High risk credits spark recovery swap revival

The high profile bankruptcy protection filing by US auto parts manufacturer Delphi last weekend and the subsequent downgrading of General Motors (GM) by Standard & Poor’s have heightened market interest in recovery swaps, say dealers.

Recovery swaps allow market participants to fix the recovery rate on credit default swaps (CDS) contracts in the case of default. For instance, two counterparties might agree to exchange a fixed recovery rate of 40% versus the realised recovery rate.

The rising number of names in the CDS market trading at very high spreads has driven trading volumes in recovery swaps, with over 100 trades in the past two months, says Marcus Schüler, Deutsche Bank’s London-based head of structured credit marketing.

Before last Saturday’s credit event, Deutsche Bank reported a trade going through on a Delphi recovery swap at 58%/60%. Meanwhile, Markit, the London-based data and risk management specialist, saw Delphi’s mid-market five-year CDS level finishing Friday trading at 19.89% upfront, a 613 basis point widening over the previous 28 days.

The focus has since shifted to the ailing Detroit-based auto maker General Motors. Deutsche Bank quoted GM CDS at 985/1005bp today – a rise of 70bp over Tuesday’s close – and reported a trade on the GM recovery swap at 40%/45%.