REUTERS UPDATE 1-Fears about Lehman CDS deadline overstated [JDCSHBD]
(Recasts lead, adds analyst quote, details)
By Karen Brettell
NEW YORK, Oct 21 (Reuters) - Tuesday's deadline to settle an
estimated $400 billion in credit default swaps on Lehman
Brothers failed to trigger feared havoc in the market, and
derivatives analysts said the concerns had reflected
misunderstandings about the process.
Tuesday is the final day credit default swaps on Lehman's
<LEH.N><LEHMQ.PK> debt can be paid out.
"It seems like a non-event," said Tim Backshall, chief
strategist at Credit Derivatives Research in Walnut Creek,
California. "There's a couple of hedge fund rumors but I am
sure they are more general redemption issues than Lehman
specific."
Speculation had mounted in recent sessions that banks,
hedge funds and other sellers had been hoarding cash to pay out
a massive 91 percent loss on the contracts.
But experts say the fears were exaggerated and in any case,
losses may not be made public until companies post their next
quarterly earnings in the months to come.
"There's been a lot of talk about this but I don't think
it's that material, there has been a lot of misunderstanding,"
said Sivan Mahadevan, head of credit derivative and structured
credit research at Morgan Stanley in New York. "I think it's
been overdone."
Credit default swaps are insurance-like securities that
protect against the risk of a borrower defaulting on debt.
The $55 trillion market has created concerns that it may
pose systemic risks as its private nature makes it impossible
to know who holds what risk, and the size of any exposures.
Part of the worry about the Lehman swaps is the $400
billion in insurance outstanding, although the figure
overstates the amount of money that will actually be
transferred.
The Depository Trust and Clearing Corporation, which clears
the vast majority of trades in the over-the-counter market,
said this month only $6 billion may actually change hands.
This is because large players in the market, such as
dealers and some hedge funds, have both bought and sold
protection, subsequently taking both gains and losses on
Lehman's default that will offset each other.
For companies with net exposure to pay out protection, much
of the pain of settling the swaps has also already been taken.
"If you were the seller of protection, you had to pay
collateral and that collateral was changed on a daily basis,
based on where Lehman's bonds were trading," Mahadevan said.
"The money's already in the system. The loss is already in
the system. I don't think of it as a big deal in terms of
losses exchanging hands," he added.
LOW RECOVERY
The price of Lehman's bonds dropped to about 12 or 13 cents
on the dollar after the investment bank filed for bankruptcy in
September, meaning sellers of protection needed to post
collateral to cover a loss of 87 percent to 88 percent on the
contracts at the time.
Some buyers of protection would have used these bonds to
settle their contracts. Others participated in an auction on
Oct. 10 to determine the value of the contracts.
When a borrower defaults on debt, sellers of protection pay
buyers the full sum insured and, in return, receive the
defaulted debt or a cash payment, which is determined by
auction.
The Oct. 10 auction involved 358 market players and
determined the swaps were worth just 8.625 cents on the dollar,
meaning sellers needed to pay out 91.375 cents on every dollar
of insurance sold.
"The auction for Lehman CDS was successful and the amount
that was paid out on this credit event is significantly lower
than what has been mentioned in the press," analysts at
Barclays said in a report.
An auction to settle credit default swaps on Washington
Mutual's <WM.N> debt is scheduled for Thursday, with payments
on those contracts due by Nov. 7.
Analysts expect that WaMu's swaps will recover a high
value, leading to fewer losses by protection sellers than those
seen on Lehman.
Meanwhile, of the companies that have so far announced
exposures to Lehman's default swaps, none has indicated any
threat to the viability of the firm.
Genworth Financial <GNW.N>, for example, said it had only
$5.4 million in credit default swap exposure to Lehman credit
default swaps, and Hartford Financial Service Group <HIG.N>
said it had $30 million in exposure to Lehman's swaps.