20218181-Fitch-2007-CDS-Survey

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Credit Policy

16 July 2007

www.fitchratings.com

Financ ia l Ins t i tu t ions

Ian Linnell+44 20 7417 [email protected]

Krishnan Ramadurai+44 20 7417 [email protected]

Eileen Fahey+1 312 368 [email protected]

Insurance

Julie Burke+1 312 368 3158 [email protected]

Financial Guarantors

Thomas Abruzzo+1 212 908 [email protected]

Credit Pol icy

James Batterman+1 212 908 0385

[email protected]

Roger Merritt+1 212 908 [email protected]

Credi t Market Research

Eric Rosenthal+1 212 908 [email protected]

In t roduct ion

Fitch Ratings comments on key trends, as well as opportunitiesand challenges facing the credit derivatives (“CDx”) market in thefifth annual update of its “Global Credit Derivatives Survey.”Fitch’s benchmark survey of the credit derivatives marketcontinues to be unique in that it captures usage and credit flowsacross geographic regions and specific sectors of the financialcommunity, often operating under separate regulatory umbrellas.

Survey Highl ights

• The credit derivatives market continues to expand at a

remarkable pace, evidenced by the dramatic increase in totalnotional amount outstanding over the past year. The totalamount of credit derivatives bought and sold combined atyear-end 2006 rose to USD49.9trn, an increase of 113% overthe USD23.4trn reported for year-end 2005.

• Leading the charge has been the traded indices, which,notably, surpassed single-name CDS (Credit Default Swaps)in terms of total notional volume outstanding last year. Fitchestimates that USD22.2trn of index products has been boughtand sold by year-end 2006, compared with USD20.0trn insingle-name CDS.

• Some of the most cited market challenges going forwardinclude those related to how smoothly the market can dealwith a turn in the credit cycle. This includes concerns withregard to liquidity in the event of such a downturn, the impactthat the unwinding of system leverage can have on volatility,and settlement following a credit event.

0

2

4

6

8

10

12

2004 2005 2006

Indices Single-name CDS

Indices vs Single-Name CDS Sold Position

(USDtrn)

Source: Fitch

Special Report CDx Survey — Market Volumes

Continue Growing while New

Concerns Emerge

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CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007

3

0123456

789

N o n e

C D S

C D O

I n d i c e s

A B S C D S

C P D O

F T D

L e v e r a g e d s u p e r s e n i o r

R e c o v e r y s w a p s

Low Growth Products(Responses)

Shows the number of respondents (out of 65 polled)

mentioning the specific structure as having lower

than average growth prospects.

Source: Fitch

Single-name CDS, some varieties of CDOs, and –perhaps surprisingly – the traded indices, are thestructures expected by some market participants toexhibit less robust growth, with no other categoryreceiving more than three votes. In fact, the mostcommon response was “none,” indicating that theentire market would continue growing at a rapidpace. The graphic above shows those structuresreceiving at least three votes in this category. Pleasenote that both the high- and low-growth productcharts show, in the case of single-name CDS and theindices, both structures, reflecting differing viewsfrom our respondents.

Market Challenges

We also asked market participants what they thoughtsome of the key challenges would be in the future,both in the near-term and out further. Some of thesewere very specific, and very difficult to categorize.

Of those that were possible to classify, the leadingcategories for the near-term included concerns withregard to infrastructure, the credit cycle in general,documentation, liquidity, and settlement following acredit event. The graphics below shows those top 10categories garnering the most votes, for both near-

term and more distant concerns. To put this incontext, recall that 65 institutions participated in oursurvey.

Concerns over infrastructure, specifically operationsand IT capacity, were most noted as potentiallyproblematic, particularly back-office operations suchas those related to trade confirmations. Anothercategory frequently mentioned was documentation.As it turns out, much of the commentary in thisregard, at least for near-term concerns, was inrelation to LCDS documentation. It is worth bearingin mind that survey results were received, to a greatextent, while deliberations as to modifications of the

US single-name form and the LCDX were stillongoing. Please refer to the box on page five for adiscussion of some of the most significant longer-term concerns.

0

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10

I n f r a s t r u c t u r e

C r e d i t c y c l e

D o

c u m e n t a t i o n

L i q u i d i t y

S e t t l e m e n t

H

o u s i n g / A B X

L B O a

c t i v i t y

S p r e a d s

S u c c e s s i o n

V o l a t i l i t y

Near-Term Challenges(Responses)

Shows the number of respondents (out of 65 polled) mentioning

the issue as a potential near-term challenge going forward.

