Auction sets 57% recovery on Washington Mutual CDS

An auction yesterday established a final settlement price of 57% for Washington Mutual bonds, leaving sellers of credit default swaps (CDS) with higher-than-expected settlement payments as they close out contracts referencing the former US bank.

The final value of Washington Mutual debt is significantly above the 8.6% recovery value set on Lehman Brothers bonds at auction 13 days ago, although below the initial expected settlement price of 63 cents on the dollar.

As a result CDS sellers will have to pay 43 cents on the dollar to cash-settle single-name, index, bespoke tranche and other contracts with counterparties that bought protection against the bank's default.

“This is still a considerably higher recovery than many anticipated only a few weeks ago when bonds were trading in the 20s; and remember that margining and collateralisation have taken care of most of the actual cashflows that are supposed to take place during settlement already,” said Tim Backshall, chief strategist at California-based research firm Credit Derivatives Research.

519 firms agreed to adhere to the result of the auction in the settlement of CDS trades while 14 credit derivatives dealers bid to reach the final settlement price, according to the International Swaps and Derivatives Association.

On September 25 Washington Mutual was seized by the Federal Deposit Insurance Corporation and the majority of its operations - minus its senior unsecured and subordinated debt – were sold off to JP Morgan for $1.9 billion, in the largest bank failure in US history.

This is just the latest in a series of credit event auctions that derivatives processing and executing firm Creditex and market data provider Markit have found themselves administering. The Lehman Brothers settlement process was preceded by auctions for Fannie Mae and Freddie Mac bonds, both of which being held on October 6.

Further auctions are scheduled for November 4, 5 and 6, when Icelandic banks Landsbanki, Glitnir and Kaupthing will have recovery values set on their respective bonds, in what will be the first ever set of credit event auctions to be held in Europe.

See also: Lehman recovery rate set at 8.625%

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