Auction determines settlement price for Fannie and Freddie

An auction to determine settlement prices on credit derivatives referencing Fannie Mae and Freddie Mac took place yesterday, making it by far the largest credit event fixing to have taken place since the process was first introduced in 2005.

The auction set the final price for Fannie Mae senior obligations at 91.51%, while subordinated obligations were fixed at 99.9%. Senior obligations of Freddie Mac were fixed at 94%, while subordinated obligations were set at 98%.

Thirteen dealers participated in the auction, which was administered by London-based data provider Markit and New York electronic trading platform Creditex. A record 651 organisations adhered to the protocol, developed by the International Swaps and Derivatives Association.

“The very high participation rate in this protocol and its success in settling a significant number of credit derivatives trades on the two government-sponsored entities (GSEs) constitute a major achievement for Isda and the industry,” commented Bob Pickel, executive director and chief executive at Isda in New York.

On September 7, the US Treasury and the Federal Housing Finance Agency announced they would take Fannie Mae and Freddie Mac into conservatorship – triggering a credit event on credit derivatives involving the two entities.

Isda announced the launch of its Fannie Mae and Freddie Mac credit default swap (CDS) protocol on September 30 – a process designed to enable institutions to amend their CDS documentation to allow settlement at a single final price, to be determined at the auction. The fixing is also meant to prevent price and settlement distortions that could occur when CDS exposure is far greater than the number of outstanding bonds.

However, the process did not run completely smoothly, with initial disagreement among market participants over whether the principal-only component of debt securities issued by the two GSEs would qualify as deliverable obligations. On September 16, law firm Allen & Overy determined that a principal-only component should not be included in the list of deliverable obligations for the purposes of the settlement auctions. A final list of deliverable obligations was published at the end of last month.

Credit event auctions were first introduced in June 2005 following the collapse of Michigan auto parts manufacturer Collins & Aikman. There have been several occasions for the industry to perfect the technique since, following defaults at US airlines Delta and Northwest, Michigan auto parts manufacturer Delphi, and, more recently, Canadian printing company Quebecor World, among others.

Having navigated the largest credit event fixing to date yesterday, the industry is gearing up for an auction on October 10, this time to determine the settlement price on CDS contracts referencing Lehman Brothers.

See also: CDS spreads on US banks tighten
Isda prepares to settle CDSs on failed banks