Delphi: The Post-Default Aftermath

Were you someone who wrote credit protection on Delphi? If so, you’re feeling a bit as though you dodged a bullet write now. Alea reports:

In 2005 when Delphi went bankrupt there was some fear of a short squeeze in the underlying bonds a the number of outstanding CDS was 12 times that of the underlying bonds. An auction was held to help get a cash settlement for excess CDSs.

Recovery price: 63.375

Delphi is having some difficulty getting out of bankruptcy and current recovery is estimated at around 32.000.

With the benefit of hindsight, paying cash instead of taking bonds was a very clever or lucky move.

Essentially, writers of protection had a choice: when the auction was over, they could either pay out $100 per contract and receive a Delphi bond in return, or else they could just pay out $36.625 in cash. Eleven out of 12 insurers paid the cash, which turns out to have been good for them, since the value of the bond they would otherwise have received in return has now halved.

On the other hand, as Satyajit Das notes, the bonds could have fallen much further:

Fitch Ratings assigned an R6 recovery rating to Delphi’s senior unsecured obligation equating to a zero to 10 per cent recovery band – far below the price established through the protocol.

In truth, the people who hold performing debt and the people who hold nonperforming debt are two very different investor bases. It might seem as though holders of Delphi bonds who protected themselves in the CDS market got a bum deal: right now their bonds are worth just 32 cents on the dollar, and they received only 36.6 cents on the dollar in cash. But in fact those holders will have long since sold their bonds by now, and Delphi’s debt is trading as quasi-equity, between very sophisticated and long-term vulture investors. Who need no one’s sympathy.