Lehman Gets Piece of All the Action

Corcoran is looking for trading in PCDSs, which totaled $6 billion in 2005, their debut year, to quadruple in 2006.

By comparison, U.S. companies sold a little under $10 billion in perpetual hybrids in 2005. But there has already been $8 billion in perpetual hybrid deals this year, including big ones by Wachovia(WB Quote) and Washington Mutual(WM Quote).

Perpetual hybrids are so named because they have no maturity date. The elimination of the maturity date on the bonds is significant -- it persuaded the big credit-rating agencies to treat perpetual offerings as a sale of stock rather than a sale of debt.

A stock deal has no direct impact on a company's credit rating. When a company issues traditional corporate bonds to pay for a stock buyback, it often results in a credit downgrade -- an event that can increase its borrowing costs down the road.

"There was a need for PCDSs,'' says Corcoran. "Until PCDSs came to the marketplace, there was no way to hedge at the preferred level of the capital structure."

Of course, what Lehman is trying to do with hybrids is have its cake and eat it, too. It's seeking to cash in on both ends of the hybrid market by serving as underwriter on a bond offering and then as the primary market maker for the PCDS that's linked to a particular hybrid offering.

Critics point out that this dual role is one of the problems with the booming $12 trillion market for credit derivatives: Wall Street banks control much of the playing field.

"How does one price them? Well, let me give you a peek behind the curtain. There is only one man manipulating the levers,'' says Janet Tavakoli, a Chicago-based structured-finance and derivatives consultant.

Currently, Lehman is making a market in 75 different PCDSs. Other Wall Street firms, including Bear Stearns(BSC Quote) and JPMorgan Chase(JPM Quote), also are making markets in PCDS trading. But Lehman is the dominant player.