Lehman CDS and debt liquidation

September 15, 2008

We will now see major deleveraging in a large number of firms, as derivatives, swaps and other positions to which Lehman was a counterparty are unwound. According to Bloomberg, 10 large banks including JPMorgan , Goldman Sachs and Citigroup have pooled 70 billion in a fund to create liquidity as deleveraging and unwinding of positions is taking place. As of May 31st, Lehman’s total debt is 613 billion dollars, according to Financial Times.



With respect to the CDS market, because Lehman’s bankruptcy filing came one hour after ISDA’s cancellation deadline,  there’s some fear that netting trades that were agreed between counterparties may have become useless. This would significantly complicate the counterparty risk issue. 



From FT Alphaville:


“The cost of insuring European corporate debt against default shot up on Monday morning, however, market participants said very little trading was actually going on and that market liquidity could be frozen for days or even longer as everyone awaited clarity on the impact of the collapse of such a large counterparty as Lehman Brothers. Traders and analysts said they hoped there might be some improvement once the US credit default swap markets opened this afternoon, but that that was far from assured.


“This is a big threat to the CDS markets as a whole, which is truly scary because that was the last liquid market. Here, we’re all wondering whether Lehman might have blown up the market”, said one hedge fund trader”



To deal with liquidity issues, BoE has offered 5 billion pounds for three days in an exceptional operation, attracting bids for 24.1 billion pounds. The European Central has also allotted 30 billion euros ($42.04 billion) in a one-day liquidity operation; again, there was far greater demand, with 51 bids for 90 billion euros. The Fed has increased the collateral window for PDCF to include stocks, and the amount offered on term securities lending facility has been expanded by 25 billion.



The hope is that a bottom can be found to the firesales, and liquidity issues that arise can be prevented from turning into solvency issues at any major firm.



Meanwhile, Fitch has downgraded Lehman’s long and short term issuer debt rating to D, and outstanding debt has been downgraded to C. The expectation for recovery in Lehman’s highest ranking, senior unsecured debt, is thought to be around 60 cents on the dollar, with  138 billion of Lehman’s bond debt owned by Bank of New York Mellon and Citigroup. Bank of New York Mellon’s role is that of a trustee, and the firm has no direct exposure, according to its statement. 



There’s also the issue of AIG’s rating downgrade, which could potentially be more problematic on the longer run.



One Response to “Lehman CDS and debt liquidation”

  1. […] on CDS developments related to Lehman for September 15th is here. Possibly related posts: (automatically generated)Market Matrix: India’s economic size grew to […]

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