Nearly $1 billion in debt from failed bank Washington Mutual Inc. sold in an auction Thursday at a markedly higher price than was seen for a similar auction of Lehman Brothers debt.
NEW YORK — Nearly $1 billion in debt from failed bank Washington Mutual Inc. sold in an auction Thursday at a markedly higher price than was seen for a similar auction of Lehman Brothers debt.
The auction priced $988 million of Washington Mutual debt at 57 cents for every $1 of debt sold.
At an auction earlier in the month, investors sold $4.92 billion in Lehman Brothers Holdings Inc. debt for only 8.625 cents on the dollar.
The significantly higher result for Washington Mutual debt indicates investors feel they will likely recover more cash on their Washington Mutual holdings than Lehman debt.
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The difference in price between Washington Mutual debt and Lehman debt comes down to what remains in actual assets available to creditors versus the amount of outstanding debt, said Michael Anderson, a vice president at SecondMarket Inc., a marketplace for trading illiquid assets. Anderson said his company has many interested parties in Washington Mutual claims.
Also, Washington Mutual’s exposure to severely depressed assets was smaller than Lehman’s, Anderson said.
Last month, amid the increasing downturn in the credit markets, Lehman filed for bankruptcy and Seattle-based Washington Mutual became the nation’s largest bank ever to fail. Washington Mutual’s banking assets were then purchased by JPMorgan Chase & Co. for $1.9 billion.
JPMorgan is assuming much of Washington Mutual’s troubled assets, which helps the price of the debt, Anderson said. One of the biggest problems at Washington Mutual was mounting losses on its mortgage lending portfolio.
The auction price could also provide a separate benefit. It could help settle future credit default swap claims traded by third parties on the debt, since the auction sets a baseline price for the debt.
Credit default swaps have played a prominent role in the mushrooming credit crisis that in the past month led to Lehman filing for bankruptcy protection, a government rescue plan for insurer American International Group Inc. and Merrill Lynch & Co. selling itself to Bank of America Corp.
The market for swaps, which is unregulated, is huge: estimated at as much as $62 trillion. While little-known to many individual investors, they are commonly used contracts to insure against the default of financial instruments such as bonds and corporate debt.
What is deemed the riskier, and likely larger portion of the swaps market, are swaps bought and sold as bets against bond defaults — a buyer doesn’t necessarily have to own a bond to buy the CDS that insures it. In such cases, investors use swaps to essentially place bets on a company’s performance, similar to shorting a stock — the move is purely speculative, as the investors are betting only on whether a bond or security will be paid off or fail.
Sellers of swaps have to make buyers whole on the price of the underlying debt if a company goes bankrupt or fails to repay the debt. In the case of Washington Mutual, setting a price for the debt at 57 cents for every $1 now means any company that sold swaps tied to Washington Mutual debt theoretically must pay out the remaining 43 cents for every $1 on the contracts. The Lehman auction, in contrast, meant sellers of swap contracts would have to pay 91.375 cents for every $1.
Unlike Washington Mutual, Lehman was heavily involved as both a seller and buyer of CDS contracts, which likely played a part in its downfall.
Any investor who held swaps on Washington Mutual debt, and has yet to settle, could now use the auction sale price as a basis for settling those outstanding contracts.