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10-06-2008, 10:04 AM
Through a series of auctions due to be completed today, the credit derivatives market will determine the price -- known as the recovery value -- for as much as $500 billion in Fannie Mae- and Freddie Mac-related contracts. "The operational risks of having [the biggest auctions ever] in an extremely risk-averse market lead us to think that recoveries may be lower than the market expects," said a Citi analyst.
By Aline van Duyn in New York
Published: October 5 2008 18:55 | Last updated: October 5 2008 18:55
The credit derivatives markets will on Monday set the price tag for settling up to $500bn of contracts related to Fannie Mae and Freddie Mac, the US mortgage lenders whose seizure by the US government had the unexpected knock-on effect of triggering defaults on derivatives deals.
This price – called the recovery value – will in turn determine the payouts that have to be made by insurers and banks that offered credit cover on the mortgage financiers in recent months.
Unwinding and settling these derivatives will be the biggest test yet for the thus-far unregulated $54,000bn credit derivatives market, which is likely to be brought under stricter supervision amid concerns from regulators that its exponential growth helped fuel the credit bubble.
The breakdown of large parts of the credit markets has raised concerns about the ability to settle the derivatives contracts, as pricing is determined by the bonds that are eligible for use in the derivatives settlement auctions.
“The operational risks of having [the biggest auctions ever] in an extremely risk-averse market lead us to think that recoveries may be lower than the market expects,” said an analyst at Citi.
The Fannie and Freddie derivatives default is unique because their underlying $1,600bn of debt is now explicitly guaranteed by the US government. However, the government’s move to place them into conservatorship triggered default, as defined by bankruptcy clauses in credit derivatives contracts.
By some estimates, these payouts could amount to $75bn, assuming a recovery value of 85 cents in the dollar, but it is hard to pinpoint because the number of derivatives that reference Fannie and Freddie is not known.
Analysts have estimated the number of credit default swaps (CDS) – a kind of insurance against debt default – which reference Fannie and Freddie to be between $200bn and $500bn.
Even though many Fannie and Freddie bonds trade at the full face value of par, the settlement price of the derivatives is expected to be lower than that.
“We estimate that the final recovery rate will trade between 85 and 90 for Fannie Mae with some potential for a much lower rate, and between 87 and 92 for Freddie Mac,” said analysts at JPMorgan.
The International Swaps and Derivatives Association has worked with dealers and investors in recent weeks to set up the auctions, which are due to be completed today.
Copyright The Financial Times Limited 2008
http://www.ft.com/cms/s/0/339dd2c2-9304-11dd-98b5-0000779fd18c.html
By Aline van Duyn in New York
Published: October 5 2008 18:55 | Last updated: October 5 2008 18:55
The credit derivatives markets will on Monday set the price tag for settling up to $500bn of contracts related to Fannie Mae and Freddie Mac, the US mortgage lenders whose seizure by the US government had the unexpected knock-on effect of triggering defaults on derivatives deals.
This price – called the recovery value – will in turn determine the payouts that have to be made by insurers and banks that offered credit cover on the mortgage financiers in recent months.
Unwinding and settling these derivatives will be the biggest test yet for the thus-far unregulated $54,000bn credit derivatives market, which is likely to be brought under stricter supervision amid concerns from regulators that its exponential growth helped fuel the credit bubble.
The breakdown of large parts of the credit markets has raised concerns about the ability to settle the derivatives contracts, as pricing is determined by the bonds that are eligible for use in the derivatives settlement auctions.
“The operational risks of having [the biggest auctions ever] in an extremely risk-averse market lead us to think that recoveries may be lower than the market expects,” said an analyst at Citi.
The Fannie and Freddie derivatives default is unique because their underlying $1,600bn of debt is now explicitly guaranteed by the US government. However, the government’s move to place them into conservatorship triggered default, as defined by bankruptcy clauses in credit derivatives contracts.
By some estimates, these payouts could amount to $75bn, assuming a recovery value of 85 cents in the dollar, but it is hard to pinpoint because the number of derivatives that reference Fannie and Freddie is not known.
Analysts have estimated the number of credit default swaps (CDS) – a kind of insurance against debt default – which reference Fannie and Freddie to be between $200bn and $500bn.
Even though many Fannie and Freddie bonds trade at the full face value of par, the settlement price of the derivatives is expected to be lower than that.
“We estimate that the final recovery rate will trade between 85 and 90 for Fannie Mae with some potential for a much lower rate, and between 87 and 92 for Freddie Mac,” said analysts at JPMorgan.
The International Swaps and Derivatives Association has worked with dealers and investors in recent weeks to set up the auctions, which are due to be completed today.
Copyright The Financial Times Limited 2008
http://www.ft.com/cms/s/0/339dd2c2-9304-11dd-98b5-0000779fd18c.html