Presentation of Mr. Gary Kopff for the PRMIA Conference on Reforming Markets for Credit Default Swaps & Collateralized Debt Obligations held in Washington, DC. June 10th, 2009.
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Reforming Markets for Credit Default SwapsReforming Markets for Credit Default Swaps& C ll t li d D bt Obli ti& C ll t li d D bt Obli ti& Collateralized Debt Obligations& Collateralized Debt Obligations
Christopher Whalen, PRMIA Chapter Head
ModeratorModerator
Gary Kopff
Christopher Whalen, PRMIA Chapter Head
y p
• Michael Greenberger J h M
PanelistsPanelists
• Joseph Mason• Kevin McPartland• Ann Rutledge• Tim Ryan
Source: Bank for International Settlements , Source: Bank for International Settlements , BIS Quarterly ReviewBIS Quarterly Review, “International Banking and Financial Market Developments,” March 2, 2009, Table 19; , “International Banking and Financial Market Developments,” March 2, 2009, Table 19; analysis and chart by Everest Management.analysis and chart by Everest Management.
ISDA survey reports greater decline (38%), based on higher EOY 2007 and lower EOY 2008
Source: ISDA Market Survey issued April 22, 2009; analysis and chart by Everest Management.Source: ISDA Market Survey issued April 22, 2009; analysis and chart by Everest Management.
“The outstanding notional value of the CDS market has declined dramatically … largely because of trade compression efforts –not a drying up of the market”
“Market participants have “Compression trades “Solutions provided by
– Kevin McPartland
significantly reduced levels of outstanding CDS trades via multilateral trade terminations (tear‐ups) to lower outstanding notional
organized by TriOptima are responsible for the termination of approximately $30 trillion notional in CDS positions in 2008 alone
CreditEx/Market and TriOptima helped to untangle the existing web of trades, netting open positions andlower outstanding notional
amounts, reducing counterparty credit exposures and operational risk. To date in 2009, tear‐ups have l d l $
positions in 2008 alone. Largely as a result of compression trades, the aggregate notional size of the CDS market has been reduced f hl $ ll
open positions and leaving a single trade, where possible.”
Source: Tabb Group, Source: Tabb Group, Credit Credit eliminated approximately $7 trillion of CDS trade notional amounts, in addition to the $32 trillion eliminated in 2008.”
from roughly $60 trillion in mid 2008 to about $39 trillion at this point.”
So rce “Polic Iss es Facing theSo rce “Polic Iss es Facing the
ppDefault Swaps: What’s Default Swaps: What’s Going OnGoing On? Kevin ? Kevin McPartland, June 2009McPartland, June 2009
Source: Statement released by Source: Statement released by Federal Reserve Bank of New Federal Reserve Bank of New York, April 1, 2009, after convening a York, April 1, 2009, after convening a meeting with industry leaders on meeting with industry leaders on overover thethe counter derivativescounter derivatives
Source: “Policy Issues Facing the Source: “Policy Issues Facing the Market for Credit Derivatives,” Market for Credit Derivatives,” Chapter 7 in Chapter 7 in The Road Ahead for the The Road Ahead for the Fed Fed ,, by Darrell Duffie, Professor at by Darrell Duffie, Professor at Stanford University Graduate School Stanford University Graduate School of Business. (of Business. (CiorciariCiorciari and John B. and John B.
overover‐‐thethe‐‐counter derivatives.counter derivatives. Taylor, eds.), April 30, 2009, Taylor, eds.), April 30, 2009, Stanford, CA, Hoover Institution Stanford, CA, Hoover Institution Press, 2009.Press, 2009.
DTCC subsidiary (Deriv/SERV) now provides online transparencyfor credit default swaps through “Trade Information Warehouse”
• On Nov. 4, 2008, DTCC began publishing CDS contract data each week for credit default swaps registered in the DTCC Trade Information Warehouse to enhance transparency in the market for over‐the‐counter (OTC) credit derivatives.
• DTCC indicates that its Warehouse is the onlycentral trade registry and industry‐recognized infrastructure for processing OTC derivativesinfrastructure for processing OTC derivatives over their life and maintaining a comprehensive trade database containing the primary record of each contract.
• DTCC’s central technology infrastructure automates and standardizes CDS trade processing – ie, record keeping, payment calculations and settlement, notional adjustments, and contract term changes over a contract’s life.
• DTCC uses confirmed transaction details as input for the Warehouse’s central trade database, so that post‐trade processing flows automatically from agreed‐upon trade terms.
Sources: Sources: DerivDeriv/SERV: Delivering Automated Solutions and Risk Management to OTC Derivatives/SERV: Delivering Automated Solutions and Risk Management to OTC Derivatives, DTCC brochure, March 2008, p. 6., DTCC brochure, March 2008, p. 6.
