Credit Policy

Special Report CDx Survey — Market Volumes

Continue Growing while New
Concerns Emerge
Financial Institutions „ Introduction
Ian Linnell Fitch Ratings comments on key trends, as well as opportunities
+44 20 7417 4344 and challenges facing the credit derivatives (“CDx”) market in the
ian.linnell@fitchratings.com
fifth annual update of its “Global Credit Derivatives Survey.”
Krishnan Ramadurai
Fitch’s benchmark survey of the credit derivatives market
+44 20 7417 3480 continues to be unique in that it captures usage and credit flows
krishnan.ramadurai@fitchratings.com across geographic regions and specific sectors of the financial
community, often operating under separate regulatory umbrellas.
Eileen Fahey
+1 312 368 5468 Survey Highlights
eileen.fahey@fitchratings.com • The credit derivatives market continues to expand at a
remarkable pace, evidenced by the dramatic increase in total
Insurance notional amount outstanding over the past year. The total
Julie Burke amount of credit derivatives bought and sold combined at
+1 312 368 3158
year-end 2006 rose to USD49.9trn, an increase of 113% over
julie.burke@fitchratings.com
the USD23.4trn reported for year-end 2005.
Financial Guarantors
Thomas Abruzzo
• Leading the charge has been the traded indices, which,
+1 212 908 0793 notably, surpassed single-name CDS (Credit Default Swaps)
thomas.abruzzo@fitchratings.com in terms of total notional volume outstanding last year. Fitch
estimates that USD22.2trn of index products has been bought
Credit Policy and sold by year-end 2006, compared with USD20.0trn in
James Batterman single-name CDS.
+1 212 908 0385
james.batterman@fitchratings.com • Some of the most cited market challenges going forward
include those related to how smoothly the market can deal
Roger Merritt with a turn in the credit cycle. This includes concerns with
+1 212 908 0636 regard to liquidity in the event of such a downturn, the impact
roger.merritt@fitchratings.com
that the unwinding of system leverage can have on volatility,
and settlement following a credit event.
Credit Market Research
Eric Rosenthal
+1 212 908 0286
eric.rosenthal@fitchratings.com
Indices vs Single-Name CDS Sold Position
Indices Single-name CDS
(USDtrn)
12

10

0
2004 2005 2006
Source: Fitch

16 July 2007
www.fitchratings.com
 Credit Policy
• Prospectively, most market participants expect As the following pie-chart illustrates, survey
the CDx market to continue its expansion, with respondents expect CDx volume to continue
CDOs (Collateralised Debt Obligations), LCDS increasing at a substantial rate, albeit possibly lower
(Loan-only Credit Default Swaps), and the than that experienced in 2006, with approximately
traded indices mentioned as the biggest growth two-thirds of respondents expecting between an 11%
vehicles. Some respondents expect single-name and 50% increase this year. No participant expected
CDS and some varieties of CDOs to lag behind volume to decline.
other structures in terms of growth.
Growth in Volume Expected This Year
• The trend towards lower-quality and unrated
Greater than
reference entities continued last year.
100%
Approximately 38% of all CDx referenced at increase
51%–100% 0%–10%
year-end 2006 was either speculative grade or 4%
increase
increase
unrated, versus 34% at year-end 2005, and only 14% 16%
18% back in 2003, a consequence of market
maturation, as well as investors’ continuing
search for higher returning risk exposures in a
spread-constrained environment.
11%–25%
26%–50%
• On the surface, banks globally appear to have increase
increase
become somewhat more conservative in terms 33%
33%
of their exposure, ending 2006 at USD304bn net
protection bought. However, while continuing to
use CDS as a hedging vehicle, banks Source: Fitch
increasingly cite “trading” as the leading
rationale for employing CDx. As a result, these CDOs, LCDS, and the traded indices were most
aggregate results hide significant variation in the frequently cited as those structures expected to
position of individual banks, with many actually exhibit the most robust levels of growth. While the
reporting positions which show them to be total notional amount sold to date on LCDS is
major sellers of protection. dwarfed by that of other structures, the rate of
increase has been very strong, spurred by the advent
• While banks remain net buyers of protection, the (in the US) of the LCDX index and refinements to
global insurance and monoline industries single-name documentation released in the middle-
continue to be key net sellers of protection at part of last year. The growth of the indices has been
USD395bn and USD355bn, respectively, at well-documented since their introduction, and as is
year-end 2006. clear from the figures, this expansion has continued
unabated. The graphic below illustrates those
This survey covers 65 financial institutions (44 structures that received at least three votes out of the
banks and broker-dealers, 13 insurance and 65 institutions surveyed. Note that some institutions
reinsurance companies and eight financial provided multiple answers, while others
guarantors), very similar to the 75 institutions provided none.
surveyed last year. In Fitch’s opinion, the institutions
covered represent some of the most important
players in the CDx market. High Growth Products
(Responses)
„ Forward-Looking View 20
18
16
Market Expects Growth to Continue 14
12
As part of Fitch’s annual CDx survey, the agency 10
asks market participants to give a prospective view 8
6
on the market in terms of expected growth in a 4
general sense, as well as for those specific structures 2
0
expected to exhibit more, as well as less, rapid
CPPI
Indices