Source: Fitch

02

4

6

8

10

C r e

d i t c y c

l e

L e v e r a g e

S e

t t l e m e n

t

I n f r a s

t r u c

t u r e

B a s e

l I I

D o c u m e n

t a t i o n

L i q u

i d i t y

P r i c

i n g

/

t r a n s p a r e n c y

R i s k

m a n a g e m e n

t

L B O

a c

t i v i t y

Future Challenges(Responses)

Shows the number of respondents (out of 65 polled) mentioning

the issue as a potential challenge going forward.

Source: Fitch

Respondent Predic t ions

Finally, Fitch asked participants to give somesurprise forecasts. The greatest number of predictions were related to an increase in spreadvolatility, followed by an unexpected increase incredit events. Other respondents expect, notunrelated to this, spreads to widen, although othersbelieve that the market will generally hold steady.Several respondents expect greater investoracceptance of credit derivatives in general, and evenmore complexity, as well as undisclosed productinnovations. A few others expect certain changesfrom the rating agencies with regard to ratingsmethodology, among other matters.

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Hedge Funds

Although in-depth data remains elusive, it isapparent that hedge funds’ pursuit of credit-orientedstrategies and their influence on key segments of the

credit markets has continued to grow at a dramaticpace. The growing influence of hedge funds in thecredit markets – cash and CDS – is supported bythird-party research from Greenwich Associateswhich reported, last year, that hedge funds areresponsible for driving nearly 60% of all CDStrading volume and one-third of trading volume inCDOs. Given the rapid growth of the CDx marketand the increasing influence of hedge funds, it isreasonable to assume that trading volumes wouldhave gone up in 2006.

Following recent market events, some high-profile

hedge funds have been forced to liquidate positionsto meet sharply increased margin requirements andstem portfolio losses. In Fitch’s opinion, theuncertain outlook for credit markets, combined withthe large positions taken by hedge funds – which ismagnified by the leverage strategies adopted bymany of them, may well result in a number of hedgefunds and banks attempting to close out positionswith no potential takers of credit risk on the otherside. This is particularly an issue in the structuredcredit markets which can be hard to value andtherefore illiquid. (For more information on the roleof hedge funds in the CDx market and credit markets

in general, see “Hedge Funds: The Credit Market’s New Paradigm”, published on 5 June 2007 andavailable at www.fitchratings.com).

Marke t Ac t i on

Growth

The CDx market’s remarkable growth rate continuedlast year, rising 110% on a sold basis in absoluteterms among survey respondents. In terms of totalvolume, Fitch identified USD25.2trn of grossprotection sold and USD24.7trn of gross protectionbought, the difference representing institutional

activity not picked up by the agency’s survey (seebelow). Indices and single-name credit default swapshave served as the driving force behind the nearlyUSD50trn notional volume bought and sold to date,accounting for approximately 84% of the market.Since Fitch released its inaugural report in 2003, thetotal notional amount outstanding has climbed astaggering 1,326%. Compared with last year’sresults, the total notional increased an impressive113%.

Leverage, Liquidi ty , and the Credit Cycle

Significantly, several of the “Challenge”categories are related, and taken collectively, formthe biggest area of concern. This includes fears

related to the credit cycle turning, market liquidityin the wake of such a downturn, and settlementconcerns following a credit event. LBO activitywas also identified as a significant risk factor thatcould influence volumes and prices in this market.

As far as the credit cycle is concerned, a smallminority of market participants expect either amajor default or a general increase in defaults inthe near-term, while certain other investors haveconcerns that liquidity may suffer or disappear inan eventual downturn of the market. Yet otherparticipants are concerned that an unwinding of system leverage will only serve to exacerbate thissituation. Note that as the time-frame expandsbeyond the next 12 months (the chart entitled“Future Challenges”), these concerns becomemore acute.

In particular, system leverage, which wasn’tanywhere near the top of the list as far the near-term view, is at the top of the longer-term list of concerns, along with the credit cycle andsettlement following a credit event. How well themarket weathers a major downturn in all these

respects remains an unanswered question. Whilenot necessarily a foreshadowing of things tocome, the recent lows experienced by the ABXindex (asset-backed index - see chart below), aswell as recent spread volatility on the corporateside, gives some credence to such concerns, andthus these rankings should be of no surprise.Other areas of concern include succession, marketvolatility, and pricing/transparency.