Trade Information Warehouse permits view of three major CDS types, but data not exportable nor available as time series to permit analysis
Single‐Name Credit Default Swaps• Corporate: North America, Europe, Emerging Europe, Emerging Europe LPN, Australia, New Zealand, Japan, Singapore, Asia (other), LatinZealand, Japan, Singapore, Asia (other), Latin America• Sovereign: Australia, New Zealand, Japan, Singapore, Asia (other), Latin America, Emerging Europe and Middle East, Western Europe (non G‐10) • Loans• Loans• RMBS ‐ Residential mortgage‐backed securities • CMBS ‐ Commercial mortgage‐backed securities
Index Credit Default SwapsUS t (CDX) hi h d hi h i ld• US corporate (CDX): high grade, high‐yield,
emerging market • European corporate (iTraxx): high grade, high‐yield, emerging market• CMBX: commercial mortgages• ABX: asset‐backed• LCDX: loans
Tranche Credit Default Swaps• CDX: US corporate• iTraxx: European corporate
Source: DTCC Source: DTCC DerivDeriv/SERV /SERV Trade Information Warehouse Trade Information Warehouse Data, May 29, 2009, Table 1; analysis and chart by Everest Management.Data, May 29, 2009, Table 1; analysis and chart by Everest Management.
p p• LCDX: loans• ABX: asset‐backed
83% of DTCC‐reported credit default swaps are dealer‐to‐dealer46% of DTCC‐reported swaps are dealer‐to‐dealer, single‐name swaps
8383%DealerDealer‐‐Dealer Dealer All TypesAll Types
Source: DTCC Source: DTCC DerivDeriv/SERV Trade Information Warehouse Data, May 29, 2009, Table 1; analysis and chart by Everest Management/SERV Trade Information Warehouse Data, May 29, 2009, Table 1; analysis and chart by Everest Management.
100% = $28.1 Trillion Notional
Almost ¼ of single‐name credit default swaps reference financial firms
Source: DTCC Source: DTCC DerivDeriv/SERV Trade Information Warehouse Data, May 29, 2009, Table 2; analysis and chart by Everest Management/SERV Trade Information Warehouse Data, May 29, 2009, Table 2; analysis and chart by Everest Management.
Top 30 single‐name credit default swapsaccount for 14% of total market
(Ranked by net notional)
NET NOTIONAL ($Billions)
GROSS NOTIONAL ($Billions)
Ratio Gross:Net
14% 13%
$198 $2,068 1030 Largest Single‐Name Credit
Default Swaps
Top 30 as % of Total
(Ranked by net notional)
Rank Change among Top 30May 22 to May 29
1 GE Capital Corp. $11.4 $77.0 72 Deutsche Bank $7.4 $77.7 113 Bank of America $7.0 $102.4 154 Morgan Stanley $6.6 $70.6 115 JPMorgan Chase $6.0 $119.9 20
FINANCIALS
Past Six Months Share PricePast Six Months Share Price
• Among Financials, JPM rose from 13th to 5th ($3.9 billion vs $6.0 billion, net notional)
• Of 5 743 net added
6 Merrill Lynch $5.4 $80.1 157 Goldman Sachs $5.2 $66.7 138 Wells Fargo $5.0 $93.7 199 Barclays Bank $4.4 $51.0 1210 Royal Bank of Scotland $4.4 $41.3 911 UBS $4.3 $39.0 9
$ $ • Of 5,743 net added contracts for all reference entities with 10+ contracts, JPMorgan Chase alone had added 5,894 contracts
12 Citigroup $4.2 $55.7 1313 AIG $3.9 $42.4 11
14 Bershire Hathaway $4.9 $19.0 415 Deutsche Telekom $4.8 $69.4 1416 Telefonica, SA $4.0 $60.7 15
OTHER CORPORATE
S Bl bS Bl b
Gross Notional (USD equivalents using prevailing foreign exchange rates)represents par amount of credit protection bought or sold, equivalent to
NATIONAL GOVERNMENTS Source: BloombergSource: Bloomberg
debt or bond amounts. (Gross Notional used to derive the couponpayment calculations for each payment period and the recovery amountsin the event of a default). Gross notional values do not reflect marketprices of contracts and may not correlate with mark‐to‐market values.
Net Notional is sum of net protection bought by net buyers and represents
the maximum possible net funds transfers between net sellers ofprotection and net buyers of protection that could be required upon theoccurrence of a credit event relating to the particular reference entity.
Are CDS used for “bets” on sovereign bailouts?$109 billion (net notional) bet against debt of 14 countries, up $1 billion from May 22
• Single‐name CDS growing with “bets” for and against sovereign debt that is increasing to fund bailout programs. Credit‐protection costs and net notional amounts have risen sharply.
