Elpida, Japan's last maker of dynamic-random-access memory, or DRAM, chips, filed for bankruptcy protection on Feb. 27, effectively defaulting on its straight and convertible bonds totaling about Y138.5 billion.

Two days later, the International Swaps and Derivatives Association declared that a "credit event" that triggers payouts in CDS contracts--similar to a decision earlier this month for CDS covering Greek sovereign debt--had occurred.

The ISDA has set the date of the Elpida CDS auction for Thursday, at which the debt recovery ratio--how much will be returned to holders of debt--will be decided. That will in effect determine who benefits and loses from the CDS trades.

Elpida has said that it will aim to restructure under the supervision of the Tokyo District Court, but credit analysts say putting together a viable plan will be difficult as global DRAM chip makers have struggled to make money in a thin-margin market plagued by overcapacity.

That means pricing the Elpida bonds will be tough, they say.

"There is a great deal of uncertainty," said Katsuhide Takahashi, credit specialist at Citigroup Global Markets Japan. "It's yet to be seen how the rehabilitation process will take shape. It's difficult to bid."

Recovery swaps, which are tradable contracts used for speculating on the recovery ratio, suggest a likely ratio of just under 20%. The swaps traded at 18.0% on Feb. 28, CDS traders said. The swaps were indicated at 17.9% last Thursday, according to Markit, a financial information services company.

An auction is a rare event within the CDS market. While CDS are known as insurance against default or restructuring of debt, payouts rarely take place. Market participants often bet on an improvement or deterioration in corporate or sovereign creditworthiness and make or lose money depending on changes in CDS prices.

Only one CDS auction was held in Japan in 2011--for Victor Company of Japan, which restructured its debts.

In Elpida's case, the ISDA's determinations committee ruled unanimously on Feb. 29 that a bankruptcy credit event had occurred. The voters were 15 key market participants, including banks and investment firms.

The recovery ratio at the auction may well be different from the actual debt recovery ratio determined when a rehabilitation plan for the company is decided.

The difference could be significant, particularly if market participants are receiving securities as payment instead of cash, said Akihito Murata, a credit analyst at Deutsche Securities.

"Once again, there will be winners and losers there," he said.

While the debt recovery ratio will be closely watched, low trading volumes in Elpida CDS mean the outcome of the auction is unlikely to affect the broader market, analysts said.

Data on global trading volumes from the Depository Trust & Clearing Corporation show that Elpida CDS is not one of the top 1,000 entities traded in the market.

By: DocMemory
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