40

60

80

100

Jan 07 Feb 07 Mar 07 May 07 Jun 07 Jul 07

ABX-HE-BBB 07-1 ABX-HE-BBB- 07-1

(% of par)

ABX-HE BBB and BBB- Pricing

Source: Markit Group

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0

4

8

12

Single-

name

CDS

Indices CDOs Portfolio

products

Total

return

swaps

Other

Gross sold Gross bought Net sold/bought

Global Positions by Product – Year End

2006

(USDtrn)

Source: Fitch

Clearly, the amount of bought positions should equalthat sold; however, the figures provided give a netsold position of USD447bn, compared withUSD377bn at year-end 2005. This net increase canmainly be attributed to the fact that hedge funds,asset managers, and pension funds, which are asubstantial part of the market, were not included inthe survey. The fact that this net gap is actually quitesmall in the context of the overall size of the marketattests to the scope of the survey. Please note that theFitch survey targets the most significant, but clearlynot every, financial institution active in CDS, withthe exception of the hedge funds, which are

generally reluctant to reveal what they view asconfidential information. For simplicity, the text thatfollows will generally refer to the amount sold.

As forecasted in last year’s report, indices wereindeed the highest-growth product at year-end 2006.After tallying USD3.7trn at year-end 2005, indicesreached a whopping USD11.1trn on a sold basis(USD22.2trn on a combined bought and sold basis)in 2006, a 198% jump from a substantial base. Interms of a regional breakdown, 55% of the volume

came from North American respondents, with thebalance coming from Europe/Asia.

-1.0

-0.5

0.0

0.5

1.0

Global banks Insurance Financial guaranty


Global Positions by Sector – Year End

2006

(USDtrn)

Broken scale used on Global banks

Source: Fitch

24.2

-24.6

For both the US and Europe, the investment-gradeseries were predominant. For example, thebreakdown of the Dow Jones CDX NA (NorthAmerica) series in terms of the total notional amountoutstanding as of year-end 2006 was 91% IG(investment-grade), 2% XO (crossover), and 7% HY(high-yield). The breakdown of the ITraxx Europeseries was similar, being 87% IG, although XO at9% was greater than HY at 4%. The ABX, CMBX,and LevX indices measured only 0.5% of the entiresold volume.

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-4

0

4

8

12

Single-name

CDS

Indices CDOs Portfolioproducts

Totalreturn

swaps

Other Total


Europe/Asian Positions by Product – Year

End 2006

(USDtrn)

Source: Fitch

From a country perspective, North Americaaccounted for the majority of index exposure, at 51%of the total protection sold, followed by Europe at46%, Asia at 2%, and the Emerging Markets at 1%.Finally, untranched index exposure outpaced that of tranched exposure by a 3:1 margin. It is important tonote that for equity or some mezzanine tranches, thedegree of leverage one can achieve through

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0

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12

16

Single-

name

CDS

Indices CDOs Portfolio

products

Total

return

swaps

Other Total


North American Positions by Product –

Year End 2006

(USDtrn)

Source: Fitch

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tranching can provide exposure to the underlyinginstruments far in excess of an untranched vehicle.

DJ NA HY

4%Itraxx

Europe XO

4%

Itraxx

Europe IG

40%

DJ NA IG

49%

Others

2%

Itraxx

Europe HY

2%

Index Sold Exposure by Type

Others include Lev X, ABX, CMBX & DJ NA XO

Source: Fitch

North

America

51%

Europe

46%

Asia

2%

Emerging

markets

1%

Index Sold Exposure by Geographic

Region

Source: Fitch

Single-Name CDS

While last year’s survey gave mixed views on thegrowth potential of single-name CDS vis-à-vis otherstructures, such as the indices, growth in this spacewas in fact a robust 69% in 2006, following a 65%increase the prior year. At year-end 2006, single-name

CDS totaled USD10.1trn gross sold, or USD20.0trnbought and sold. However, for the first time, single-name CDS volume trailed that of the indices. WhileLCDS was identified as another growth area last year,this was not evident in year-end 2006 numbers, whichshow just USD29bn of total volume, compared withcorporate bond CDS of USD19.5trn. However, the 22May introduction of the LCDX, as well as changes tosingle-name documentation and generally greaterinvestor understanding/acceptance of this structure isalready showing an effect, with trading volumesincreasing notably.

Other Produc t s

Corporate synthetic CDOs and structured financesynthetic CDOs at USD3.6trn bought and sold madeup just 7% of the entire volume, while other

portfolio products, at 6%, comprised USD3.1trn. Inaddition, the combined figures for total return swaps,credit swaptions, recovery swaps, market valueproducts, and other products consisted of less than2% of the entire volume.

Global Banks’ Net Posit i on

Global banks remained net buyers of protection atUSD304bn at year-end 2006. Note, however, thatthis aggregate position masks significant variance inthe positions of individual banks, with 45% of the 44banks surveyed being net sellers of protection.Furthermore, several of the regions/countries

exhibited noticeable swings, in particular, the UK &Switzerland. After maintaining an essentially flatposition at year-end 2005, the region, at USD170bnnet long, was the biggest net protection buyer atyear-end 2006. Germany’s banks collectively werethe sole net sellers of protection at year-end 2006, atUSD76bn, a significant increase from 2005; however,this has been driven principally by two large players.15 institutions saw their net position fluctuate byUSD10bn or greater from the previous year’s results.

