Cash found in wrecked Citadel trades

AllianceBernstein Holding LP and TIAA-CREF are betting they have better timing in the credit markets than hedge fund Citadel Investment Group LLC and Deutsche Bank AG.

They are part of a growing number of investors seeking to profit from a record-wide difference between corporate bond yields and the cost of protecting the securities from default. The gap exceeded 8 percentage points in some cases last month, meaning an investor would earn $800,000 a year for every $10 million put into the trade.

At their core, so-called negative basis trades are essentially bets that the worst of the seizure in credit markets is over. That's what Frankfurt-based Deutsche Bank thought before Lehman Brothers Holdings Inc. went bankrupt in September, costing the firm $1 billion, while funds run by Chicago-based Citadel fell 55 percent in value last year, in part because of the trades, according to people familiar with their strategies.

"Whoever was in the trade at that time found out that it's not a free money trade," said Steve Sterman, head of fixed- income trading in New York at TIAA-CREF, which oversees $398 billion in assets. "There's no such thing as free money."

In a negative-basis trade, investors buy bonds such as the 8.125 percent notes due in 2013 issued by Little Rock, Arkansas- based phone company Windstream Corp.

They then purchase credit-default swaps, which pay the buyer the face value of the bonds in exchange for the securities should the company fail to honor its debt agreements. Banks charge about 2.6 percentage points a year for five years of protection on Windstream debt.

Since the Windstream notes yield about 7.3 percentage points more than benchmark interest rates, investors get 4.7 percentage points net of fees for the credit-default swap contract. The potential profit increases if the gap narrows and the investor sells the bond and exits the contract.

For investors able to hold onto the trades, the positions are "extremely attractive," said J.J. McKoan, who oversees about $65 billion as director of global credit at AllianceBernstein in New York.

Deutsche Bank trader Boaz Weinstein, 35, and Citadel Chief Executive Officer Kenneth C. Griffin, 40, were burned last year when Lehman's collapse forced corporate bond yields to rise at a faster pace than the cost of credit-default swaps.