October 9, 2008 / 4:54 PM / 10 years ago

Icelandic bank CDS holders to face price auction

(Repeats to additional subscriber services)

By Jane Baird and Natalie Harrison

LONDON, Oct 9 (Reuters) - Sellers of protection on debt of the three Icelandic banks that went into receivership this week could get to to know their losses within the next month.

The International Swaps and Derivatives Association (ISDA) said on Thursday there will be an auction process to determine the cash settlement between buyers and sellers of protection on the debt of Landsbanki LAIS.IC, Glitnir GLB.IC and Kaupthing KAUP.IC.

ISDA said no date had been set for the auction, but one analyst said it was likely to be in about a month’s time.

Financial regulators seized control of all three banks this week. That triggered the first payment in Europe of credit default swaps, or so-called credit events, since Parmalat in 2003, analysts said.

That means investors who bought protection against a default on Kaupthing debt will be paid out a cash sum determined by an auction process, if they wish to join this process.

First of all banks and investors have to estimate what the recovery rates on the underlying bonds are expected to be.

The auction process will then be used to come to a consensus decision on that recovery rate. The seller of protection then pays out in cash the difference between par value and the estimated recovery rate of the underlying bond to the buyer of protection.

“We are working on where the recoveries are now,” said a recovery specialist at a major European bank. “It’s a very difficult situation.”

For one, the latest financial figures available on the Icelandic banks date back to June. “The world has moved a lot since then,” he said.

In addition, there is a lack of historical data available on recovery prices in the banking sector. Deciding a recovery rate is therefore a highly theoretical exercise, said Simon Adamson, an analyst at independent research firm CreditSights.


Based on prices in the CDS market, implied recovery rates on senior debt were 24.4 percent for Kaupthing, 20.5 percent for Glitnir and 20.7 percent for Landsbanki, according to data from Markit.

Looking at market prices for their cash bonds, where most analysts start their research, Kaupthing and Landsbanki senior bonds were bid at around 20 percent of face value, or 20 cents on the euro, and offered at 30, the recovery specialist said. Glitnir bonds were at 5 percent bid and 15 percent offered.

Taking a mid-point for Kaupthing at 25 and assuming it will take two years for bondholders to be paid, leads to a recovery rate of around 40 percent at the end of that time, he added.

He also gave little weight to the guarantee given to the banks by Iceland’s government, given that their combined debt amounts to 10 to 12 times the country’s economy. The guarantees would probably extend little beyond covering Iceland’s domestic depositors, he said.

Another issue is the UK government’s freeze on any movement of assets to Iceland, assets that in effect cannnot be used to repay the banks’ bonds.

In the United States the auction to settle CDS on defaulted Lehman Brothers bonds takes place on Friday. Sellers of protection on Lehman debt are expected to face massive losses of around 90 percent of the insurance they sold [ID:nN08418117].

“It’s hard to second guess a level where the recovery rates (for the Icelandic banks) will be. But at the moment, I don’t really see how this will be radically different from what happened with Lehman,” said Jeroen van den Broek, a credit strategist at ING.

“We’re talking about leveraged players on the financial side.” (Editing by Greg Mahlich)

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