-200

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-120

-80

-40

0

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G e r m a n y

A u s t r a l i a / A s i a

B e n e l u x

N o r t h A m e r i c a

F

r a n c e / I t a l y / O t h e r

U K / S w i t z e r l a n d

Net sold Net bought

Global Banks: Net Position by Region –

Year End 2006

(USDbn)

Source: Fitch

Ratings Qual i ty

Once again, the low default environment, coupledwith tight spreads, pushed investors further down thecredit curve. Speculative-grade and unrated tranchestotaled 40% of the gross sold exposure at year-end2006 (38% if the bought and sold amounts areaveraged), with the bulk of this coming from theunrated facilities.

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AAA

9% AA

5%

A

21%

Below

investment

grade

40%

BBB

25%

Global Credit Derivatives Exposure by

Rating (Protection Sold) − Year End 2006

Source: Fitch

0

5

10

15

20

25

30

35

40

AAA AA A BBB Below

investment

grade

2002 2003 2004 2005 2006

Global Credit Derivatives Exposures by

Rating (Protection Sold) – Year End

2002–2006

(%)

Source: Fitch

When Fitch started its survey, speculative andunrated exposure as a percentage of the total wasrelatively small, at 8%. Since then, this segment of the CDx market moved to 18% in 2003 and then24% in 2004, before reaching 31% in 2005. This hasbeen the result of negative credit migration, as wellas investors reaching for increased spread in anincreasingly spread-constrained environment, inaddition to the general growth of the CDx market.

At the opposite end of the spectrum, the proportionof credits rated at or above ‘AAA’ minimumthresholds have declined each year, starting at 22%at year-end 2002 and falling to 9% at year-end 2006,although clearly this is due to the rapid expansion of other areas of the market. In notional terms, the‘AAA’ sector continues to grow.

Tenor

With the CDx market becoming well established,trading longer (as well as shorter) tenors is becomingmore commonplace. For example, at year-end 2006,

tenors of seven years (protection sold) or greater

accounted for 25% of volume, up from 19% at year-end2005 and 10% at year-end 2004.

In examining the data on a flow basis, it appears as

though volume is moving away from the benchmark five-year point of the curve.

3–4 years

35%

5–6 years

20%

1–2 years

14%

Less than 1

year

5%

Greater than

10 years

3%

9–10 years

12%

7–8 years

11%


Tenor (Protection Sold) − Year End 2006

Source: Fitch

Reference Ent i t ies

Automotive and telecommunication companies, alongwith sovereigns, occupied the top 10 slots on both abought and sold basis for the most cited referenceentities. General Motors Corp. (rated ‘B’) andDaimlerChrysler AG (‘BBB+’) held the top two spotson both lists.

The two automotive companies have maintained atop-four position since Fitch published its initialreport. Sovereigns, in particular Italy (‘AA-’), Brazil(‘BB+’), and Russia (‘BBB+’), were the mostcommonly cited names, with 36% and 28% of theseseen on the respective bought and sold top 25 lists.

With regard to industrial sectors, telecommunicationcompanies make up 20% of the cited names whileautomotives comprise 16% of the total. In terms of thebiggest movers, Telefonica SA (‘BBB+’), BT Groupplc (‘BBB+’), and Time Warner Inc. (‘BBB’) movedup from the prior survey.

In terms of concentration, the top five referenceentities on a sold basis accounted for 13% of thosecited, down from 18% at year-end 2005. From abought perspective, the results are similar, with thefigures falling to 17% at year-end 2006 from 21%the prior year.

This somewhat lower concentration is also evidentwhen examining the top 20 names, which dropped to34% of the total universe from 38% on a sold basis.By sector, non-financial corporate instruments

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comprised 64% of the volume, followed by financialinstitutions at 23%, structured finance at 8%,sovereigns at 5%, and others at 1% on a sold basis.

Top Reference Entit ies Year End 2006:Gross Sold and Bought Protection by TradeCount

Protection sold Protection bought

1 General Motors/GMAC — General Motors/GMAC — 2 DaimlerChrysler — DaimlerChrysler 3 Telecom Italia Ford Motor Corp./Ford Motor

Credit Co. 4 Italy France Telecom —

5 Deutsche Telekom Telecom Italia —

6 Ford Motor Corp./Ford

Motor Credit Co. Telefonica

7 Brazil Brazil —

8 Telefonica NE Deutsche Telekom

9 France Telecom Italy — 10 Russia Volkswagen 11 BT Group plc NE Russia 12 Fannie Mae Time Warner 13 General Electric/GECC Turkey 14 Spain NE Argentina NE 15 Turkey BT Group plc NE

