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California Budget Crisis Spurs Trading in Credit-Default Swaps
Feb. 2 (Bloomberg) -- Banks, hedge funds and other investors seeking to protect themselves from losses tied to California’s budget crisis are driving an increase in trading in credit- default swaps linked to the state.
Credit-default swaps protecting against a default by California, the nation’s most populous state, have more than tripled since Sept. 5, according to CMA DataVision in London. Last week, the contracts for the first time showed up on a list of the 1,000 most actively traded in the Depository Trust & Clearing Corp.’s trade warehouse.
Banks and investors are using the derivatives to hedge against losses on interest-rate swaps, commodities contracts and other assets that face losses if the state can’t make good on its obligations, said Fabrice Pilato, head of muni derivative trading at Morgan Stanley in New York.
“Because California is the largest U.S. state and is currently facing a well-publicized cash shortfall, many parties that have exposure to munis in general and to California in particular” are using the contracts as a hedge, Pilato said in a telephone interview.
Plunging housing prices and financial markets and rising unemployment have siphoned tax revenue from the state, which is set to face $42 billion less than it will need to pay for schools, police and other services through June 2010.
Moody’s Investors Service last month placed $67 billion of the state’s debt on review for a possible downgrade, citing a “lack of legislative solutions” for closing the budget gap. Moody’s rates California’s long-term debt A1, tied with Louisiana as the lowest among U.S. states. Standard & Poor’s, which has an equivalent rating of A+ on California’s general obligation bonds, said in December it was considering a downgrade.
Budget Shortfall
Governor Arnold Schwarzenegger said Jan. 26 that legislative leaders were closing in on an agreement to eliminate the budget shortfall.
Despite the increase in trading of California credit-default swaps, the market remains relatively illiquid compared with that for contracts linked to companies. The rush to hedge and speculation there will be more negative headlines in coming months are distorting the actual default risks for the state, said Matt Fabian, managing director at Municipal Market Advisors.
Traditional tax-exempt municipal bond investors haven’t been using the credit-default swaps market, he said.
‘More Bad News’
“I think what the market is saying is there’s a high likelihood of more bad news,” Fabian said. “The risk of California defaulting hasn’t changed very much. It would have to stop paying on tens of billions of dollars of regular expenses before its constitution would let it default on its debt.”
Credit-default swaps protecting against losses on the state’s debt for 10 years have jumped 257 basis points to 350 basis points since Sept. 5 and reached as high as 507 basis points in December, according to CMA DataVision.
A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
Five-year contracts on the Markit MCDX index, tied to 50 municipal issuers including California, have risen 59 basis points since the end of October to 210 basis points, CMA data show. It reached 350 basis points last month.
Credit-default swaps, used to hedge against losses or to speculate on the ability of borrowers to repay their debt, rise as investor confidence deteriorates. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent if borrowers fail to meet their debt obligations.
As of Jan. 23, there were outstanding credit-default swaps on California covering a net $375 million of debt, according to data from the Depository Trust’s registry. That compares with an average of about $1.2 billion for the 1,000 most actively traded names, the data show.
To contact the reporter on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net
Find out more about Bloomberg for iPhone: http://bbiphone.bloomberg.com/iphone
California Budget Crisis Spurs Trading in Credit-Default Swaps
Feb. 2 (Bloomberg) -- Banks, hedge funds and other investors seeking to protect themselves from losses tied to California’s budget crisis are driving an increase in trading in credit- default swaps linked to the state.
Credit-default swaps protecting against a default by California, the nation’s most populous state, have more than tripled since Sept. 5, according to CMA DataVision in London. Last week, the contracts for the first time showed up on a list of the 1,000 most actively traded in the Depository Trust & Clearing Corp.’s trade warehouse.
Banks and investors are using the derivatives to hedge against losses on interest-rate swaps, commodities contracts and other assets that face losses if the state can’t make good on its obligations, said Fabrice Pilato, head of muni derivative trading at Morgan Stanley in New York.
“Because California is the largest U.S. state and is currently facing a well-publicized cash shortfall, many parties that have exposure to munis in general and to California in particular” are using the contracts as a hedge, Pilato said in a telephone interview.
Plunging housing prices and financial markets and rising unemployment have siphoned tax revenue from the state, which is set to face $42 billion less than it will need to pay for schools, police and other services through June 2010.
Moody’s Investors Service last month placed $67 billion of the state’s debt on review for a possible downgrade, citing a “lack of legislative solutions” for closing the budget gap. Moody’s rates California’s long-term debt A1, tied with Louisiana as the lowest among U.S. states. Standard & Poor’s, which has an equivalent rating of A+ on California’s general obligation bonds, said in December it was considering a downgrade.
Budget Shortfall
Governor Arnold Schwarzenegger said Jan. 26 that legislative leaders were closing in on an agreement to eliminate the budget shortfall.
Despite the increase in trading of California credit-default swaps, the market remains relatively illiquid compared with that for contracts linked to companies. The rush to hedge and speculation there will be more negative headlines in coming months are distorting the actual default risks for the state, said Matt Fabian, managing director at Municipal Market Advisors.
Traditional tax-exempt municipal bond investors haven’t been using the credit-default swaps market, he said.
‘More Bad News’
“I think what the market is saying is there’s a high likelihood of more bad news,” Fabian said. “The risk of California defaulting hasn’t changed very much. It would have to stop paying on tens of billions of dollars of regular expenses before its constitution would let it default on its debt.”
Credit-default swaps protecting against losses on the state’s debt for 10 years have jumped 257 basis points to 350 basis points since Sept. 5 and reached as high as 507 basis points in December, according to CMA DataVision.
A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
Five-year contracts on the Markit MCDX index, tied to 50 municipal issuers including California, have risen 59 basis points since the end of October to 210 basis points, CMA data show. It reached 350 basis points last month.
Credit-default swaps, used to hedge against losses or to speculate on the ability of borrowers to repay their debt, rise as investor confidence deteriorates. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent if borrowers fail to meet their debt obligations.
As of Jan. 23, there were outstanding credit-default swaps on California covering a net $375 million of debt, according to data from the Depository Trust’s registry. That compares with an average of about $1.2 billion for the 1,000 most actively traded names, the data show.
To contact the reporter on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net
Find out more about Bloomberg for iPhone: http://bbiphone.bloomberg.com/iphone
Sent from my iPhone
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