Correlation
CDO

CPDO

CLO
Options
LCDS

CDS

growth than the rest of the market. Additionally,

Fitch solicits views on any challenges facing the
market, along with any predictions for the coming Shows the number of respondents (out of 65 polled) mentioning
year. the specific structure as having higher than average growth
prospects. Source: Fitch

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
2
 Credit Policy
US single-name form and the LCDX were still
Low Growth Products
(Responses)
ongoing. Please refer to the box on page five for a
9
discussion of some of the most significant longer-
8 term concerns.
7
6
5
4 Near-Term Challenges
3 (Responses)
2 10
1
0 8

Recovery swaps
Indices
None

Leveraged super senior

CPDO
CDS

ABS CDS

FTD
CDO

2
Shows the number of respondents (out of 65 polled)
mentioning the specific structure as having lower 0

Credit cycle

Volatility
Liquidity

LBO activity
Housing/ABX
Infrastructure

Spreads

Succession
Documentation

Settlement
than average growth prospects.
Source: Fitch

Single-name CDS, some varieties of CDOs, and –

perhaps surprisingly – the traded indices, are the Shows the number of respondents (out of 65 polled) mentioning
structures expected by some market participants to the issue as a potential near-term challenge going forward.
Source: Fitch
exhibit less robust growth, with no other category
receiving more than three votes. In fact, the most
common response was “none,” indicating that the
entire market would continue growing at a rapid Future Challenges
pace. The graphic above shows those structures (Responses)
receiving at least three votes in this category. Please 10
note that both the high- and low-growth product 8
charts show, in the case of single-name CDS and the 6
indices, both structures, reflecting differing views
4
from our respondents.
2

Market Challenges 0
Infrastructure

Documentation

transparency

management
Leverage

Settlement

Basel II
Credit cycle

Liquidity

LBO activity
We also asked market participants what they thought
Pricing/

some of the key challenges would be in the future, Risk

both in the near-term and out further. Some of these
were very specific, and very difficult to categorize.
Shows the number of respondents (out of 65 polled) mentioning
the issue as a potential challenge going forward.
Of those that were possible to classify, the leading Source: Fitch
categories for the near-term included concerns with
regard to infrastructure, the credit cycle in general,
documentation, liquidity, and settlement following a Respondent Predictions
credit event. The graphics below shows those top 10 Finally, Fitch asked participants to give some
categories garnering the most votes, for both near- surprise forecasts. The greatest number of
term and more distant concerns. To put this in predictions were related to an increase in spread
context, recall that 65 institutions participated in our volatility, followed by an unexpected increase in
survey. credit events. Other respondents expect, not
unrelated to this, spreads to widen, although others
Concerns over infrastructure, specifically operations believe that the market will generally hold steady.
and IT capacity, were most noted as potentially Several respondents expect greater investor
problematic, particularly back-office operations such acceptance of credit derivatives in general, and even
as those related to trade confirmations. Another more complexity, as well as undisclosed product
category frequently mentioned was documentation. innovations. A few others expect certain changes
As it turns out, much of the commentary in this from the rating agencies with regard to ratings
regard, at least for near-term concerns, was in methodology, among other matters.
relation to LCDS documentation. It is worth bearing
in mind that survey results were received, to a great
extent, while deliberations as to modifications of the

