Financial Company Default Risk

While default risk has dropped dramatically for the financial companies listed below, it's still interesting to see how the firms compare with each other on the CDS front. Below we highlight current credit default swap prices for 24 financial firms across the globe. These prices represent the cost per year to insure $10,000 worth of debt for 5 years.

As shown, default risk is the highest for Morgan Stanley (MS), followed by Goldman Sachs (GS), American Express (AXP), UBS, and Citigroup (C). The premium against default for JP Morgan (JPM) is the lowest among US financial firms, with Wachovia (WB), Wells Fargo (WFC), and Bank of America (BAC) not far behind. BNP Paribas (BNPQY.PK) and Credit Agricole have the lowest default risk of the 24 financial firms shown.

Comments

[HankWest:]

Dude, no guts, no glory!

Jan 10 06:35 PM

[Crocodilian:]

Thanks for this. I've been interested in the precise terms of the CDS contracts-- and what precisely constitutes a default. We've had any number of complex transactions, and these companies often have a holding company/operating subsidiary structure.

I've yet to see any discussion about the particulars of WaMu, for instance, were the operating subsidiary was purchased by JPM/Chase, but the holding company (and its debt) were left outstanding.

In cases like these, or like Bear Stearns, I assume that the CDS is not triggered -- but that would depend on the specific language of these. In starting to read up on these intruments, there's a remarkable opacity and complexity to them, along with room for disagreement . . . "credit events" are determined by a "calculation agent", usually a third party.

But grounds for disagreement and litigation are many, and there's no reason to believe that these instruments will speedily resolve. Here's a description of a recent litigation:

"The court first examined whether a credit event had
occurred. Citibank argued that a particular credit event applicable under the contract—an “Implied Write- down”—had occurred because the securities held by the Millstone CDO (which had issued the Class B notes) had decreased in value. VCG argued that the Implied Writedown provision only applied if there was a writedown in the Class B Notes themselves, regardless whether there was a decrease in the value of the securities in the Millstone CDO. After analyzing the CDS contract and the indenture for the Millstone CDO, the court concluded that the Implied Writedown provision referred to collateralized assets held by the CDO and not to the notes issued by the CDO. Accordingly, the court found that Citibank’s determination that a credit event had occurred in the form of an Implied Writedown was proper and that Citibank was entitled to judgment on the pleadings on that issue."

(from "Manhattan Federal Court Enforces ‘Clear’ Terms of Credit Default Swap Contract on Pillsburylaw.com website)

The point of all this is that not only are the amounts of outstanding CDS contracts huge, but their terms are not necessarily crystal clear . . . imagine if you had to litigate to effect settlement of your options trades!

Jan 10 07:33 PM

[John Lounsbury:]

How were these prices determined? I assume there is a record of transactions somewhere? If so, what volume of transactions have taken place recently and on what dates?

Jan 10 11:13 PM

[Rakesh Saxena:]

Good summary by Bespoke. But, Crocodilian, you have a valid point, which the regulators must clarify immediately before talking about a central clearing house. How "central" are these CDS contracts? What the variation levels in their contract terms? Many thanks - Rakesh


On Jan 10 07:33 PM Crocodilian wrote:

> Thanks for this. I've been interested in the precise terms of the
> CDS contracts-- and what precisely constitutes a default. We've had
> any number of complex transactions, and these companies often have
> a holding company/operating subsidiary structure.
>
> I've yet to see any discussion about the particulars of WaMu, for
> instance, were the operating subsidiary was purchased by JPM/Chase,
> but the holding company (and its debt) were left outstanding.
>
> In cases like these, or like Bear Stearns, I assume that the CDS
> is not triggered -- but that would depend on the specific language
> of these. In starting to read up on these intruments, there's a remarkable
> opacity and complexity to them, along with room for disagreement
> . . . "credit events" are determined by a "calculation agent", usually
> a third party.
>
> But grounds for disagreement and litigation are many, and there's
> no reason to believe that these instruments will speedily resolve.
> Here's a description of a recent litigation:
>
> "The court first examined whether a credit event had
> occurred. Citibank argued that a particular credit event applicable
> under the contract—an “Implied Write- down”—had occurred because
> the securities held by the Millstone CDO (which had issued the Class
> B notes) had decreased in value. VCG argued that the Implied Writedown
> provision only applied if there was a writedown in the Class B Notes
> themselves, regardless whether there was a decrease in the value
> of the securities in the Millstone CDO. After analyzing the CDS contract
> and the indenture for the Millstone CDO, the court concluded that
> the Implied Writedown provision referred to collateralized assets
> held by the CDO and not to the notes issued by the CDO. Accordingly,
> the court found that Citibank’s determination that a credit event
> had occurred in the form of an Implied Writedown was proper and that
> Citibank was entitled to judgment on the pleadings on that issue."
>
>
> (from "Manhattan Federal Court Enforces ‘Clear’ Terms of Credit Default
> Swap Contract on Pillsburylaw.com website)
>
> The point of all this is that not only are the amounts of outstanding
> CDS contracts huge, but their terms are not necessarily crystal clear
> . . . imagine if you had to litigate to effect settlement of your
> options trades!

Jan 11 12:27 AM

[Deehena:]

Bespoke -- Many thanks for this very valuable information. Dee

Jan 11 11:29 AM

[PROXIMO:]

I was curious as to the current credit default swap prices of the financial firms relative to each other. Thanks for lining it up.

Jan 11 12:15 PM

[Crocodilian:]

@Rakesh
"But, Crocodilian, you have a valid point, which the regulators must clarify immediately before talking about a central clearing house. How "central" are these CDS contracts? What the variation levels in their contract terms? Many thanks - Rakesh"

Short answer: No one knows what the variation in the terms are. These instruments were designed by financial engineers at a small number of institutions -- JP Morgan probably has the best overall picture of what the terms look like.

But the more you read about these instruments, the more complex the story is. These contracts have complex provisions to account for certain kinds of M&A events, for example. The "Calculation Agent" (usually the firm that designed the product) has to evaluate many complex corporate histories, mergers, sales of assets, and figure out how that applies to each of these instruments.

The more you look, the less amenable to "central clearing' the existing instruments appear to be:

European CDS instruments typically have different terms from US ones, for example.

Wikipaedia has an _excellent_ article on CDS
en.wikipedia.org/wiki/...

Jan 11 02:04 PM

[Gold Barron:]

The banks are nothing but financial casinos. The American people need to demand that our government stop this NOW!

Jan 11 06:43 PM