16 Portugal — General Electric/GECC 17 United Mexican States — Altria Group NE 18 France Bombardier 19 Germany Merrill Lynch NE

20 Altria Group Philippines 21 Deutsche Bank United Mexican States 22 Merrill Lynch AIG 23 Gazprom — Bayer NE 24 Time Warner NE Citigroup NE

25 Volkswagen Clear Channel NE

— Neutral; Up; Down; NE New EntryExcludes IndicesCommonly quoted reference entities, based on frequency of occurrenceSource: Fitch

Financial

Institution

23%

Sovereign

5%

Corporate

63%

Other

1%Structured

Finance

8%

Global Reference Entity by Type

(Protection Sold) − Year End 2006

Source: Fitch

Top Reference Entit ies Year End 2006:

Gross Sold and Bought Protection by NotionalAmount

Protection sold Protection bought

1 General Motors/GMAC — General Motors/GMAC — 2 Brazil Brazil 3 DaimlerChrysler DaimlerChrysler 4 Ford Motor Corp./Ford

Motor Credit Co. France Telecom

5 Turkey Turkey 6 Telecom Italia Ford Motor Corp./Ford Motor

Credit Co. 7 Russia — Telecom Italia 8 France Telecom Deutsche Telecom 9 Deutsche Telecom Russia 10 Telefonica NE Telefonica NE 11 United Mexican States AT&T Corp. 12 BT Group plc NE BT Group plc NE 13 Italy AIG

14 AT&T Corp. — Volkswagen 15 General Electric/GECC General Electric/GECC 16 AIG Gazprom 17 Fannie Mae — Banco Santander Central

Hispano NE 18 Altria Group NE Safeway NE 19 KPN United Mexican States 20 Vodafone NE Altria Group NE 21 Portugal Telecom NE Argentina NE 22 VNU NE KPN NE 23 Safeway NE Venezuela NE 24 Gazprom AXA NE

25 Venezuela NE Supervalu NE

— Neutral; Up; Down; NE New EntryExcludes IndicesSource: Fitch

Counterpar t ies

Regarding market-making activity, the top 10counterparties made up 62% of the total exposure ona trade count basis, down from 66% at year-end2005 and 70% at year-end 2004. However, on anotional basis, concentration has been increasing toever higher levels, with the top 10 institutionsproviding 89% of the total notional amount boughtand sold.

This represents an increase from the 86%experienced at year-end 2005. Morgan Stanley(‘AA-’), Deutsche Bank (‘AA-’), Goldman Sachs(‘AA-’), and JP Morgan Chase (‘AA-’) were the topfour counterparties for the second year in a row, andhave held one of the four top slots for the past fouryears.

In terms of trade count and volume (total notionalamount traded), nine and eight, respectively, of thetop 10 counterparties were the same as in 2005. Inaddition, 19 of the top 20 names are the same as in2005, indicative of the lack of change in this area.For better or worse, counterparty concentrationappears to remain a feature of this market.

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Top 20 Counter part ies 2006 by Trade

Count

1 Morgan Stanley — 2 Deutsche Bank — 3 Goldman Sachs — 4 JP Morgan Chase — 5 Barclays 6 UBS 7 Lehman Brothers 8 Credit Suisse 9 Merrill Lynch 10 BNP Paribas — 11 ABN Amro 12 Bear Stearns — 13 Citigroup 14 Societe Generale 15 HSBC 16 Dresdner 17 Bank of America

18 Royal Bank of Scotland 19 Calyon 20 CIBC NE

— Neutral; Up; Down; NE New EntrySource: Fitch

Top 20 Counterpart ies 2006 by Notional

Amount

1 Morgan Stanley 2 Goldman Sachs 3 JP Morgan Chase — 4 Deutsche Bank

5 ABN Amro 6 Barclays — 7 Lehman Brothers — 8 UBS 9 Bear Stearns 10 Merrill Lynch 11 Credit Suisse 12 Bank of America — 13 Dresdner 14 BNP Paribas 15 Citigroup 16 Societe Generale 17 Royal Bank of Scotland 18 Calyon 19 HVB NE 20 AIG NE

— Neutral; Up; Down; NE New EntryBased on notional volumesSource: Fitch

Credit Events

Credit events noted by respondents fell to a benign44 in 2006 from 105 in 2005. Automotive partsuppliers Dana Corp. and Dura Operating Corp.accounted for 73% of the 2006 credit events cited.Calpine was the next highest referenced name, at just7%. On 3 March 2006, Dana filed for Chapter 11bankruptcy, with roughly USD2bn of outstanding

debt. The company experienced financial stress as aresult of reduced business from its key domestic

customers. On 15 October 2006, Dura failed to makea coupon payment and two weeks later filed forChapter 11 with roughly USD800m of outstandingdebt. Dura cited cutbacks by US automakers and

rising raw materials costs for its bankruptcy filing.

