Analyst: Credit swaps won't help CME

Exchanges including CME Group Inc. and Intercontinental Exchange Inc. shouldn't expect a big boost in profit from guaranteeing credit-default swaps with their clearinghouses, said Sanford C. Bernstein Co. analyst Brad Hintz.

The contracts, traded now between private parties in the over-the-counter market, don't change hands frequently enough to drive clearing revenue comparable to futures contracts, Hintz wrote in a note to clients yesterday. He expects profit from trading credit-default swaps to remain with JPMorgan Chase & Co., Morgan Stanley and the other banks that control the market.

"Bernstein remains skeptical that any CDS clearing product -- important as it may be for the health of the global financial markets -- will prove highly profitable," wrote Hintz, who was the top-rated analyst for brokers and asset managers last year by Institutional Investor magazine.

Analysts from Wachovia Capital Markets and Keefe Bruyette & Woods Inc. have estimated an exchange may make between $100 million and $400 million a year in revenue from clearing contracts in the $29 trillion credit-default swap market.

Hintz declined to give a profit or revenue forecast today in an interview, saying it was too difficult to predict how the market will grow.

"Twelve hundred CDS contracts trade a week," he said. "That's not enough to move the needle" in terms of growing profits at exchanges.

The total number of trades registered in the Depository Trust & Clearing Corp. warehouse, where credit-default swap transactions are catalogued, is equal to the number of contracts cleared at Intercontinental Exchange in one day, Hintz said in his note, citing an executive from the Atlanta-based exchange.

Profit Potential

"CDS contracts traded in the OTC market do not rapidly turn over; therefore, they do not generate the large volumes that have provided the scale economics of standardized futures," he said.

Chicago-based CME Group is the world's largest futures exchange. Intercontinental Exchange is the second-largest U.S. futures market. Both companies are awaiting regulatory approval to begin clearing credit-default swaps.

CME Group has lost about 73 percent of its stock market value in the past year and Intercontinental about 63 percent. Slowing volumes for the companies' businesses have been driven by less credit available to traders, fewer hedge funds and lowered trading by banks that were seeking to reduce their risk.

CME Group fell $6.17, or 3.66 percent, to $162.2 as of 10:28 a.m. in Nasdaq Stock Market trading. Intercontinental rose 5 cents to $53.18 in New York Stock Exchange composite trading.

Credit Crisis

Hintz lowered his projections for futures volume growth this year and next in the note, with trading at CME Group to fall 9 percent this year. Trading at Intercontinental will expand by 4 percent. He said the fixed income and credit markets won't improve until at least the second half of this year.

U.S. equity markets and the general domestic economy will not improve until 2010, he said. "Our more negative macroeconomic outlook has resulted in a significant reduction in our futures volume forecast," he said.

Declining trading at CME Group will be led by a 22 percent drop in its key interest-rate contracts, according to Hintz.

In the first nine months of 2008, interest rate trading represented 57 percent of total volume at CME Group and 33 percent of transaction fees earned by the exchange.

"The impact of the credit crisis on CME has turned out to be worse than we had originally forecasted, driven by weakness in interest rate futures volumes," he said.