Fitch says recovery values could complicate physical delivery on financial guarantors

In Fitch Ratings' latest report on the CDS market and financial guarantors, the analysts say physical settlement of CDS on a financial guarantor (not the holding company) itself would likely take the form of protection buyers delivering a suitable wrapped security to the protection seller in return for the full notional amount of the swap.

Given the massive number of securities that have been wrapped by the financial guarantors, these securities presumably can be found in abundance, they note. But they add that massive differences in recovery values between a wrapped municipal obligation and a wrapped structured finance CDO, both of which would be deliverable, could complicate delivery. This would be more of the case where the financial guarantor's business is not split up.

Fitch says some market participants have noted that if a cash settlement protocol is to be used, the same might need to be modified to accommodate the unique characteristics of the situation. They add that there appears to be a large number of obligations that may be potentially deliverable should a credit event occur, although a large percentage of these would be expected to have a high recovery value.