First American Bank: Credit Default Swaps

It was approaching 8 p.m. on a Wednesday in April 2002 when Chris Kittal received an urgent call from a contact at Charles Bank International (CBI). Kittal was a managing director in First American Bank's credit derivatives unit in New York City. CBI, a medium-sized U.S. commercial bank based on the East Coast, had recently been approached by one of its corporate clients in need of additional funding. The client, CapEx Unlimited (CEU), a rapidly growing telecommunications company, had been a loyal banking customer with CBI for over five years and had used the bank in some lucrative transactions during that time. CEU was in the middle of an industry shakeout and required $50 million to finance the expansion of its network. The company had already accumulated $100 million in previous loans from CBI and was depending on their relationship with the bank for the additional funding. While reasonable by itself, the new loan, when added to CBI's existing loans to CEU, would put CBI over its credit exposure limit with respect to a single client. In compliance with its internal lending statutes, CBI was unable to extend the additional loan to CEU and faced the possibility of damaging their banking relationship. Taking steps to prevent this, CBI's management called on Kittal to see if CBI could use credit derivatives to their advantage. Kittal envisioned helping CBI mitigate the credit risk exposure to the additional loan using a single-name credit ...

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