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
3

Leverage, Liquidity, and the Credit Cycle
Significantly, several of the “Challenge”
categories are related, and taken collectively, form
the biggest area of concern. This includes fears
related to the credit cycle turning, market liquidity
in the wake of such a downturn, and settlement
concerns following a credit event. LBO activity
was also identified as a significant risk factor that
could influence volumes and prices in this market.
As far as the credit cycle is concerned, a small
minority of market participants expect either a
major default or a general increase in defaults in
the near-term, while certain other investors have
concerns that liquidity may suffer or disappear in
an eventual downturn of the market. Yet other
participants are concerned that an unwinding of
system leverage will only serve to exacerbate this
situation. Note that as the time-frame expands
beyond the next 12 months (the chart entitled
“Future Challenges”), these concerns become
more acute.
In particular, system leverage, which wasn’t
anywhere 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 and
settlement following a credit event. How well the
market weathers a major downturn in all these
respects remains an unanswered question. While
not necessarily a foreshadowing of things to
come, the recent lows experienced by the ABX
index (asset-backed index - see chart below), as
well as recent spread volatility on the corporate
side, gives some credence to such concerns, and
thus these rankings should be of no surprise.
Other areas of concern include succession, market
volatility, and pricing/transparency.
ABX-HE BBB and BBB- Pricing
A B X-HE-B B B 07-1 A B X-HE-B B B - 07-1
(% o f par)
100
80
60
40
Jan 07 Feb 07 M ar 07 M ay 07 Jun 07
So urce: M arkit Gro up
CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
Credit Policy
Hedge Funds
Although in-depth data remains elusive, it is
apparent that hedge funds’ pursuit of credit-oriented
strategies and their influence on key segments of the
credit markets has continued to grow at a dramatic
pace. The growing influence of hedge funds in the
credit markets – cash and CDS – is supported by
third-party research from Greenwich Associates
which reported, last year, that hedge funds are
responsible for driving nearly 60% of all CDS
trading volume and one-third of trading volume in
CDOs. Given the rapid growth of the CDx market
and the increasing influence of hedge funds, it is
reasonable to assume that trading volumes would
have gone up in 2006.
Following recent market events, some high-profile
hedge funds have been forced to liquidate positions
to meet sharply increased margin requirements and
stem portfolio losses. In Fitch’s opinion, the
uncertain outlook for credit markets, combined with
the large positions taken by hedge funds – which is
magnified by the leverage strategies adopted by
many of them, may well result in a number of hedge
funds and banks attempting to close out positions
with no potential takers of credit risk on the other
side. This is particularly an issue in the structured
credit markets which can be hard to value and
therefore illiquid. (For more information on the role
of 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 and
available at www.fitchratings.com).
„ Market Action
Growth
The CDx market’s remarkable growth rate continued
last year, rising 110% on a sold basis in absolute
terms among survey respondents. In terms of total
volume, Fitch identified USD25.2trn of gross
protection sold and USD24.7trn of gross protection
bought, the difference representing institutional
activity not picked up by the agency’s survey (see
below). Indices and single-name credit default swaps
have served as the driving force behind the nearly
USD50trn notional volume bought and sold to date,
accounting for approximately 84% of the market.
Since Fitch released its inaugural report in 2003, the
total notional amount outstanding has climbed a
staggering 1,326%. Compared with last year’s
results, the total notional increased an impressive
113%.
Jul 07
4
 Credit Policy
came from North American respondents, with the
Global Positions by Product – Year End
balance coming from Europe/Asia.
2006
Gross sold Gross bought Net sold/bought
Global Positions by Sector – Year End
(USDtrn)
2006
12 Gross sold Gross bought Net sold/bought
8
(USDtrn)
4 24.2
1.0
0
-4
0.5
-8
-12 0.0
Single- Indices CDOs Portfolio Total Other
name products return
-0.5
CDS swaps

Source: Fitch -1.0

-24.6
Global banks Insurance Financial guaranty
Clearly, the amount of bought positions should equal Broken scale used on Global banks
Source: Fitch
that sold; however, the figures provided give a net
sold position of USD447bn, compared with
USD377bn at year-end 2005. This net increase can For both the US and Europe, the investment-grade
mainly be attributed to the fact that hedge funds, series were predominant. For example, the
asset managers, and pension funds, which are a breakdown of the Dow Jones CDX NA (North
substantial part of the market, were not included in America) series in terms of the total notional amount
the survey. The fact that this net gap is actually quite outstanding as of year-end 2006 was 91% IG
small in the context of the overall size of the market (investment-grade), 2% XO (crossover), and 7% HY
attests to the scope of the survey. Please note that the (high-yield). The breakdown of the ITraxx Europe
Fitch survey targets the most significant, but clearly series was similar, being 87% IG, although XO at
not every, financial institution active in CDS, with 9% was greater than HY at 4%. The ABX, CMBX,
the exception of the hedge funds, which are and LevX indices measured only 0.5% of the entire
generally reluctant to reveal what they view as sold volume.
confidential information. For simplicity, the text that
follows will generally refer to the amount sold. Europe/Asian Positions by Product – Year
End 2006
As forecasted in last year’s report, indices were Gross sold Gross bought Net sold/bought
indeed the highest-growth product at year-end 2006.
(USDtrn)
After tallying USD3.7trn at year-end 2005, indices
reached a whopping USD11.1trn on a sold basis 12

(USD22.2trn on a combined bought and sold basis) 8

4
in 2006, a 198% jump from a substantial base. In
0
terms of a regional breakdown, 55% of the volume
-4
-8
North American Positions by Product – -12
Single- Indices CDOs Portfolio Total Other Total
Year End 2006 name products return
Gross sold Gross bought Net sold/bought CDS swaps
(USDtrn)
16 Source: Fitch
12
8 From a country perspective, North America
4
0 accounted for the majority of index exposure, at 51%
-4 of the total protection sold, followed by Europe at
-8 46%, Asia at 2%, and the Emerging Markets at 1%.
-12
-16
Finally, untranched index exposure outpaced that of
Single- Indices CDOs Portfolio Total Other Total
tranched exposure by a 3:1 margin. It is important to
name products return note that for equity or some mezzanine tranches, the
CDS swaps degree of leverage one can achieve through
Source: Fitch

