Credit Derivatives Led by Too Few Banks; GM

Discussion in 'Wall St. News' started by The Kin, Nov 22, 2005.


    Credit Derivatives Led by Too Few Banks, Fitch Says (Update1)
    Nov. 18 (Bloomberg) -- The $12.4 trillion market for credit derivatives is dominated by too few banks, making it vulnerable to a crisis if one of them fails to pay on contracts that insure creditors from companies defaulting, Fitch Ratings said.

    JPMorgan Chase & Co., Deutsche Bank AG, Goldman Sachs Group Inc. and Morgan Stanley are the most frequent traders in a market where the top 10 firms account for more than two-thirds of the debt-insurance contracts bought and sold, Fitch said in its Global Derivatives Survey for 2004 published today.

    Investors use so-called credit-default swaps to insure debt payments or bet on credit quality. Demand surged this week for swaps protecting payments by General Motors Corp. on concern the world's largest automaker may use up most of its $19.2 billion in cash reserves in the event of a strike at Delphi Corp., its largest auto-parts supplier. Delphi defaulted on about $2 billion of bonds when it filed for bankruptcy on Oct. 8.

    ``Risk concentration remains high,'' said Ian Linnell at Fitch in London. ``In the event that there was a major default, for instance General Motors, and then one of the major dealers also defaulted, the market would be in major trouble.''

    Credit-default swaps are the fastest growing part of the $270 trillion derivatives market, based on the so-called notional value of the debts that underlie the contracts, according to the Bank for International Settlements. The default swaps market worldwide jumped 60 percent to $10.2 trillion in the first half of 2005, the BIS said in a report yesterday.


    The growth is so rapid that the New York Federal Reserve in September summoned 14 of the biggest banks in the market, for failing to keep pace in processing the transactions, causing a backlog that threatened the stability of the banking system.

    ``The probability of a major dealer defaulting is extremely low, but as the market continues to grow, the issue is being ramped up all the time,'' Linnell said.

    In a credit-default swap, the buyer pays an annual premium to guard against a borrower's failing to pay its debts. In the event of default, the buyer gets paid the full amount insured, and hands over defaulted loans or bonds to the swap seller. Swap prices typically decline when creditworthiness improves, and rise when it worsens.

    A derivative is a financial obligation whose value is derived from such underlying assets as debt and equity, commodities and currencies.

    GM was among the five companies most frequently included in credit-derivatives contracts in 2004, along with Ford Motor Co., France Telecom SA, DaimlerChrysler AG and Deutsche Telekom AG, Fitch said. Investors bought more contracts protecting payments from Korea, Italy and Russia than any other governments.


    Traders of GM credit-default swaps last week demanded upfront payments in addition to annual premiums to protect debt payments by the Detroit-based company. By doing so, the market relegated GM to the same status that Delphi and Delta Air Lines Inc. had just before those companies defaulted.

    The annual cost of insuring $10 million of GM debt for five years using default swaps rose to a record of $2.35 million upfront plus $500,000 a year, compared with an annual premium of about $1 million early last week, according to Deutsche Bank prices. The debt-insurance contracts changed hands at about $260,000 at the start of this year, according to Bloomberg data.

    The survey of 120 banks and financial institutions showed that banks are typically net buyers of debt insurance because they can use default swaps to reduce the risk of corporate loans.

    Banks used credit derivatives to transfer a record $427 billion of credit risk from their balance sheets to other counterparties in 2004, up from $260 billion a year earlier, Fitch said.

    To contact the reporter on this story:
    Hamish Risk in London
    Last Updated: November 18, 2005 03:43 EST
  2. Credit-default swaps are the fastest growing part of the $270 trillion derivatives market...

    I cannot comprehend a market of that size.
  3. Chagi


    I suspect that the writer of the article is talking about notional principal, if so, it would greatly inflate the dollar values quoted for the swap market.

    I haven't studied credit default swaps yet (I'm actually about to do that this weekend for my bond class), but interest rate swaps for example use notional principal to determine cashflows, I would suspect that credit default swaps do as well.
  4. I think the most interesting thing in that article is the substantial increase in GM swaps recently.
  5. tomcole


    Anyone remember when Chrysler was rumored to collapse? The Feds rescued it.
  6. What party was in office at that time? What term is the current president in?

  7. Chrysler didn't owe $250 billion dollars. Gm will not be rescued by the government.
  8. tomcole


    You're dreaming - a company that is one of the largest employers in one of the biggest industries in the world, simply cannot fail.
  9. Sounds like you have it all mapped out!:eek:

  10. Detriot = Democrats

    The company will fall.
    #10     Nov 25, 2005