Fannie, Freddie Credit-Default Swaps May Be Unwound (Update2)
By Oliver Biggadike and Laura Cochrane
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Sept. 8 (Bloomberg) -- Investors may be forced to unwind contracts protecting $1.47 trillion of Fannie Mae and Freddie Mac bonds against default after the U.S. government seized control of the companies in a bid to bolster the housing market.
Thirteen ``major'' dealers of credit-default swaps agreed ``unanimously'' that the rescue constitutes a credit event triggering payment or delivery of the companies' bonds, the International Swaps and Derivatives Association said in a memo obtained by Bloomberg News today. Market makers for the privately traded contracts will discuss how to settle them in a conference call at 11 a.m. in New York, the document said.
``This is a big deal,'' said Sarah Percy-Dove, head of credit research at Colonial First State Global Asset Management in Sydney. ``The market is not experienced at settling a credit event for a name of this size, so it is a bit of an unknown.''
A settlement of credit-default swaps would probably be the biggest attempted in the market's decade-long history because Fannie and Freddie are members of the benchmark index of U.S. credit risk, Percy-Dove said. The index comprises the most frequently traded contracts in the U.S.
Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. An increase indicates deterioration in the perception of credit quality; a decline, the opposite.
Dealer Poll
Treasury Secretary Henry Paulson and Federal Housing Finance Agency Director James Lockhart yesterday placed Freddie and Fannie in a government-operated conservatorship, ousting their chief executives and eliminating their dividends. The Treasury may purchase up to $200 billion of stock in the firms to keep them solvent.
Today's conference call will determine whether enough dealers agree the Treasury's action constitutes a credit event, Louise Marshall, spokeswoman for ISDA, said in a phone interview from New York today.
``We believe conservatorship is a credit event,'' Barclays Plc analysts Vince Breitenbach and Jeff Meli said in a note to clients yesterday. Barclays is a member of the ISDA.
Contracts on Fannie and Freddie subordinated debt may fall more than 100 basis points as the companies gain Treasury backing and dealers close positions, the analysts said. U.S. default protection costs as measured by the Markit CDX North America Investment Grade Index will also decline, they said. A basis point, or 0.01 percentage point, is worth $1,000 on a swap that protects $10 million of debt.
Default Protection Costs
Five-year contracts on Fannie Mae notes fell from a record high of 364 basis points on Aug. 20 and closed on Sept. 5 at 233, CMA Datavision prices show. The cost is equivalent to $233,000 annually to protect $10 million in notes from default.
The ISDA, which sets standards for the global derivatives market and counts investment banks including Deutsche Bank AG and Lehman Brothers Holdings Inc. as members, will arrange any settlement of the default swaps, spokeswoman Marshall said. She declined to name any participants on today's call.
``Although the settlement effort will be massive, we do not see it as necessarily a negative,'' Gus Medeiros, credit analyst at Deutsche Bank in Sydney, wrote today in a research note. ``Write downs are potentially an issue for holders of preferred equity, but the Treasury said financial institutions exposed to these securities will work with regulators to restore capital positions.''
Treasury Control
Under the U.S. plan, the Treasury will get $1 billion of senior preferred stock in coming days, with warrants representing ownership stakes of 79.9 percent of Fannie Mae and Freddie Mac. The government will receive annual interest of 10 percent on its stake.
While common stockholders of Fannie and Freddie won't be eliminated, they will be last in line for any claims, Paulson said yesterday. Preferred shareholders will be second in absorbing losses, he said. Interest and principal payments will continue to be made on the companies' subordinated debt. |