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
5
 Credit Policy
tranching can provide exposure to the underlying Other Products
instruments far in excess of an untranched vehicle. Corporate synthetic CDOs and structured finance
synthetic CDOs at USD3.6trn bought and sold made
Index Sold Exposure by Type up just 7% of the entire volume, while other
portfolio products, at 6%, comprised USD3.1trn. In
Itraxx addition, the combined figures for total return swaps,
Europe HY
Others credit swaptions, recovery swaps, market value
DJ NA HY 2%
2% products, and other products consisted of less than
Itraxx 4%
2% of the entire volume.
Europe XO
4%
Global Banks’ Net Position
DJ NA IG Global banks remained net buyers of protection at
49% USD304bn at year-end 2006. Note, however, that
Itraxx
Europe IG
this aggregate position masks significant variance in
40% the positions of individual banks, with 45% of the 44
banks surveyed being net sellers of protection.
Furthermore, several of the regions/countries
Others include Lev X, ABX, CMBX & DJ NA XO exhibited noticeable swings, in particular, the UK &
Source: Fitch
Switzerland. After maintaining an essentially flat
position at year-end 2005, the region, at USD170bn
Index Sold Exposure by Geographic net long, was the biggest net protection buyer at
year-end 2006. Germany’s banks collectively were
Region Emerging
Asia
the sole net sellers of protection at year-end 2006, at
markets
2% 1%
USD76bn, a significant increase from 2005; however,
this has been driven principally by two large players.
15 institutions saw their net position fluctuate by
USD10bn or greater from the previous year’s results.

Europe North
46% America
Global Banks: Net Position by Region –
51% Year End 2006
(USDbn) Net sold Net bought
80
40
0
Source: Fitch -40
-80
-120
Single-Name CDS -160
While last year’s survey gave mixed views on the -200
France/Italy/Other

UK/Switzerland
Germany

Benelux
Australia/Asia

North America

growth potential of single-name CDS vis-à-vis other

structures, such as the indices, growth in this space
was in fact a robust 69% in 2006, following a 65%
increase the prior year. At year-end 2006, single-name Source: Fitch
CDS totaled USD10.1trn gross sold, or USD20.0trn
bought and sold. However, for the first time, single-
name CDS volume trailed that of the indices. While Ratings Quality
LCDS was identified as another growth area last year,
Once again, the low default environment, coupled
this was not evident in year-end 2006 numbers, which
with tight spreads, pushed investors further down the
show just USD29bn of total volume, compared with
credit curve. Speculative-grade and unrated tranches
corporate bond CDS of USD19.5trn. However, the 22
totaled 40% of the gross sold exposure at year-end
May introduction of the LCDX, as well as changes to
2006 (38% if the bought and sold amounts are
single-name documentation and generally greater
averaged), with the bulk of this coming from the
investor understanding/acceptance of this structure is
unrated facilities.
already showing an effect, with trading volumes
increasing notably.

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
6
 Credit Policy
accounted for 25% of volume, up from 19% at year-end
Global Credit Derivatives Exposure by
2005 and 10% at year-end 2004.
Rating (Protection Sold) − Year End 2006
AAA In examining the data on a flow basis, it appears as
9% AA though volume is moving away from the benchmark
Below 5%
investment
five-year point of the curve.
grade
40%
A Global Credit Derivatives Exposure by
21% Tenor (Protection Sold) − Year End 2006

Greater than Less than 1

10 years year
3% 5%
BBB 1–2 years
25% 9–10 years 14%
12%
Source: Fitch
7–8 years
11%

Global Credit Derivatives Exposures by

Rating (Protection Sold) – Year End 5–6 years
3–4 years
20%
2002–2006 35%
2002 2003 2004 2005 2006 Source: Fitch
(%)
40
35
30
25
Reference Entities
20 Automotive and telecommunication companies, along
15 with sovereigns, occupied the top 10 slots on both a
10
5
bought and sold basis for the most cited reference
0 entities. General Motors Corp. (rated ‘B’) and
AAA AA A BBB Below DaimlerChrysler AG (‘BBB+’) held the top two spots
investment on both lists.
grade
Source: Fitch
The two automotive companies have maintained a
top-four position since Fitch published its initial
When Fitch started its survey, speculative and report. Sovereigns, in particular Italy (‘AA-’), Brazil
unrated exposure as a percentage of the total was (‘BB+’), and Russia (‘BBB+’), were the most
relatively small, at 8%. Since then, this segment of commonly cited names, with 36% and 28% of these
the CDx market moved to 18% in 2003 and then seen on the respective bought and sold top 25 lists.
24% in 2004, before reaching 31% in 2005. This has
been the result of negative credit migration, as well With regard to industrial sectors, telecommunication
as investors reaching for increased spread in an companies make up 20% of the cited names while
increasingly spread-constrained environment, in automotives comprise 16% of the total. In terms of the
addition to the general growth of the CDx market. biggest movers, Telefonica SA (‘BBB+’), BT Group
plc (‘BBB+’), and Time Warner Inc. (‘BBB’) moved
At the opposite end of the spectrum, the proportion up from the prior survey.
of credits rated at or above ‘AAA’ minimum
thresholds have declined each year, starting at 22% In terms of concentration, the top five reference
at year-end 2002 and falling to 9% at year-end 2006, entities on a sold basis accounted for 13% of those
although clearly this is due to the rapid expansion of cited, down from 18% at year-end 2005. From a
other areas of the market. In notional terms, the bought perspective, the results are similar, with the
‘AAA’ sector continues to grow. figures falling to 17% at year-end 2006 from 21%
the prior year.
Tenor
With the CDx market becoming well established, This somewhat lower concentration is also evident
trading longer (as well as shorter) tenors is becoming when examining the top 20 names, which dropped to
more commonplace. For example, at year-end 2006, 34% of the total universe from 38% on a sold basis.
tenors of seven years (protection sold) or greater By sector, non-financial corporate instruments

