By Karen Brettell
NEW YORK, Nov 18 (Reuters) - An auction to settle credit default swaps on CIT Group is likely to be the largest the market has faced so far, and trading by banks with exposures to CIT's swaps could potentially squeeze its the prices of its bond and drive up CDS valuations.
CIT, a lender to hundreds of thousands of small and medium-sized U.S. businesses, filed for a prepackaged bankruptcy on Nov. 1, triggering payments on its credit default swaps -- contracts that protect against losses from a debt default.
The auction on Friday will determine a value for the CDSs, which will be used to settle the contracts.
An unexpectedly high CDS valuation, in general, may favor protection sellers while a low valuation could benefit protection buyers. This is because the protection seller pays the buyer the full sum insured, minus the recovery value when a borrower defaults.
CIT's collapse is unlikely to lead to outsized losses in the CDS market though.
'The overall impact of CIT's default should be relatively contained given that its troubles have been well anticipated by the market, as evidenced by its recent spread history,' Atish Kakodkar, analyst at credit research firm CreditSights, said in a recent report.
The CIT auction is significant, however, as it will likely involve the largest volumes the process has seen to date.
Net volumes of around $3.1 billion are outstanding in single name protection on CIT's debt, while an additional $2.9 billion is outstanding in trades based on indexes the company is included in.
A large amount of protection on CIT was also sold in tranche trades based on the indexes. In addition, the company was among the most popular credits included in other collateralized debt obligations (CDOs) backed by CDSs.
Volumes in these deals are hard to estimate, though analysts say they are likely large.
Standard & Poor's said in July that it rated 2,470 CDO tranches that had exposure to CIT.
BANK BID
Banks that were counterparties to CDOs including CIT are likely to provide a large bid to buy bonds in the auction, which could potentially drive up the value of the CDSs, analysts said.
'Dealers who choose to buy the bonds during theauction could cause final recovery on the name to be higher than it would otherwise be,' analysts at Barclays said in a recent report.
Strong demand by banks for the debt could push up CIT's final CDS price by as much as 2.5 points to 4 points, Barclays said.
The company's bonds traded on Wednesday between 66 and 70 cents on the dollar, according to MarketAxess.
CIT, which was rated investment grade until April this year, was a popular company to include in CDOs because its CDSs yielded an attractive premium relative to the company's rating when the majority of the deals were issued between 2005 and 2007.
Banks that acted as counterparties to these deals hedged their exposures by selling protection on the companies underlying the deal in the single name market. These single name contracts, however, are settled one to two months before contracts in the CDOs are.
The banks are expected to buy CIT's bonds to protect against losses they would face if CIT's debt gains in the gap between settling each of the trades.
Potentially countering this bid are so-called basis investors, who own CIT's debt and also own CDS protection. These investors are expected to be large sellers of the bonds in the auction.
If enough of these investors sell bonds in the auction they may offset any the bank bid for the debt.
'The net open interest to buy or sell bonds in the auction should, therefore, depend primarily on the buying demand from correlation desks versus the selling interest from basis traders,' said CreditSights' Kakodkar. For other related fixed-income quotations, stories and guides to Reuters pages, please double click on the symbol: U.S. corporate bond price quotations... U.S. credit default swap column........ U.S. credit default swap news.......... European corporate bond market report.. European corporate bond market report.. Credit default swap guide.............. Fixed income guide..................... U.S. swap spreads report............... U.S. Treasury market report............ U.S. Treasury outlook.................. U.S. municipal bond market report...... Keywords: MARKETS CREDIT/ (karen.brettell@thomsonreuters.com; +1 646 223 6274; Reuters Messaging: karen.brettell.reuters.com@reuters.net ) COPYRIGHT Copyright Thomson Reuters 2009. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.
NEW YORK, Nov 18 (Reuters) - An auction to settle credit default swaps on CIT Group is likely to be the largest the market has faced so far, and trading by banks with exposures to CIT's swaps could potentially squeeze its the prices of its bond and drive up CDS valuations.
CIT, a lender to hundreds of thousands of small and medium-sized U.S. businesses, filed for a prepackaged bankruptcy on Nov. 1, triggering payments on its credit default swaps -- contracts that protect against losses from a debt default.
The auction on Friday will determine a value for the CDSs, which will be used to settle the contracts.
An unexpectedly high CDS valuation, in general, may favor protection sellers while a low valuation could benefit protection buyers. This is because the protection seller pays the buyer the full sum insured, minus the recovery value when a borrower defaults.
CIT's collapse is unlikely to lead to outsized losses in the CDS market though.
'The overall impact of CIT's default should be relatively contained given that its troubles have been well anticipated by the market, as evidenced by its recent spread history,' Atish Kakodkar, analyst at credit research firm CreditSights, said in a recent report.
The CIT auction is significant, however, as it will likely involve the largest volumes the process has seen to date.
Net volumes of around $3.1 billion are outstanding in single name protection on CIT's debt, while an additional $2.9 billion is outstanding in trades based on indexes the company is included in.
A large amount of protection on CIT was also sold in tranche trades based on the indexes. In addition, the company was among the most popular credits included in other collateralized debt obligations (CDOs) backed by CDSs.
Volumes in these deals are hard to estimate, though analysts say they are likely large.
Standard & Poor's said in July that it rated 2,470 CDO tranches that had exposure to CIT.
BANK BID
Banks that were counterparties to CDOs including CIT are likely to provide a large bid to buy bonds in the auction, which could potentially drive up the value of the CDSs, analysts said.
'Dealers who choose to buy the bonds during theauction could cause final recovery on the name to be higher than it would otherwise be,' analysts at Barclays said in a recent report.
Strong demand by banks for the debt could push up CIT's final CDS price by as much as 2.5 points to 4 points, Barclays said.
The company's bonds traded on Wednesday between 66 and 70 cents on the dollar, according to MarketAxess.
CIT, which was rated investment grade until April this year, was a popular company to include in CDOs because its CDSs yielded an attractive premium relative to the company's rating when the majority of the deals were issued between 2005 and 2007.
Banks that acted as counterparties to these deals hedged their exposures by selling protection on the companies underlying the deal in the single name market. These single name contracts, however, are settled one to two months before contracts in the CDOs are.
The banks are expected to buy CIT's bonds to protect against losses they would face if CIT's debt gains in the gap between settling each of the trades.
Potentially countering this bid are so-called basis investors, who own CIT's debt and also own CDS protection. These investors are expected to be large sellers of the bonds in the auction.
If enough of these investors sell bonds in the auction they may offset any the bank bid for the debt.
'The net open interest to buy or sell bonds in the auction should, therefore, depend primarily on the buying demand from correlation desks versus the selling interest from basis traders,' said CreditSights' Kakodkar. For other related fixed-income quotations, stories and guides to Reuters pages, please double click on the symbol: U.S. corporate bond price quotations... U.S. credit default swap column........ U.S. credit default swap news.......... European corporate bond market report.. European corporate bond market report.. Credit default swap guide.............. Fixed income guide..................... U.S. swap spreads report............... U.S. Treasury market report............ U.S. Treasury outlook.................. U.S. municipal bond market report...... Keywords: MARKETS CREDIT/ (karen.brettell@thomsonreuters.com; +1 646 223 6274; Reuters Messaging: karen.brettell.reuters.com@reuters.net ) COPYRIGHT Copyright Thomson Reuters 2009. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.
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