Friday, October 23, 2009

Thomson CDS auction a good deal for some

Posted on Forbes.com by Jane Merriman and Jane Baird:

The outcome of an auction on Thursday to settle credit default swaps on Thomson after a debt restructuring at the French electronics firm could leave some investors dissatisfied with the process.

T
he auction produced a surprisingly high recovery rate for debt with short maturities, according to analysts.

The auction set the cash payout on debt maturing up to 2.5 years at 3.75 pct of the amount sellers of protection agreed to cover.

'The outcome for the 2.5 year maturity bucket looks beneficial to sellers of protection if their contracts were triggered against them, as it costs them only 3.75 percent,' said Matthew Leeming, part of Barclays Capital's credit derivatives quantitative strategy team.

The auction was the first of its kind under a new system known as 'Small Bang' to try to smooth settlement of credit default swap (CDS) contracts on a company after a debt restructuring rather than a default

'The main point is still that the mechanism of the auction does not make sure that the final recoveries are not driven by market technicals,' said Tim Brunne, credit analyst at Unicredit.

'Some investors will look at the auction and not be very satisfied,' he said. 'You need a robust auction process and their might be the necessity for improvements.'

The Thomson ( TOC - news - people ) auction had attracted a lot of attention because of a drive by politicians and regulators to standardise credit derivatives markets and make them more transparent.

It took weeks to organise, following Thomson's July debt restructuring, partly because of the complexity of the process and because of a relatively small number of Thomson bonds to deliver against a much bigger number of CDS contracts.

'Thomson was a great example because all of the debt was private, so it wasn't clear what was going to be deliverable and what the debt maturity profile was like,' Leeming said.

'So it was a fairly special case.'

SURPRISING AUCTION OUTCOME

The final value of CDS contracts was set at 96.25 percent on debt up to 2.5 years, 65.125 percent up to five years and 63.25 percent up to 7.5 years, according to results published by auction administrators Creditex and Markit.

The price of the 2.5 year bucket came in far above the 75 percent overall recovery rate estimated by dealers on Oct. 13, the deadline for triggering payment under CDS contracts.

The settlement for bonds with up to five and seven year maturities was priced at a much lower recovery value than some had expected.

The 96.25 percent recovery rate for the 2.5 year bucket was higher than the recovery swaps market had indicated, said Tobias Sproehnle, Markit's director of indices.

'The process went smoothly and worked the way we normally do it,' with the one difference being that three auctions were held at once, said Charles Longden, managing director of fixed income for Markit.

A credit default swap is effectively an insurance contract on a company's debts that can pay out if it defaults or restructures.

An auction following default is much more straightforward since all CDS contracts are automatically triggered.

A restructuring improves a company's prospects of staying in business, particularly in the short term. Its recovery value should be higher and its CDS spreads tighter for two years than for seven years.

Data from the Depository Trust and Clearing Corp showed that the net notional value of all Thomson CDS contracts amounted to nearly $2.1 billion as of Oct. 9, ranking it among the world's top 1,000 referenced names.

International Swaps and Derivatives Association (ISDA) data showed that a total of 7,496 contracts were triggered, which is likely to amount to a sizeable chunk of the net notional value of the Thomson CDS contracts.

ISDA would not provide data on the overall value of triggered contracts.

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