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
7
 Credit Policy
comprised 64% of the volume, followed by financial
Top Reference Entities Year End 2006:
institutions at 23%, structured finance at 8%,
sovereigns at 5%, and others at 1% on a sold basis. Gross Sold and Bought Protection by Notional
Amount
Protection sold Protection bought
Top Reference Entities Year End 2006: 1 General Motors/GMAC — General Motors/GMAC —
Gross Sold and Bought Protection by Trade 2 Brazil × Brazil ×
Count 3 DaimlerChrysler × DaimlerChrysler ×
4 Ford Motor Corp./Ford France Telecom ×
Protection sold Protection bought
Motor Credit Co. Ø
1 General Motors/GMAC — General Motors/GMAC — 5 Turkey × Turkey ×
2 DaimlerChrysler — DaimlerChrysler × 6 Telecom Italia × Ford Motor Corp./Ford Motor
3 Telecom Italia × Ford Motor Corp./Ford Motor Credit Co. Ø
Credit Co. Ø 7 Russia — Telecom Italia ×
4 Italy × France Telecom — 8 France Telecom Ø Deutsche Telecom ×
5 Deutsche Telekom × Telecom Italia — 9 Deutsche Telecom × Russia Ø
6 Ford Motor Corp./Ford Telefonica × 10 Telefonica NE Telefonica NE
Motor Credit Co. Ø 11 United Mexican States Ø AT&T Corp. ×
7 Brazil × Brazil — 12 BT Group plc NE BT Group plc NE
8 Telefonica NE Deutsche Telekom × 13 Italy Ø AIG ×
9 France Telecom Ø Italy — 14 AT&T Corp. — Volkswagen Ø
10 Russia × Volkswagen Ø 15 General Electric/GECC Ø General Electric/GECC Ø
11 BT Group plc NE Russia × 16 AIG × Gazprom Ø
12 Fannie Mae × Time Warner × 17 Fannie Mae — Banco Santander Central
13 General Electric/GECC Ø Turkey × Hispano NE
14 Spain NE Argentina NE 18 Altria Group NE Safeway NE
15 Turkey Ø BT Group plc NE 19 KPN × United Mexican States Ø
16 Portugal — General Electric/GECC Ø 20 Vodafone NE Altria Group NE
17 United Mexican States — Altria Group NE 21 Portugal Telecom NE Argentina NE
18 France Ø Bombardier × 22 VNU NE KPN NE
23 Safeway NE Venezuela NE
19 Germany × Merrill Lynch NE
24 Gazprom Ø AXA NE
20 Altria Group Ø Philippines Ø 25 Venezuela NE Supervalu NE
21 Deutsche Bank Ø United Mexican States Ø
22 Merrill Lynch × AIG Ø — Neutral; × Up; Ø Down; NE New Entry
23 Gazprom — Bayer NE Excludes Indices
Source: Fitch
24 Time Warner NE Citigroup NE
25 Volkswagen Ø Clear Channel NE
— Neutral; × Up; Ø Down; NE New Entry Counterparties
Excludes Indices
Commonly quoted reference entities, based on frequency of occurrence Regarding market-making activity, the top 10
Source: Fitch counterparties made up 62% of the total exposure on
a trade count basis, down from 66% at year-end
2005 and 70% at year-end 2004. However, on a
Global Reference Entity by Type notional basis, concentration has been increasing to
(Protection Sold) − Year End 2006 ever higher levels, with the top 10 institutions
providing 89% of the total notional amount bought
Sovereign
and sold.
Other
5% 1%
Structured This represents an increase from the 86%
Finance
8%
experienced at year-end 2005. Morgan Stanley
(‘AA-’), Deutsche Bank (‘AA-’), Goldman Sachs
(‘AA-’), and JP Morgan Chase (‘AA-’) were the top
Financial
Institution
four counterparties for the second year in a row, and
23% have held one of the four top slots for the past four
Corporate years.
63%
In terms of trade count and volume (total notional
amount traded), nine and eight, respectively, of the
Source: Fitch top 10 counterparties were the same as in 2005. In
addition, 19 of the top 20 names are the same as in
2005, indicative of the lack of change in this area.
For better or worse, counterparty concentration
appears to remain a feature of this market.

