The number of high-profile defaults of late from Lehman (LEH) and Washington Mutual (WM), combined with the technical defaults of Fannie (FNM) and Freddie (FRE) and a ratings downgrade of AIG that pushed the company to the brink of insolvency due to collateral calls have all thrust credit default swaps – CDS, for short – past subprime mortgage securitizations and into the center spotlight of the financial mess. I’ve had a front row seat for most of this, thanks to my investment in both the common stock of Primus Guaranty (PRS) and the senior debt (PRD).
A recap of the last few weeks:
Primus’s CDS-writing subsidiary lost its Aaa-rating from Moody’s, and the holding company debt was cut a full notch from Baa to Ba. The former is mostly a non-event because Primus has essentially written no new business; the latter shouldn’t be a surprise given how wide the spread on Primus’ debt had become.
The credit events have started to roll in. What begin with a technical default on $215 million in notional swaps on Fannie (FNM) and Freddie (FRE) that resulted in no losses thanks to the government backing turned ugly when $80 million in notional swaps on Lehman (LEH) were triggered as that firm went under. The recovery value on Lehman debt appears to be in the high single digits, putting this at a $70+ million loss.
Washington Mutual (WM) was another credit event ($16 million notional), although the settlement auction set a value of 57 cents on the dollar, making the net loss estimate about $7 million. The most, um, interesting of the CDS reference entities Primus had was Kaupthing Bank ($68 million notional), an Icelandic financial institution whose nationalization is only part of the enormous collateral damage dealt to that country. Primus provided no estimate of recovery value for Kaupthing, although I’ve seen estimates of 20-30%, implying a net loss of $51 million by taking the mid-point of that range.
The last event was a technical trigger caused by a downgrade of part of the (proportionally small) CDS on ABS portfolio, with a notional value of $10 million. Primus said they don’t expect any immediate redemptions of those swaps.
In total – excluding Fannie/Freddie – that amounts to notional defaults of $174 million, with a rough loss estimate of $133 million.