• Some investors think the U.S. and European bank rescue plans will work and some don't. CDS are being used to trade these views. It's a way to make money on how the market is viewing that risk.
• Different use of CDS from emerging markets where sovereign CDS have long been used to protect against a far moreDifferent use of CDS from emerging markets, where sovereign CDS have long been used to protect against a far more likely prospect of default.
Source: DTCC Source: DTCC DerivDeriv/SERV /SERV Trade Information Warehouse Trade Information Warehouse Data, May Data, May 29, 2009, Table 6; analysis and chart by Everest Management29, 2009, Table 6; analysis and chart by Everest Management
Source: Source: CreditDerivativesResearchCreditDerivativesResearch; “Seven Sovereigns” are ; “Seven Sovereigns” are United States, United States, France, Germany, Italy, Spain, United Kingdom, & Japan.France, Germany, Italy, Spain, United Kingdom, & Japan.
Industry’s risk exposure highly concentrated among five commercial banks;At each bank the risk exposure is a very large multiple of the bank’s risk‐based capital
Bilaterally netted exposure Total credit exposure
382*
278*278*
179*
1 056*1,056*
105*
*Total Credit Exposure as multiple of Tier I + Tier II Risk‐Based Capital
NOTE: The OCC defines total credit exposure in derivatives as the credit equivalent amount from derivative contracts (RCNOTE: The OCC defines total credit exposure in derivatives as the credit equivalent amount from derivative contracts (RC‐‐R lineR line 54) or the sum of netted 54) or the sum of netted current credit exposure and “potential future exposure.”current credit exposure and “potential future exposure.”
Source: Source: OCC's Quarterly Report on Bank Derivatives ActivitiesOCC's Quarterly Report on Bank Derivatives Activities, Table 4, from Call Reports, , Table 4, from Call Reports, SchSch RCRC‐‐R, December 31, 2008; analysis and charts by R, December 31, 2008; analysis and charts by Everest ManagementEverest Management
Perceived risk of default by 13 leading swap dealers(Average of five‐year swaps)
““Fourteen DealersFourteen Dealers” [13 with Bank of America/Merrill Lynch merged] are ” [13 with Bank of America/Merrill Lynch merged] are Bank of America, Bank of America, BNP Paribas, Barclays Bank, Citigroup, BNP Paribas, Barclays Bank, Citigroup, Credit Suisse, Credit Suisse, Deutsche Bank, Dresdner Bank, Deutsche Bank, Dresdner Bank, Goldman Sachs, HSBC Bank, JP Morgan Chase, Merrill Lynch, Morgan Stanley, Royal Bank of Goldman Sachs, HSBC Bank, JP Morgan Chase, Merrill Lynch, Morgan Stanley, Royal Bank of
Sources: Sources: JPMorgan, MCM, JPMorgan, MCM, IFRMarketsIFRMarkets/Thompson, /Thompson, CreditfluxCreditflux, Bloomberg; , Bloomberg; analysis and chart by Everest Management. analysis and chart by Everest Management.
NOTE: NOTE: DeaLogicDeaLogic compiles data by compiles data by bookrunnerbookrunner parent and includes only parent and includes only tranches sold (not Super Senior tranches retained).tranches sold (not Super Senior tranches retained).
Source: Source: DeaLogicDeaLogic; analysis and chart by Everest Management.; analysis and chart by Everest Management.
Source: DeaLogic; analysis and charts by Everest Management
NOTES: *DeaLogic compiles data by bookrunner parent and includes only rank‐rated tranches sold by broker/dealers (not Super Senior tranches retained).
Multi‐trillion losses referencing non‐prime U.S. mortgages were concentrated in $542 billion Mezzanine & High Grade Structured Finance CDOs [$436 billion “cash” & $106 billion synthetically created with credit default swaps]
Sources: JPMorgan, MCM, IFRMarkets/Thompson, Creditflux, Bloomberg; analysis and charts by Everest Management
Unregulated CDS + Unregulated CDOs + Astonishing Greed/Risk Taking + Unregulated CDS + Unregulated CDOs + Astonishing Greed/Risk Taking + Abusive NonAbusive Non‐‐Prime U.S. Mortgages = Prime U.S. Mortgages = GLOBAL CREDIT CRISISGLOBAL CREDIT CRISIS
•• A very few global banks/investment banks in 2004A very few global banks/investment banks in 2004‐‐2007 harnessed CDS technology to corrupt2007 harnessed CDS technology to corruptA very few global banks/investment banks in 2004A very few global banks/investment banks in 2004 2007 harnessed CDS technology to corrupt 2007 harnessed CDS technology to corrupt further ABS SF CDOs. further ABS SF CDOs.