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
8
 Credit Policy
customers. On 15 October 2006, Dura failed to make
Top 20 Counterparties 2006 by Trade
a coupon payment and two weeks later filed for
Count Chapter 11 with roughly USD800m of outstanding
1 Morgan Stanley — debt. Dura cited cutbacks by US automakers and
2 Deutsche Bank — rising raw materials costs for its bankruptcy filing.
3 Goldman Sachs —
4 JP Morgan Chase —
5 Barclays × Motivation for Using Credit Derivatives
6 UBS Ø Trading and hedging/credit risk management were
7 Lehman Brothers Ø given as the dominant motivations for using credit
8 Credit Suisse × derivatives. The five categories used that attempt to
9 Merrill Lynch × capture the institutional rationale behind using credit
10 BNP Paribas —
11 ABN Amro ×
derivatives can be seen in the charts below. From a
12 Bear Stearns — banking perspective, trading served as the dominant
13 Citigroup Ø purpose, with 58% of the respondents electing this
14 Societe Generale × category. This is up from the 51% figure seen a year
15 HSBC × earlier, and is significant, as it confirms the transition
16 Dresdner Ø of CDx from a hedging vehicle into primarily
17 Bank of America Ø
another trading asset class. In general, most of the
18 Royal Bank of Scotland ×
19 Calyon Ø 2006 banking figures were in line with the prior year
20 CIBC NE results. On the insurance side, hedging/credit risk
— Neutral; × Up; Ø Down; NE New Entry
management and the use of credit derivatives as an
Source: Fitch alternative asset class remain the primary
motivations for employing credit derivatives.

Top 20 Counterparties 2006 by Notional Global Banks Motivations – Year End

Amount 2006
1 Morgan Stanley × Minimal/not relevant Active Dominant
2 Goldman Sachs Ø
Hedging/credit risk
3 JP Morgan Chase —
management
4 Deutsche Bank Ø
5 ABN Amro × Regulatory capital
6 Barclays —
7 Lehman Brothers —
Trading
8 UBS Ø
9 Bear Stearns ×
10 Merrill Lynch Ø Alternative asset class
11 Credit Suisse Ø
12 Bank of America — Intermediary/marketmaker
13 Dresdner ×
14 BNP Paribas Ø 0 10 20 30 40 50 60 70
15 Citigroup Ø Source: Fitch
16 Societe Generale Ø
17 Royal Bank of Scotland ×
18 Calyon Ø
19 HVB NE Global Insurance Motivations – Year End
20 AIG NE 2006
— Neutral; × Up; Ø Down; NE New Entry Minimal/not relevant Active Dominant
Based on notional volumes
Source: Fitch Hedging/credit risk
management

Regulatory capital
Credit Events
Credit events noted by respondents fell to a benign
Trading
44 in 2006 from 105 in 2005. Automotive part
suppliers Dana Corp. and Dura Operating Corp. Alternative asset class
accounted for 73% of the 2006 credit events cited.
Calpine was the next highest referenced name, at just Intermediary/ market-maker
7%. On 3 March 2006, Dana filed for Chapter 11
bankruptcy, with roughly USD2bn of outstanding 0 20 40 60 80 100
Source: Fitch
debt. The company experienced financial stress as a
result of reduced business from its key domestic

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
9

Market Values
Given the difficulties in collating and interpreting
market value data, Fitch has not published any
specific-market value figures. Although market
values clearly add to a better understanding of risk
than notional amounts, Fitch would like to highlight
that as valuations are largely driven by model
assumptions which may not always reflect realizable
market prices, institutions may be understating losses
or overstating gains. Recent market events in the US
sub-prime market reinforce the point that caution
must be exercised when analyzing market values.
„ Sector Results
Global Banks
Globally, a small number of banks and broker-
dealers continue to dominate credit derivatives
activity. The 44 banks and broker-dealers surveyed
had an aggregate of nearly USD24.6trn (2005:
USD11.3trn) gross bought positions, which
represents a growth rate of 117%, and is largely a
manifestation of their role as traders and market
makers, as well as risk transfer activity undertaken
by banks as part of a broader business strategy which
focuses on an “originate-and-distribute” model of
business in contrast to the traditional “buy and hold”
model. Such a strategy has also helped banks to
diversify and reduce concentration risks in their
credit portfolios. These banks and broker-dealers
also reported a 120% increase in gross sold positions
to more than USD24.2trn (2005: USD11.0trn). The
increase in gross sold positions was influenced by
the larger intermediation role played by banks and
broker-dealers in meeting investors’ demand for
portfolio diversification, enhanced yield, and general
preference for increased structural complexity and
leverage. The rapid growth of CDx indices and
index-related products (indices exposures constitute
46% of exposures by products at year-end 2006) has
been an additional factor in driving growth for the
Global Banks: Positions by Products – Year End 2006
Gross sold Gross bought
(USDtrn)
12
-4
-8
-12
Single-name CDS Indices CDOs
Source: Fitch
CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
10
Credit Policy
second year in succession. Collectively, the global
banking industry remains a net buyer of protection,
with USD304bn of notional credit risk being
transferred 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 not
necessarily a reflection of true underlying risk being
transferred from the banking book by banks to other
players in the financial markets, given the growing
dominance of trading activities compared with
traditional hedging of banking book exposures.
Indeed, the net position of many of these institutions
increasingly reflects their current view of the credit
markets, and both net bought and sold positions are
taken. Gross and net positions were also influenced
by market demand and supply factors.
In line with past trends, there were notable swings in
the net sold and bought positions within the banking
sector, both in Europe and the US; while some large
banks shifted from being net protection sellers to net
protection buyers, there were an equal number of
banks that shifted from being net protection buyers
to net protection sellers. This is partially a reflection
of the varying views and positions taken by
participants in credit as an asset class.
On a cumulative net basis, the European banks
bought USD220bn of protection, North American
banks and broker-dealers bought USD70bn of
protection and Asian banks bought USD14bn of
protection, which sums to the aforementioned
USD304bn global figure. As stated before, this
overall picture however, masks differences at the
country level within the various regions, where some
banks have substantial sold positions while others
have significant bought positions. Some of the
smaller regional banks continue to use CDx as an
additional means of originating credit.
Given the relatively benign credit environment in
2006 and the continuing demand from investors for
Net sold/bought
Portfolio products Total return swaps Other
 Credit Policy

