Lehman Bonds Priced Lower than Expected (less than 10 cents to the dollar)

[girl gone mad]

The initial fixings in the auction to settle Lehman Brothers credit derivatives trades put the value of those senior bonds at 9.75 cents on the dollar, below analyst expectations, which means those who sold protection against default on Lehman debt will recover less than expected. This is not final pricing.

The data, posted on Creditfixings.com, shows open interest of $4.92 billion. The expectation was for a recovery rate of about 12 to 15 cents on the dollar, according to various analysts.

The rate suggests a potential for “bigger losses for those writing protection,” notes Ian Lyngen of RBS Greenwich Capital. The equity market, which had put in a middling performance prior to this news, fell on the report, as investors expected better results. About $500 billion in derivative contracts linked to Fannie Mae and Freddie Mac was settled earlier in the week, but those CDS settled between 91.5 and 99.9 cents on the dollar.

However, Tim Backshall, strategist at Credit Derivatives Research, says the results are not worth panic. “Given the size of the open interest, the recovery rate is a little lower but not dramatically lower than what everyone was expected — I think this will be fairly orderly,” he says.

Mr. Backshall says the volume of open interest to sell, that is, bonds that those who sold protection against them that need to now be settled, is lower than expected. He says investors that bought protection against default had been in the market already, buying up bonds.

Those who sold protection (the insurance) owe the bondholder the value of the bonds at par (or 100 cents on the dollar), and they’re the ones taking the loss. But the low volume — thus far — suggests that “there will be net loss to somebody today of 90% of that $5 billion, and that wouldn’t be a surprise but not like you can see hundreds of billions changing hands here,” he says.

http://blogs.wsj.com/marketbeat/2008/10/10/lehman-bonds-priced-lower-than-expected/

[dkf]

1. Only $5 billion in bonds outstanding?

Or only $5 billion covered by CDS?

How does that work?