Structured derivatives are making a comeback.
After a nearly two-year hiatus, heavy institutional demand for higher yields as well as corporate treasurers' need to hedge risks have helped revive the market for the derivatives, bankers said.
Among those to profit from the resurgence has been Bankers Trust New York Corp., whose structured derivatives deals with Gibson Greetings and Procter & Gamble helped sour the market. Bankers Trust said rising popularity of the profitable structured derivatives was a big reason it had a $325 million increase in trading revenue during the first quarter.
"A lot of people have done their homework in the past year, and they are starting to use more structured products as a result," said Chase Manhattan Corp.'s Jeffrey Larsen, head of the bank's structured and specialty products group.
Known for their flexibility, structured derivatives allow issuers to alter the maturity, interest rate, currency denomination, and other terms of securities. This means a security issuer can quickly respond to a single investor looking for an investment with specific characteristics.
The market for the highly profitable instruments sank into controversy after Gibson Greetings, Procter & Gamble, and others reported losses on structured derivatives in 1994.
Objective measures of volume in privately traded structured derivatives are not available, but the impact from the lost business was evident in depressed trading revenues at big banks for much of 1994 and 1995.
Now, thanks to low interest rates on other securities, dealers report the market for structured derivatives has returned.
"We've seen a big increase in structured deals," said one investment banker. The banker said the increase is attributable primarily to institutional investors, both foreign and domestic.
These investors were big users of these products before the market plummeted in 1994, said Mr. Larsen.
"Pension fund managers had used these products prudently before, but when the scare came they backed off," he said. Now, he added, activity in these products is increasing.
Corporations have been slower to return to the market, said one risk management consultant. The reason, he said, was that finance executives were forced to explain their use of these products after Proctor & Gamble's problems.
"People that have to create exposure are using structured products," the consultant said. "But corporations remain as far away from these things as they can be."
Those corporations using structured derivatives are doing so to hedge specific risks that other products cannot handle, said Mr. Larsen.
"They are trying to hedge so they don't get blown away by something they are not expected to manage," he said.
Banks are already cashing in on the revival.
Bankers Trust reported trading revenue of $247 million for the first quarter, compared with a $78 million loss in the year-ago period.
Others are seeking to cash in on this high-margin business by restructuring their derivatives businesses to take advantage of the expected windfall. Chase is attempting to link its strengths in derivatives with its investment banking subsidiary to gain a foothold in securities underwriting.
BankAmerica Corp., previously a weak player in the customer derivatives business, restructured its derivatives business in February to take advantage of the changes. The bank will now have one marketing team focusing on customers' risk management needs and another trying to meet the structured product needs of institutional investors.
Charles Smithson, a managing director at Canadian Imperial Bank of Commerce and head of its financial products school, said one big reason for the renewed interest is that financial officers and boards of directors are more comfortable with these products. He attributes this confidence to efforts by most large dealers to educate them about derivatives.
"For any firm to do business with you, they have to be comfortable with what you're offering," he said. "Everybody buying these products are sensitive to headline risk, even if the losses are not material."