Global Insurance: Positions by Products – Year End 2006

Gross sold Gross bought Net sold/bought

(USDbn)
500

400

300

200

100

-100
Single-name CDS Indices CDOs Portfolio products Total return swaps Other

Source: Fitch

more yield in a yield-constrained environment, the
data indicates that banks increasingly tend to trade
across the entire ratings spectrum and in longer
tenors (25% of gross sold positions were seven years
or greater, compared to 18% for the same maturity at
year-end 2005).
Products’ sizeable position, the global insurance
industry 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 smaller
sample than in the previous year.

Global Insurance By product on a sold basis, single-name CDS

The global insurance/reinsurance sector, representing consisted of 63% of the volume, while corporate
principally AIG Financial Products, remained a large synthetic CDOs and structured finance synthetic
seller of protection, registering an aggregate gross sold CDOs made up just 16% of the total. Similarly, the
position of USD503bn. On a net basis, the sector credit profile, excluding AIG, of the industry
stood at USD395bn sold, up slightly from the changed, with ‘BBB’ representing 40%, ‘A’ at 35%,
USD383bn tallied at year-end 2005. Structured and ‘AA’ at 10%, while speculative grade
finance synthetic CDOs and corporate synthetic CDOs represented 8%, and ‘AAA’ 6% of the notional
accounted for 93% of the sold volume. In terms of amount sold. By product on a sold basis, single-
quality, of the total gross amount sold, 93% was in the name CDS consisted of 63% of the volume, while
super-‘AAA’ segment, versus 91% reported in last corporate synthetic CDOs and structured finance
year’s survey. synthetic CDOs made up just 16% of the total.
Similarly, the credit profile, excluding AIG, of the
industry changed, with ‘BBB’ representing 40%, ‘A’
Global Insurance Rating Quality: With and
at 35%, and ‘AA’ at 10%, while speculative grade
Without AIG Financial Products represented 8%, and ‘AAA’ 6% of the notional
With AIG FP Without AIG FP amount sold.
(%)
100 Financial Guarantors
80
The eight financial guaranty companies surveyed
had an aggregate of USD407bn gross sold protection
60 outstanding as of year-end 2006, with a net position
40
of USD355bn sold. The USD407bn sold amount
represents a growth rate of 34% in synthetic CDS
20 gross sold protection. The significant increase in the
yearly growth rate can be attributed to the expansion
0
AAA AA A BBB Below
of the CDx market as well as a generally tight-spread
investment environment, which has increased underwriting
Source: Fitch grade hurdles in other market sectors, making the CDx
arena more attractive. Like the global insurance
sector, corporate synthetic CDOs and structured
In addition, 68% of the tenor sold ranged from one finance synthetic CDOs were the most popular
year to four years (compared with 44% at year-end financial guarantor products, accounting for 76% of
2005) though that was driven by AIG’s dominant the volume sold.
“footprint” in this market. Excluding AIG Financial

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
11
 Credit Policy

Financial Guarantors: Positions by Products – Year End 2006

Gross sold Gross bought Net sold/bought

(USDbn)
350
300
250
200
150
100
50
0
-50
Single-name CDS Indices CDOs Portfolio products Total return swaps Other

Source: Fitch

While net sold exposure increased markedly, it
should 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 was
the amount of activity transacted with tenors of five
years or greater. In 2006, 62% of the sold volume
possessed this longer tenor, up from 48% in 2005
and 44% in 2004, respectively. The maturation of the
CDx market, coupled with a tight credit spread
environment causing financial guarantors to accept
additional risk in order to generate acceptable returns,
might explain these longer maturities.

