An interesting post by Zerohedge outlines 69 companies whose credit risk is ranked better than the United States government as determined by credit default swap prices (see first chart below). This is not just a recent phenomenon that has occurred simply due to the recent USA CDS widening as a number of companies have maintained relatively low credit default swap prices for a while such as those mentioned in a CreditLime posting over a year ago including IBM, McDonald’s, Hewlett Packard, Baxter International, Bristol Myers Squibb, Campbell Soup and ConocoPhillips. This is not simply an American phenomenon either as there are companies in a number of countries around the world whose credit risk is deemed safer than the corporations domiciled country debt.
This comes as the USA sovereign CDS curve has inverted and 1-year CDS has reached a new record. According to the FT,
The International Swaps & Derivatives Association (ISDA) also released a special question & answer feature answering inquiries about what would happen in the event of an American sovereign default. As paraphrased by the FT,
In the case of the US, a credit event would occur if the Treasury failed to make a payment on government bonds. In that situation, a committee under the auspices of the ISDA would rule that a default event had occurred only if the payment had not been made after a three-day grace period. At that point, US CDS trades would be triggered and then settled.
In the event of a US credit event, the buyers of CDS would locate the February 2039 Treasury bond, currently priced at less than $88, and deliver that to the writers of insurance and receive $100 back, or par.
At current levels, for a $10m trade in CDS, that would generate a return of more than $1m, said Mr Jersey.
The reason for finding the particular 2039 T-bond mentioned above is because it is one of the cheapest-to-deliver treasuries (as opposed to premium-priced T-bonds originally sold when interest rates were higher during the early-mid 2000’s and before. You could actually lose money despite the CDS hedge if you owned say a $150 premium-priced Treasury which you could then only deliver into the CDS to get back $100).
Another interesting question answered by ISDA is below:
Would a Credit Event on the US lead to massive payments by protection sellers?
No. According to the Depository Trust & Clearing Corporation’s CDS data warehouse, the total net exposure of market participants who have sold CDS credit protection on US sovereign debt is approximately $4.8bn as of July 15, 2011. This figure is calculated by summing the net exposures of the protection sellers, and so it is impossible for any one firm selling protection to have more than $4.8bn in exposure and, of course, given that there are many net sellers, any one seller’s exposure is likely to be far less.
Also, firms’ net exposures are partially offset by the recovery value of underlying obligations. For example, if the CDS auction showed the recovery value of debt to be (hypothetically) 90%, the maximum aggregate amount payable would, in the US’s case, be 10% of $4.8bn: $.48bn.
Furthermore, statistics indicate that, on average, 70% of derivatives exposure is collateralized and the level of CDS collateralization is likely to be even higher as over 90% of CDS transactions (by numbers of trades) are collateralized. Thus, in this example, of the $2.4bn payable, at least $2bn has effectively already been paid.
Perhaps more interesting is another related list comparing the cash on balance-sheet levels of 29 corporations which is greater than the cash held by the Fed according to the Zerohedge author. We suspect some readers might get quite a laugh out of one of the companies mentioned on the list: Gujarat Automotive Gears which they have listed having almost $87 billion in cash – or more than General Electric, HSBC, Goldman Sachs or Berkshire Hathaway. Quite impressive for a medium-sized industrial which most Americans have probably never heard of. We suspect the may have confused Indian rupees for US dollars in making that calculation because it is quite an astonishing cash pile for a company that only took in about US$4 million (net sales of Rs.1763.13 lacs in local currency) in revenue last year and reports current assets of just US$2.6 million (Rs.1176 lacs in local currency) according to Rediff. Also perhaps noticeably missing is Apple and its $75.876 billion cash-and-equivalents pile. Reason being is because only $2.769 billion of that is actually reported as held in cash ($12.091 billion in cash and cash equivalents) while most of its ‘cash’ is actually held in money market and other long or short-term securities (Level 1 & 2 assets) including US Treasuries ($10.7 billion) and other corporate securities ($30.4 billion).
