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Friday November 7, 2008

Firms’ credit default swap exposure lower than debt


NEW YORK: The amount of debt outstanding at General Motors Corp, Ford Motor Co, General Electric and others dwarfs the amount of credit default swap (CDS) risk on the companies, according to new data.

The data contrast with fears that CDS volumes have surged to represent several times the amount of debt they insure, and that the high volumes raise the risk that protection sellers will be unable to make payments when borrowers default.

Credit default swaps are used to protect against the risk of a corporate, sovereign or other borrower defaulting on their debt, or to speculate on their credit quality.

Growth in the contracts has propelled gross volumes to US$33.56 trillion globally, drawing ire and fear from regulators and observers concerned about the market’s runaway growth.

New data, however, show that for most of the actively traded companies, the real amount of CDS exposure is far below their debt.

The confusion arises from the oft-quoted gross numbers, which vastly overstate the actual amount of risk.

For example, US$64.72bil in gross CDS exposure, known as its notional volume, is outstanding on GM, according to data the Depository Trust & Clearing Corp (DTCC) released for the first time on Tuesday. DTCC clears the majority of CDS trades and has agreed to release the data on a weekly basis to improve the transparency of the market.

GM’s net exposure is significantly lower than the US$32.45bil the company has in outstanding long-term debt.

“The net notionals are designed to represent the payment from protection sellers to protection buyers upon default, whereas the gross notionals can include duplicated and closed out trades,” said Brian Yelvington, analyst at research firm CreditSights.

Ford’s net CDS exposures are also lower than its long-term debt, at US$4.59bil and US$25bil respectively. Similarly, net CDS exposures on GE’s finance arm, General Electric Capital Corp, stand at US$12.15bil, compared with US$321.91bil in long-term debt.

“Getting those net numbers out there and making people realise that the net amount that’s going to change hands is much, much smaller (than gross numbers) will assuage some fears,” Yelvington said. — Reuters


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