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
12
 Credit Policy
„ Appendix 1

Year-End 2005 Cumulative − Totals

Global Positions by Product – Year End Global Positions by Sector – Year End
2005 2005
Gross sold Gross bought Net sold/bought Gross sold Gross bought
Net sold/bought Cash CDO
(USDtrn) (USDtrn)
11.0
6 1.0
4
0.5
2
0
0.0
-2
-4 -0.5
-6
Single- Indices Portfolio Other Cash -1.0
-11.3
name CDS products CDOs Global banks Insurance Financial guaranty
Broken scale used on Global banks
Source: Fitch
Source: Fitch

North American Positions by Product – Global Credit Derivatives Exposure by

Year End 2005 Rating (Protection Sold) – Year End 2005
Gross sold Gross bought Net sold/bought
AAA
(USDtrn) 11%
8 AA Below
6 6% investment
4 grade
2 31%
0
-2 A
-4 23%
-6
-8
Single- Indices Portfolio Other Cash Total
name CDS products CDOs CDS/CDO BBB
29%
Source: Fitch Source: Fitch

Europe/Asian Positions by Product – Year Global Credit Derivatives Exposure by

End 2005 Tenor (Protection Sold) – Year End 2005
Gross sold Gross bought Net sold/bought Greater than
10 years Less than 1
(USDtrn) 2% year
9–10 years
6 11% 5%

4 1–2 years
7–8 years 17%
2 6%
0
-2
-4 5–6 years
-6 21%
Single- Indices Portfolio Other Cash Total
3–4 years
name CDS products CDOs CDS/CDO
38%

Source: Fitch Source: Fitch

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
13
 Credit Policy

Global Reference Entity by Type Global Insurance: Positions by Products –

(Protection Sold) – Year End 2005 Year End 2005
Gross sold Gross bought Net sold/bought
ABS Sovereigns (USDbn)
4% 4% 600
Other 500
11%
400
300
200
Financials 100
18% Corporates
0
63%
-100
Single- Indices Portfolio Other Cash Total
name CDS products CDOs CDS/CDO
Source: Fitch Source: Fitch

Global Banks: Positions by Products – Financial Guarantors: Positions by

Year End 2005 Products – Year End 2005
Gross sold Gross bought Net sold/bought Gross sold Gross bought Net sold/bought
(USDtrn) (USDbn)
12 400
8
300
4
200
0
-4 100

-8 0
-12
-100
Single- Indices Portfolio Other Cash Total
name CDS products CDOs CDS/CDO Single- Indices Portfolio Other Cash Total
name CDS products CDOs CDS/CDO
Source: Fitch
Source: Fitch

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
14
 Credit Policy
„ Appendix 2

Survey Respondents
Ambac Assurance Corp.
American International Group, Inc.
Ameriprise Financial Inc.
Asahi Mutual Life Insurance Company
Assured Guaranty Corp.
Banca Intesa
Banco Bilbao Vizcaya Argentaria
Banco Santander Central Hispano
Bank of America Corp.
Barclays plc
BNP Paribas
Caixa Catalunya
Caja de Ahorros y Monte de Piedad de Madrid (Caja Madrid)
Calyon Corporate & Investment Bank
CIFG Guaranty
Citigroup Inc.
Commerzbank
Credit Suisse Group
Deutsche Bank AG
Deutsche Zentral-Genossenschaftsbank
Dexia
Dresdner Bank AG
Financial Guaranty Insurance Company
Financial Security Assurance Inc.
Fortis
Goldman Sachs Group, Inc.
HSBC Holdings plc
HSH Nordbank
IKB Deutsche Industriebank
ING Bank NV
JPMorgan Chase & Co.
KBC Bank
La Caixa
Landesbank Baden-Württemberg
Landesbank Berlin
Landesbank Hessen-Thüringen
Landesbank Rheinland-Pfalz
Landesbank Sachsen
Lehman Brothers Holdings Inc.
Massachusetts Mutual Life Insurance Co.
MBIA Insurance Corp.
Meiji Yasuda Life Insurance Company
Merrill Lynch & Co., Inc.
Mitsui Trust Holdings, Inc.
Morgan Stanley
Nippon Life Insurance Company
Nordea
Northwestern Mutual Life Insurance Company
Old Mutual Financial Network
Principal Financial Services, Inc.
Rabobank Group
Radian Asset Assurance Inc.
Royal Bank of Scotland Group plc
Shinsei Bank, Limited
Sompo Japan Insurance Inc.
Sumitomo Mitsui Financial Group, Inc.
Taiyo Life Insurance Company
Teachers Insurance & Annuity Association
The Bank of Tokyo-Mitsubishi UFJ, Ltd.
The Bear Stearns Companies Inc.
The Mitsubishi UFJ Trust and Banking Corporation
Tokio Marine
UBS AG
Wachovia Corporation
XL Capital Assurance Inc.
Source: Fitch

CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
15
 Credit Policy

Copyright © 2007 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. One State Street Plaza, 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 the
information 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 or
verify 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 an
opinion 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 not
engaged 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 by
the 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 does
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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, other
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CDx Survey — Market Volumes Continue Growing while New Concerns Emerge: July 2007
16