Traders Rethink Credit Positions After Railtrack Default

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Traders Rethink Credit Positions After Railtrack Default

The collapse last week of U.K. rail operator Railtrack is causing credit derivatives professionals to reconsider their positions in other companies regulated or subsidized by the U.K. government. The Railtrack collapse is significant because it is the first investment grade default in the European market. Since the company was put into administration traders are revaluing credit-default swaps that are priced with an implicit government guarantee on the reference credit, according to credit traders. For example five-year protection on National Grid widened 15bps to 40-45bps last week. Although National Grid does not have explicit backing, the company's rate of return is determined by the government.

British Airways could also come under pressure; some traders said it has been supported by the assumption the government would not allow its flagship carrier to go under. "I'm not convinced the government would support BA," said Roger Harvey, a credit derivatives analyst at J.P. Morgan in London, stressing that investors have to look at companies on a case-by-case basis.

"The market is looking at all government-sponsored public enterprises, on any businesses that rely on government support," added one credit derivatives trader. However, the Railtrack and Swissair examples may undermine that belief. The trader reported pressure on BA protection, which was at 400-450bps last Tuesday.

In the broader market, European credit derivatives professionals said credit-default swaps seemed to have passed the litmus test posed by the Railtrack plc default. One trader said, "Even though Railtrack was A2 on Friday and in default on Monday, it's actually been a smooth process so far, with all the counterparties calling right away and no one contesting."

Just one trading day before the administrators were sent in five-year protection on Railtrack was trading at around 110 basis points and the bonds had an A2 rating from Moody's Investors Service with a stable outlook.

A trader at a top-tier bank in London, which has notional exposure via credit-default swaps of USD200 million before netting, said the triggers have not been contested and participants now have 30 days to settle their contracts. Traders report the default swaps were among the most active in the U.K. market, after BA and British Telecommunications.

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