Bloomberg News

Sovereign Default Swap Costs Rise as Greek Credit Event Looms

February 09, 2012

Feb. 9 (Bloomberg) -- The cost of insuring European government bonds rose amid speculation a bailout package for Greece will trigger a credit event leading to a payout on default swaps insuring the nation’s debt.

Investors are betting losses will have to be imposed on private investors who fail to support a debt restructuring through so-called collective action clauses. The nation’s creditors meet in Paris today to discuss a debt-swap designed to halve the country’s privately held obligations.

A payout on Greek swaps makes it more likely contracts on other indebted nations may be triggered, and the Markit iTraxx SovX Western Europe Index of swaps on 15 governments climbed five basis points to 328 at 11:30 a.m. in London, the highest in a week. An increase signals deterioration in perceptions of credit quality.

“Collective action clauses will have to go in place,” Paul Donovan, deputy head of global economics at UBS AG in London, said in an interview with Caroline Hyde on Bloomberg Television’s “First Look.” “That will mean that credit- default swaps should be triggered.”

Credit-default swaps on Greece signal an 86 percent chance the nation will default within five years. Contracts insuring $10 million of the government’s bonds for five years cost $6.6 million in advance and $100,000 annually.

Bond Payment

Greece faces a 14.5 billion-euro bond payment on March 20 and is struggling to secure financing to avert a collapse of the economy that could spark a new round of contagion in the euro area.

The proposed bond exchange is intended to help the country reduce its debt-to-gross domestic product ratio to 120 percent by 2020 from 162 percent in 2011.

The Institute of International Finance, which is holding the meeting in Paris, represents the region’s banks. Hedge funds may resist a deal, seeking to get paid in full or compensated from insurance contracts.

“Even 70 percent participation is not enough to reach a 120 percent target,” said Alessandro Giansanti, a senior rates strategist at ING Groep NV in Amsterdam. “That target is already short based on new expectations of GDP growth. They really want full participation and the only possibility for that is a coercive exchange. The risk is high for a credit event.”

The cost of insuring European financial company debt also rose with the Markit iTraxx Financial Index linked to senior bonds of 25 banks and insurers increasing eight basis points to 211 and the subordinated index climbing 10 to 351, according to JPMorgan Chase & Co.

Crossover Index

The Markit iTraxx Crossover Index of 50 companies with mostly high-yield credit ratings jumped nine basis points to 572 while the Markit iTraxx Europe Index of 125 companies with investment-grade ratings rose 0.25 basis point to 131.5 basis points.

A basis point on a credit-default swap protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

--Editors: Michael Shanahan, Paul Armstrong

To contact the reporter on this story: Abigail Moses in London at Amoses5@bloomberg.net

To contact the editor responsible for this story: Paul Armstrong at Parmstrong10@bloomberg.net


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