Fear that settlements of Lehman Brothers Holdings Inc.'s credit default swaps could unhinge markets are looking to be unfounded as the final day to settle them winds to a close. It's been unclear exactly since the investment bank filed for bankruptcy on Sept. 15 what the total counterparty exposure would be, as estimates ranged from $6 billion all the way up to $400 billion in swaps.
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A few weeks ago, there were major concerns that exposure could be in the
hundreds of billions. But in a
statement last week, the Depository Trust
& Clearing Corp., which clears most trades in the
over-the-counter market, estimated that "net funds transfers from net
sellers of protection to net buyers of protection are expected to be in
the $6 billion range," which seems to have tamped down much of the fear.
But with markets still jittery, there was speculation that banks and other
sellers of CDSs were hoarding their cash in order to pay out on
losses of slightly more than 91% on Lehman contracts. The size of the
CDS market (estimated at roughly $55 trillion) added to the fact that
no one is quite sure who holds what risk, and how large any one party's
exposures might be, left stock markets and regulators with their nerves on
edge. In order to sort out the mess of settlement prices for default swaps underlying Lehman's bonds,
an auction took place on Oct. 10, where the unexpectedly low
price of 8.625% of par as set.
The Deal's Vipal Monga and Matt Miller wrote:
Before the auction, traders had expected the settlement to
be priced in the range of 12 cents or 13 cents on the dollar. At the
8.625 level, sellers of the swaps will be expected to pay 91.375% of
the face value of the Lehman bonds to protection buyers. Although there
are no accurate estimates on the value of the CDS contracts tied to
Lehman's debt, Robert Pickel, CEO of the International Swaps and
Derivatives Association trade group, said in an afternoon conference
call that the figure could be as high as $400 billion.
More than 350 firms opted into the auction process as a legally binding
way to settle the CDS contracts. Because CDS buyers don't have to own
the underlying bonds to collect in the event of a default, they are
typically issued in far greater number than the underlying assets.
Consequently, the $400 billion figure is far higher than the $127.6
billion of Lehman Brothers debt that defaulted when the investment bank
failed on Sept. 15.
However in spite of the $400 billion figure, nowhere near that amount
was needed to change hands since participants in the CDS market typically
hold both swaps and owe on their payout, resulting in many contracts
ending up canceling each other out. Most participants' exposure should
generally net out to zero if they are hedged correctly, bringing the
real exposure to about 2% of the $400 billion amount, putting actual
losses in the $8 billion range. -
George White See more on The Deal.comSee DTCC statement
