Rapid credit derivatives growth set to continue, Deutsche's Tierney says

By Reshmi Basu

New York, Dec. 6 - The huge growth in the credit derivatives market looks set to continue for several years, said John Tierney, head of credit derivatives research at Deutsche Bank, although he added that the market would be helped by more "real money" players.

The credit derivative market has been growing at an astonishing rate of 50% per annum, he said at a 2006 credit derivatives outlook conference held by brokerage firm GFI.

Since 1997, the market has been growing at 45% to 50% per year and it looks like that the year-over-year growth for 2004 to 2005 will be close 100% if not more, said Tierney. And that pace of growth could possibly continue over the next few years.

Additionally the growth of new participants coming into the market as well as new products will be phenomenal, he noted.

Tierney estimates that the credit derivatives market could hit $13 to $14 trillion in 2006, and the mark could even be higher.

Nonetheless, Tierney noted that the credit derivative market is centered on the United States and Europe. Europe makes up 44% of the market, followed by North America with 40%. Asia, Australia and Japan comprise a mere 9% of the market.

"A big part of the reason for this is that the corporate bond market is largely North America," he said, adding that the corporate market is growing rapidly in Europe. But Europe is more bank-oriented.

But he added that as the Basel II regulations are implemented, there will be more players out of Asia, including Japan. But for now, Europe and the United States will be the focal points.

But he added that the market needs more real money, a sector that currently makes up a small portion.

Meanwhile the outlook for U.S. credit spreads should remain positive and spreads should stay tight for several quarters, Tierney said.

Looking ahead, Tierney said that there is limited downside for spreads.

"The healthy credit cycle can continue. It won't get any better but it will take several quarters to get worse." He added that spreads could remain tight for a long time.

Tierney stressed that the "ebb and flow of defaults" in the economy determines credit spreads. Moreover default rates could stay at these low levels for a while.

Meanwhile companies have been resorting to stock buybacks to compensate for the lack of strength in their equity prices. But they have relied on cash flows instead of issuing debt to fund the purchases. This trend has had a minimal impact on the market because the bigger companies have been conservative in how they manage their spreadsheets.

But he warned that the explosion of LBO activity is more of risk to Europe than the United States since European companies are smaller and less expensive and make better targets for private equity firms.

"We are seeing a number of companies undergoing restructurings," he said, noting that they are selling their assets to private equity firms.

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