Mot ivat ion for Us ing Credi t Der ivat ives

Trading and hedging/credit risk management weregiven as the dominant motivations for using creditderivatives. The five categories used that attempt tocapture the institutional rationale behind using creditderivatives can be seen in the charts below. From abanking perspective, trading served as the dominantpurpose, with 58% of the respondents electing thiscategory. This is up from the 51% figure seen a yearearlier, and is significant, as it confirms the transitionof CDx from a hedging vehicle into primarily

another trading asset class. In general, most of the2006 banking figures were in line with the prior yearresults. On the insurance side, hedging/credit risk management and the use of credit derivatives as analternative asset class remain the primarymotivations for employing credit derivatives.

0 10 20 30 40 50 60 70

Intermediary/marketmaker

Alternative asset class

Trading

Regulatory capital

Hedging/credit risk

management

Minimal/not relevant Active Dominant

Global Banks Motivations – Year End

2006

Source: Fitch

0 20 40 60 80 100

Intermediary/ market-maker

Alternative asset class

Trading

Regulatory capital

Hedging/credit risk

management

Minimal/not relevant Active Dominant

Global Insurance Motivations – Year End

2006

Source: Fitch

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Market Values

Given the difficulties in collating and interpretingmarket value data, Fitch has not published anyspecific-market value figures. Although market

values clearly add to a better understanding of risk than notional amounts, Fitch would like to highlightthat as valuations are largely driven by modelassumptions which may not always reflect realizablemarket prices, institutions may be understating lossesor overstating gains. Recent market events in the USsub-prime market reinforce the point that cautionmust be exercised when analyzing market values.

Sector Resul ts

Global Banks

Globally, a small number of banks and broker-

dealers continue to dominate credit derivativesactivity. The 44 banks and broker-dealers surveyedhad an aggregate of nearly USD24.6trn (2005:USD11.3trn) gross bought positions, whichrepresents a growth rate of 117%, and is largely amanifestation of their role as traders and marketmakers, as well as risk transfer activity undertakenby banks as part of a broader business strategy whichfocuses on an “originate-and-distribute” model of business in contrast to the traditional “buy and hold”model. Such a strategy has also helped banks todiversify and reduce concentration risks in theircredit portfolios. These banks and broker-dealers

also reported a 120% increase in gross sold positionsto more than USD24.2trn (2005: USD11.0trn). Theincrease in gross sold positions was influenced bythe larger intermediation role played by banks andbroker-dealers in meeting investors’ demand forportfolio diversification, enhanced yield, and generalpreference for increased structural complexity andleverage. The rapid growth of CDx indices andindex-related products (indices exposures constitute46% of exposures by products at year-end 2006) hasbeen an additional factor in driving growth for the

second year in succession. Collectively, the globalbanking industry remains a net buyer of protection,with USD304bn of notional credit risk beingtransferred to other sectors and institutions although

20 of the banks surveyed, or 45%, were net sellers of protection. The net bought or sold position is notnecessarily a reflection of true underlying risk beingtransferred from the banking book by banks to otherplayers in the financial markets, given the growingdominance of trading activities compared withtraditional hedging of banking book exposures.Indeed, the net position of many of these institutionsincreasingly reflects their current view of the creditmarkets, and both net bought and sold positions aretaken. Gross and net positions were also influencedby market demand and supply factors.

In line with past trends, there were notable swings inthe net sold and bought positions within the bankingsector, both in Europe and the US; while some largebanks shifted from being net protection sellers to netprotection buyers, there were an equal number of banks that shifted from being net protection buyersto net protection sellers. This is partially a reflectionof the varying views and positions taken byparticipants in credit as an asset class.

On a cumulative net basis, the European banksbought USD220bn of protection, North Americanbanks and broker-dealers bought USD70bn of protection and Asian banks bought USD14bn of

protection, which sums to the aforementionedUSD304bn global figure. As stated before, thisoverall picture however, masks differences at thecountry level within the various regions, where somebanks have substantial sold positions while othershave significant bought positions. Some of thesmaller regional banks continue to use CDx as anadditional means of originating credit.

Given the relatively benign credit environment in2006 and the continuing demand from investors for

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Single-name CDS Indices CDOs Portfolio products Total return swaps Other


Global Banks: Positions by Products – Year End 2006

(USDtrn)

Source: Fitch

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more yield in a yield-constrained environment, thedata indicates that banks increasingly tend to tradeacross the entire ratings spectrum and in longertenors (25% of gross sold positions were seven yearsor greater, compared to 18% for the same maturity atyear-end 2005).

