Was Delphi’s filing for bankruptcy protection a well-flagged event? It didn’t necessarily look like one at the time. On September 26, in their monthly conference call, Barclays Capital’s credit analysts’ view was that “an agreement [between Delphi and the UAW] will go to the wire but will happen. Delphi won’t file.” Three days later, though, Citigroup’s quant credit strategy team reckoned that a default was a high risk before October 17.
Citigroup’s view was more sensible. By late September the credit market was already working out recovery values around Delphi’s credit. It was trying to price in an absolute loss, not the likelihood of an event happening or not.
The complexity of Delphi’s pension and healthcare problems and its relationship with GM makes finding that absolute level very difficult. Nevertheless, recovery values at the beginning of October were optimistic. Recovery swaps were priced around 55%, whereas 40% would have been more realistic.
But the single-name market was at least pricing in some risk. Neither the new CDX series 5 index or the series 4 index features Delphi, so it’s hard to discern whether and where the probable bankruptcy was priced into bespoke CDO tranches. Throughout September, the lower parts of the CDO capital structure steadily sold off. But that happened in both the US and Europe, indicating that it was aimed at hedging positions in new super-senior issuance. Arguably, Delphi’s bankruptcy was not priced in.
It should have been. That it wasn’t suggests that the CDO market still has serious difficulty comprehending the impact of a credit event in a widely referenced name.
Tranche trading: The great credit correlation unwind - part 2?