•• SECRET FINANCIAL ENGINEERINGSECRET FINANCIAL ENGINEERING: structure with : structure with ““Unfunded Super SeniorsUnfunded Super Seniors” ” to highly to highly leverage equity tranches; possible due to access to investors willing to accept very leverage equity tranches; possible due to access to investors willing to accept very low interestlow interest only payments (only payments (egeg LL + 5 to 15 basis points) for allegedly risk+ 5 to 15 basis points) for allegedly risk free positionsfree positionslow, interestlow, interest‐‐only payments (only payments (egeg, L, L9090 + 5 to 15 basis points) for allegedly risk+ 5 to 15 basis points) for allegedly risk‐‐free positions.free positions.
•• CDS enabled CDO size to reach $1 billion+ more quickly with 60CDS enabled CDO size to reach $1 billion+ more quickly with 60‐‐80% of assets created 80% of assets created synthetically; [CDO = Protection Seller] instead of CDO owning cash bonds (synthetically; [CDO = Protection Seller] instead of CDO owning cash bonds (egeg, RMBS/CMBS) , RMBS/CMBS) which were too scarce in 2005which were too scarce in 2005‐‐2007 to fulfill global sales force ability to sell the product2007 to fulfill global sales force ability to sell the product
•• Allegedly lowAllegedly low‐‐risk “Unfunded Super Senior” made even less risky allegedly when partially risk “Unfunded Super Senior” made even less risky allegedly when partially hedged with reverse CDS [Investor = Protection Buyer]; counterhedged with reverse CDS [Investor = Protection Buyer]; counter‐‐party risk from AIG and party risk from AIG and monolinemonoline bond insurers’ “transformer” units was gravely underestimated. bond insurers’ “transformer” units was gravely underestimated.
•• A few global banks whose investment banking & CDS staff created synthetic/hybrid CDOs A few global banks whose investment banking & CDS staff created synthetic/hybrid CDOs ““drank their own cool aiddrank their own cool aid” and invested heavily (” and invested heavily (ieie, $10, $10‐‐$50 billion) on the bank balance $50 billion) on the bank balance sheet in allegedly risksheet in allegedly risk‐‐free free ““Unfunded Super SeniorUnfunded Super Senior” ” tranches.tranches.
•• Banks and rating agencies woefully underestimated “correlation risk” as losses often wiped Banks and rating agencies woefully underestimated “correlation risk” as losses often wiped out 3out 3rdrd party investors in lower tranches and then breached 15party investors in lower tranches and then breached 15‐‐100% attachment points for100% attachment points forout 3out 3 party investors in lower tranches and then breached 15party investors in lower tranches and then breached 15 100% attachment points for 100% attachment points for “Unfunded Super Seniors.” “Unfunded Super Seniors.”
•• Virtually no disclosure to regulators & shareholders of these “secret” highVirtually no disclosure to regulators & shareholders of these “secret” high‐‐risk plays that risk plays that created some of the most toxic of assets; bailouts directly and indirectly by taxpayer funding created some of the most toxic of assets; bailouts directly and indirectly by taxpayer funding committed $406 billion for a few global banks changed markcommitted $406 billion for a few global banks changed mark‐‐toto‐‐market and lowered the barmarket and lowered the bar
committed $406 billion for a few global banks, changed markcommitted $406 billion for a few global banks, changed mark‐‐toto‐‐market, and lowered the bar market, and lowered the bar with “stress tests” that allow losses from with “stress tests” that allow losses from ““Unfunded Super SeniorsUnfunded Super Seniors” ” to remain undisclosed.to remain undisclosed.
Despite inadequate transparency of toxic CDO assets and Treasury delays launching “Public‐Private Investment Program” for banks’ “Legacy Assets,”
stock markets/single name CDS recognize loss exposure of a few global banksstock markets/single‐name CDS recognize loss exposure of a few global banks
NOTE: Includes Bank of America’s $118 billion loss guarantee for Merrill toxic assets sold with MER financing & “NOTE: Includes Bank of America’s $118 billion loss guarantee for Merrill toxic assets sold with MER financing & “clawbacksclawbacks” prior to BAC acquisition ” prior to BAC acquisition plus other MER undisclosed losses; includes UBS’ $54 billion transfer of toxic assets to Swiss National bank; plus other MER undisclosed losses; includes UBS’ $54 billion transfer of toxic assets to Swiss National bank; SociétéSociété GénéralGénéral, Royal Bank of Scotland and , Royal Bank of Scotland and Barclays , and UBS government funds are from France, United Kingdom, and Switzerland, respectively.Barclays , and UBS government funds are from France, United Kingdom, and Switzerland, respectively.Sources: U.S. Treasury Department; AIG Press Release,3/15/09; SEC 10Sources: U.S. Treasury Department; AIG Press Release,3/15/09; SEC 10‐‐Ks; IMF exchange rates 12/31/08; analysis & chart by EvereKs; IMF exchange rates 12/31/08; analysis & chart by Everest Management st Management