Bond insurers top sellers of credit protection, Fitch survey finds, General Motors top name

By Peter Heap

New York, March 10 - Bond insurers are the top providers of credit protection, accounting for about one in every six dollars in a new Fitch Ratings survey of the credit derivatives market.

The study also found that General Motors Corp. was the most popular name for credit derivative contracts.

Financial guarantors have sold $222 billion of credit protection on a net basis, Fitch said.

That was 17% of the $1.3 trillion total reported by the 147 companies responding to the rating agency's survey. Fitch estimates the credit derivatives market at $2 trillion in size. Fitch's study looked only at rated entities - which excluded hedge funds and some Asian financial institutions - and also excluded asset swaps.

Of the $222 billion of credit protection provided by the 10 bond insurers surveyed, credit default swaps made up $166 billion and insured collateralized debt obligations $56 billion.

Insurance and reinsurance companies were the next biggest providers of credit protection with $141 billion of credit derivatives and CDOs. Of the total 3.3% or $4.7 billion was below investment grade.

Synthetic and cash-funded CDOs were 93% of the total while U.S. insurers accounted for $105 billion of the net sales, spread among 42 companies.

Fitch commented that corporate credit risk is appealing to insurers since it is considered unrelated to other underwritten risks, offering diversification. Meanwhile CDOs and other credit derivatives offer a yield premium relative to other comparably rated debt.

However the recent high level of defaults and concerns raised by regulators could cut interest in credit derivatives from insurers, Fitch said.

While bond insurers and other insurers are net sellers of protection, Fitch found an outflow of credit risk from major banks to other sectors.

Banks bought $97 billion of credit protection on a net basis, the Fitch study found. Of this total, U.S. banks made up $31 billion net while European banks had €65 billion of net purchases of protection.

However Fitch said the European figures are misleading since only 30% of the region's banks active in the market are net protection buyers - and these are generally the larger, more sophisticated universal banks.

Nearly three-quarters of European banks are net sellers of protection, using credit derivatives as a revenue-generating tool to gain exposure to regions and sectors where they are underweighted.

"This is a somewhat surprising finding since the conventional view is that banks are primarily net buyers of protection," Fitch said.

German banks are particularly prominent as sellers of protection. In total their net sold position is €11 billion but the total for banks that are net sellers only is €27 billion, skewed heavily by the landesbanks looking for revenue outside their low-margin domestic business.

In total Fitch surveyed 121 banks and broker dealers but noted that the top 30 held 98% of the positions in this sector.

The most common reference company for credit derivatives was General Motors Corp. and General Motors Acceptance Corp., based on the number of mentions.

In second place was DaimlerChrysler followed by Ford Motor Co. and Ford Motor Credit Corp., General Electric Co. and General Electric Capital Corp., and France Telecom.

Positions six through 10 were: AOL Time Warner, Bank of America, Citigroup, Deutsche Bank and Philip Morris.

The rest of the top 25 were: Amgen, Deutsche Telecom, Household, JPMorgan Chase, Merrill, Walt Disney, BNP Paribas, Commerzbank, Province of Quebec, ABN Amro, AT&T Corp., British Telecom, Greece, Italy, and Royal Bank of Scotland.

Fitch's survey found 93% of the $1.3 trillion total was for investment-grade credits, broken down as 28% for the BBB category, 28% for A and 37% for AA and AAA. The remaining 7% or $84 billion covered junk-rated credits.

"This reinforces the view that this is largely a market for larger, investment-grade credit at this stage," Fitch said in its study. "As the credit derivative market evolves and becomes more mature, credit derivatives are expected to extend to more illiquid, less creditworthy names."

Fitch received reports of 108 credit events but these were concentrated in a small number of names. Of the total, 76 (or 70%) came from the top 10 reference entities, namely: WorldCom, Enron, Marconi, Railtrack, Xerox, Argentina, Teleglobe, TXU, Pacific Gas & Electric and Swissair.

Total exposure to CDOs was $115 billion with bond insurers taking the biggest part at $56 billion of policies written, including $2.4 billion rated below investment grade.

Insurance and reinsurance companies accounted for $19.2 billion of CDO investments while banks reported holding $42 billion, more than three quarters of it from European banks.

The list of counterparties for credit derivatives was dominated by the big banks and brokers.

JP Morgan Chase was number one, followed by Merrill Lynch and Deutsche Bank.

Other top 10 counterparties were Morgan Stanley, Credit Suisse First Boston, Goldman Sachs, UBS, Citigroup, Lehman Brothers and Commerzbank.

"In Fitch's view, concentration of counterparty risk is a notable feature of this market," the rating agency commented. "In many cases, the major market intermediaries are dependent on the performance of these primary sellers of protection - financial guarantors, reinsurance, and insurance companies - as well as the other major intermediaries. Much of this exposure may be well 'out of the money' due to credit enhancement, and many of the largest protection sellers are highly rated. Nonetheless, in a time of severe market stress, capital calls for the major counterparties relative to available capital could be substantial and jeopardize ability to perform."

Fitch also noted that hedge funds - which were not covered by the study - are one of the fastest growing and more influential segments of the credit derivatives market as protection buyers. The rating agency estimated they account for 5%-10% of the total.

Fitch added that it believes this may present additional challenges to the market related to hedge funds' propensity for minimal disclosure, their demonstrated ability to influence pricing/liquidity and the potential for increased counterparty risk.

Fitch sent surveys to a total of 200 banks, insurance companies, reinsurers, financial guarantors and broker-dealers. The rating agency said Monday it is extending the survey by 60 to 90 days as it works to obtain more responses.

After that time, Fitch said it will share its findings with regulators to in an attempt to encourage greater disclosure.

"Credit derivatives have diffused credit risk throughout the capital markets; however, in the absence of increased disclosure investors will not be able to place future losses in their proper context," said Robert Grossman, chief credit officer at Fitch Ratings, in a news release. "This is an area where issues will likely arise in the future. We will be incorporating the findings of the survey into our rating process, and we believe that greater disclosure is in the best interest of all market participants."

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