Global Insurance

The global insurance/reinsurance sector, representingprincipally AIG Financial Products, remained a largeseller of protection, registering an aggregate gross soldposition of USD503bn. On a net basis, the sectorstood at USD395bn sold, up slightly from the

USD383bn tallied at year-end 2005. Structuredfinance synthetic CDOs and corporate synthetic CDOsaccounted for 93% of the sold volume. In terms of quality, of the total gross amount sold, 93% was in thesuper-‘AAA’ segment, versus 91% reported in lastyear’s survey.

0

20

40

60

80

100

AAA AA A BBB Below

investment

grade

With AIG FP Without AIG FP

Global Insurance Rating Quality: With and

Without AIG Financial Products

(%)

Source: Fitch

In addition, 68% of the tenor sold ranged from oneyear to four years (compared with 44% at year-end

2005) though that was driven by AIG’s dominant“footprint” in this market. Excluding AIG Financial

Products’ sizeable position, the global insuranceindustry had a net position of only USD11bn(USD21bn gross sold), down from the USD15bn(USD29bn gross sold) compiled at year-end 2005.Some of the decline can be attributed to a smallersample than in the previous year.

By product on a sold basis, single-name CDSconsisted of 63% of the volume, while corporatesynthetic CDOs and structured finance syntheticCDOs made up just 16% of the total. Similarly, thecredit profile, excluding AIG, of the industrychanged, with ‘BBB’ representing 40%, ‘A’ at 35%,and ‘AA’ at 10%, while speculative graderepresented 8%, and ‘AAA’ 6% of the notionalamount sold. By product on a sold basis, single-name CDS consisted of 63% of the volume, whilecorporate synthetic CDOs and structured financesynthetic CDOs made up just 16% of the total.Similarly, the credit profile, excluding AIG, of theindustry changed, with ‘BBB’ representing 40%, ‘A’at 35%, and ‘AA’ at 10%, while speculative graderepresented 8%, and ‘AAA’ 6% of the notionalamount sold.

Financial Guarantors

The eight financial guaranty companies surveyed

had an aggregate of USD407bn gross sold protectionoutstanding as of year-end 2006, with a net positionof USD355bn sold. The USD407bn sold amountrepresents a growth rate of 34% in synthetic CDSgross sold protection. The significant increase in theyearly growth rate can be attributed to the expansionof the CDx market as well as a generally tight-spreadenvironment, which has increased underwritinghurdles in other market sectors, making the CDxarena more attractive. Like the global insurancesector, corporate synthetic CDOs and structuredfinance synthetic CDOs were the most popularfinancial guarantor products, accounting for 76% of

the volume sold.

-100

0

100

200

300

400

500



Global Insurance: Positions by Products – Year End 2006

(USDbn)

Source: Fitch

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While net sold exposure increased markedly, itshould be noted that ‘AAA’ exposure reached 97%in 2006, up from 94% in 2005, with the majority of this attaching well above the minimum ‘AAA’thresholds. Another area that exhibited growth wasthe amount of activity transacted with tenors of fiveyears or greater. In 2006, 62% of the sold volume

possessed this longer tenor, up from 48% in 2005and 44% in 2004, respectively. The maturation of theCDx market, coupled with a tight credit spreadenvironment causing financial guarantors to acceptadditional risk in order to generate acceptable returns,might explain these longer maturities.

-50

0

50

100

150

200

250

300

350



Financial Guarantors: Positions by Products – Year End 2006

(USDbn)

Source: Fitch

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Appendix 1

Year-End 2005 Cumulat ive − Tota ls

-6

-4

-2

0

2

4

6

Single-

name CDS

Indices Portfolio

products

Other Cash

CDOs


Global Positions by Product – Year End

2005

(USDtrn)

Source: Fitch

-8

-6

-4

-2

0

2

4

6

8

Single-

name CDS

Indices Portfolio

products

Other Cash

CDOs

Total

CDS/CDO


North American Positions by Product –

Year End 2005

(USDtrn)

Source: Fitch

-6

-4

-2

0

2

4

6

Single-

name CDS

Indices Portfolio

products

Other Cash

CDOs

Total

CDS/CDO


Europe/Asian Positions by Product – Year

End 2005

(USDtrn)

Source: Fitch

-1.0

-0.5

0.0

0.5

1.0

Global banks Insurance Financial guaranty

Gross sold Gross boughtNet sold/bought Cash CDO

Global Positions by Sector – Year End

2005

(USDtrn)

