would be triggered if it files for bankruptcy protection, and through deals transacted by its Enron Credit subsidiary, which specialised in trading credit protection on third parties.

Credit derivatives are insurance-like tools that allow investors to hedge or gain the risk of an issuer defaulting on a loan or bond. Default swaps, the most liquid type of credit derivative, involve the buyer paying the protection seller an annual premium, measured in basis points.

Accountants PriceWaterhouseCoopers said they had been appointed administrator to Enron's European division on Thursday. Some dealers predicted that if Enron goes under, the credit derivative contracts on Enron and entered into by Enron would be unwound in an orderly way.

"It will be another good example of how the market does work... it will regain people's confidence in the market," said Guy America, vice president for credit derivatives at J P Morgan Chase in London.

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However, other dealers predicted a messy conclusion.

"The impact is clearly a loss of confidence in the credit derivative market overall," said a default swaps trader with a European bank.

The most recent corporate failure to trigger a large number of default swaps, that of UK rail operator Railtrack, resulted in banks calling in lawyers to see if they had to pay out on certain obligations.

Dealers said Enron was an actively traded name in the default swaps market, mainly in New York. As a privately negotiated market, it is difficult to get accurate figures for the value of contracts outstanding on Enron, however, dealers said well over a billion dollars of protection on Enron had been written.

"(It was) one of the benchmark names for the US credit (derivative market)...so you can guess that a lot of people were involved in this credit through default swaps," said the European bank trader.

UNCERTAIN CREDIT INSURANCE

Potentially more damaging for the credit derivatives market is the failure of Enron Credit. The subsidiary specialised in selling credit risk mitigation tools to companies who wanted to hedge against customers going bankrupt and failing to pay.

If end-users now find the derivatives they bought no longer give them the level of credit protection they expected, it may make it harder for banks in future to convince more of their customers to start using the tools.

On the back of demand from end-users, Enron credit was active in the inter-dealer default swaps market. A filing for bankruptcy by Enron Corp could trigger settlement on all the contracts into which Enron Credit entered.

This would involve a large number of contracts and dealers say this would be concentrated among the limited circle of banks, mainly Enron Corp's bank lenders, which accepted Enron Credit as a dealing counterparty.

"It was not broadly accepted as a counterparty," said one dealer, who added that he hadn't seen the firm in the market since October.

LENDERS FACE BIGGEST LOSS

However, most dealers concur that any losses the banks might incur on credit derivatives contracts would be small compared to potential lending losses.

"Counterparty losses would be dwarfed by direct lending exposure," said the head of credit derivatives at a European bank.

Dealers said some banks had looked at taking on the Enron Credit trading book but that this now looked unlikely.

"The banks that were involved in trying to rescue the bank recently were also involved in overlooking their credit book and potentially making a bid to take it into their own book," said one trader.

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