The cutting hedge

Bank loan portfolio managers have powerful new credit hedging tools such as bespoke single-tranche CDOs at their disposal. But with credit derivatives hamstrung by accounting issues and bespoke synthetics prey to pricing disputes, are these really a panacea? Navroz Patel reports

Bank of America’s (BoA) second-quarter earnings announcement last month illustrates the dilemma facing loan portfolio managers. Either they don’t hedge their loan books and so bear the credit risk and concomitant regulatory capital charge. Or, trying to be prudent and sophisticated risk managers – like those at BoA – they hedge with credit derivatives and are forced to stomach the bitter pill of mark-to-market losses as they wash through earnings.

Mark-to-market losses on credit derivatives used