Broken scale used on Global banks

Source: Fitch

11.0

-11.3

BBB

29%

A

23%

AA

6%

AAA

11%Below

investment

grade

31%


Rating (Protection Sold) – Year End 2005

Source: Fitch

Less than 1

year5%

1–2 years

17%

3–4 years

38%

9–10 years11%

5–6 years

21%

7–8 years

6%


Tenor (Protection Sold) – Year End 2005

Source: Fitch

Greater than

10 years

2%

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Corporates

63%

Financials

18%

Other

11%

ABS

4%

Sovereigns

4%

Global Reference Entity by Type

(Protection Sold) – Year End 2005

Source: Fitch

-12

-8

-4

0

4

8

12

Single-name CDS

Indices Portfolioproducts

Other CashCDOs

TotalCDS/CDO


Global Banks: Positions by Products –

Year End 2005

(USDtrn)

Source: Fitch

-100

0

100

200

300

400

500

600

Single-

name CDS

Indices Portfolio

products

Other Cash

CDOs

Total

CDS/CDO


Global Insurance: Positions by Products –

Year End 2005

(USDbn)

Source: Fitch

-100

0

100

200

300

400

Single-

name CDS

Indices Portfolio

products

Other Cash

CDOs

Total

CDS/CDO


Financial Guarantors: Positions by

Products – Year End 2005

(USDbn)

Source: Fitch

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Appendix 2

Survey Respondents

Ambac Assurance Corp.American International Group, Inc.Ameriprise Financial Inc.Asahi Mutual Life Insurance CompanyAssured Guaranty Corp.Banca IntesaBanco Bilbao Vizcaya ArgentariaBanco Santander Central HispanoBank of America Corp.Barclays plcBNP ParibasCaixa CatalunyaCaja de Ahorros y Monte de Piedad de Madrid (Caja Madrid)Calyon Corporate & Investment BankCIFG GuarantyCitigroup Inc.CommerzbankCredit Suisse GroupDeutsche Bank AGDeutsche Zentral-GenossenschaftsbankDexiaDresdner Bank AGFinancial Guaranty Insurance CompanyFinancial Security Assurance Inc.FortisGoldman Sachs Group, Inc.HSBC Holdings plcHSH NordbankIKB Deutsche IndustriebankING Bank NVJPMorgan Chase & Co.KBC BankLa Caixa

Landesbank Baden-WürttembergLandesbank BerlinLandesbank Hessen-ThüringenLandesbank Rheinland-PfalzLandesbank SachsenLehman Brothers Holdings Inc.Massachusetts Mutual Life Insurance Co.MBIA Insurance Corp.Meiji Yasuda Life Insurance CompanyMerrill Lynch & Co., Inc.Mitsui Trust Holdings, Inc.Morgan StanleyNippon Life Insurance CompanyNordeaNorthwestern Mutual Life Insurance CompanyOld Mutual Financial Network

Principal Financial Services, Inc.Rabobank GroupRadian Asset Assurance Inc.Royal Bank of Scotland Group plcShinsei Bank, LimitedSompo Japan Insurance Inc.Sumitomo Mitsui Financial Group, Inc.Taiyo Life Insurance CompanyTeachers Insurance & Annuity AssociationThe Bank of Tokyo-Mitsubishi UFJ, Ltd.The Bear Stearns Companies Inc.The Mitsubishi UFJ Trust and Banking CorporationTokio MarineUBS AGWachovia CorporationXL Capital Assurance Inc.

Source: Fitch

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Copyright © 2007 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. One State Street P laza, NY, NY 10004.Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. All of theinformation contained herein is based on information obtained from issuers, other obligors, underwriters, and other sources which Fitch believes to be reliable. Fitch does not audit orverify the truth or accuracy of any such information. As a result, the information in this report is provided “as is” without any representation or warranty of any kind. A Fitch rating is anopinion as to the creditworthiness of a security. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. Fitch is notengaged in the offer or sale of any security. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors bythe issuer and its agents in connection with the sale of the securities. Ratings may be changed, suspended, or withdrawn at anytime for any reason in the sole discretion of Fitch. Fitch doesnot provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. Fitch receives fees from issuers, insurers, guarantors, otherobligors, and underwriters for rating securities. Such fees generally vary from US$1,000 to US$750,000 (or the applicable currency equivalent) per issue. In certain cases, Fitch will rateall or a number of issues issued by a particular issuer, or insured or guaranteed by a particular insurer or guarantor, for a single annual fee. Such fees are expected to vary from US$10,000to US$1,500,000 (or the applicable currency equivalent). The assignment, publication, or dissemination of a rating by Fitch shall not constitute a consent by Fitch to use its name as anexpert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of Great Britain, or the securities laws of any particular jurisdiction. Due to the relative efficiency of electronic publishing and distribution, Fitch research may be available to electronic subscribers up to three days earlier than toprint subscribers.

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