Bank sub debt restructuring results in first over par CDS settlement

A bond modification by Northern Rock’s bad bank has resulted in the first ever credit event settlement auction where the final price has risen above par. In a dealer auction today, traders bid up the UK bank’s shorter dated bonds from an initial market midpoint of 99.25 to 104.25. This is the first time since auctions were introduced for mass settlement of credit default swaps in 2005 that a final result has been greater than par. It will mean that the protection buyer will make a small payment to the protection seller to settle each credit default swap. The only previous example of a near par auction result was for Freddie Mac subordinated bonds in 2008, which produced a final settlement price of 99.9.

While the Northern Rock (Asset Management) zero to 2.5 year bucket settled above par, the 2.5 to five year bucket resulted in a final price of just under par – 99.125. In both auctions there was just one dealer looking to buy bonds to deliver into credit default swaps through which it had bought protection. In the shorter bucket this was Credit Suisse, with a €17.5 million settlement request. In the other auction, Bank of America put in a request to buy €11 million of bonds.

Northern Rock (Asset Management) triggered a credit event on its credit default swaps on 15 December when it changed the terms of its subordinated debt.