Fitch Credit Event Study Identifies Best Practices for CDS Valuations.

NEW YORK & LONDON -- Fitch Ratings recognizes best practices in a credit default swap (CDS) valuation procedure that promote equitable settlement prices to both protection buyers and sellers according to the agency's latest global synthetic CDO credit event study. Fitch observed best practices including a minimum of five bidders excluding the calculation agent and waiting at least 45 days following the credit event date to start the valuation process. Fitch's 2005 update to its credit event study examines realized recoveries on Delphi and recent ISDA CDS Index Protocols.

'The explosive growth in the over US$12 trillion credit derivatives market makes it inevitable that credit events will occur in the future where the notional CDS exceeds the outstanding par amount of cash bonds, eliminating physical delivery as a practical settlement option,' said Kevin Kendra, Senior Director, Fitch Ratings. 'As such, continued use of the ISDA CDS index protocols to settle index and single-name CDS are advantageous to the market. While the ISDA protocol auctions are typically held 28 days following bankruptcy, our research indicates that increasing the length of the process to 45 days will minimize the impact of technical factors and produce recoveries that better reflect fundamental credit risk.'

Further proof of this is in a recent case study conducted by Fitch. The ISDA auction protocol for Delphi yielded a settlement price of 63.375 twenty-seven days after the Delphi bankruptcy. Yet, according to Shaun Baddeley, Senior Director, Fitch Ratings, 'This price contrasts with the average Delphi recovery of 53.5% seen in the Fitch-rated synthetic CDO universe. These recoveries were received on average 58 days following the bankruptcy date.'

Fitch's case study is based on 99 final valuations on Delphi, which ranged from 40% to 63%, highlighting the lack of standardization and transparency in the settlement process. Final valuations on Delphi in 53 synthetic CDOs are still outstanding, however recently received valuations more closely represent the average recovery than the ISDA protocol price.

'Credit Events in Global Synthetic CDOs: 2005 Update' is the fourth edition of Fitch's analysis on both credit events and the impact of valuation procedures on recovery rates in synthetic CDOs. The report is available on the Fitch Ratings web site at 'www.fitchratings.com'.

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