Credit derivative officials are starting to face up to the potential mammoth losses if auto giant General Motors Corp. defaults. The dollar impact of such a move is impossible to predict, they say, but it would far outstrip anything so far weathered by the market.
The name is referenced in an estimated 80% of bespoke synthetic structures. Olivier Renault, credit strategist at Citigroup in London, said, "What is most concerning is the presence of GM in almost every CDO on the planet." He noted because of this size, and possible contamination in the auto sector, the full extent of potential damage is too hard to quantify.
GM appeared to be drawing closer to default after its downgrade by Standard & Poor's last Tuesday to B from BB minus. This came three weeks after the name began trading up front in the credit default swap market, a move that usually presages a spiral into bankruptcy. On Thursday the price of one-year upfront protection was 20.5 basis points with 500 bps running. This equates to 1475 bps in CDS spreads, said one trader. Credit analysts and dealers declined to speculate on the outstanding notional of single name GM CDS, but said it is far in excess of the USD285 billion of consolidated GM and General Motors Acceptance Corp. bonds.
Despite the uncertainty, some bulls are looking to capitalize on the tumult. One trader at a U.S. house in Europe said a number of players are buying long-dated GM bonds and shorting one-year CDS. This protects them against default in the short-term but equips them with an improving cash investment if GM recovers. Another trader said one-year protection buying is also being jumped on by existing bond holders.
In addition, default could present opportunities to enter the indices market. In a report published last week, analysts at Barclays Capital said it would create a wave of spread widening in the CDX and iTraxx investment grade incides, as investors turn to these most liquid of credit instruments to short their exposures. "At this point, because credit fundamentals are still strong, it is a good opportunity to go long the indices," said Thibault Scaramanga, index strategist in London, noting both corporate leverage and overall default rates are low. Another analyst predicted spreads on IG credit indices could widen between 10-15 basis points.
