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significantly off-market to the advantage of the dealer. Duffie
stated similarly to Parsons that there should be no credit
adjustment at the inception of a swap with a counterparty rated
AA, but that a downward credit adjustment would subsequently be
warranted if changes in interest rates caused the value of the
swap to become positive.
We agree with the testimony of Duffie and Parsons. Given
that FNBC discounted at an AA rate, the midmarket values being
reduced by credit adjustments already were discounted by a factor
reflecting the risk of nonpayment by an AA-rated counterparty.
The impact of the AA discount rate coupled with the claimed
credit adjustments is that FNBC is taking two adjustments for the
risk of default by AA-rated counterparties. FNBC did not
increase the value of swaps with A and above A-rated
counterparties to take into account the impact of FNBC’s credit
rating of A-.77
5. Credit Enhancements
Whereas many of FNBC’s swaps were supported by credit
enhancements such as credit triggers, guarantees, collateral, and
credit agreements, FNBC did not take those enhancements into
account in computing its credit adjustments. We believe that
collateral and other types of credit enhancements must be
77 Duffie testified that it would be unusual to see a
difference in prices between counterparties rated AAA and AA.
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