This page has been archived and commenting is disabled.

EFSF And Sovereign CDS Pitchbook Updates

Tyler Durden's picture




 

From Peter Tchir of TF Market Advisors

EFSF And Sovereign CDS Pitchbook Updates

Yesterday was a big day in the market for EFSF and Sovereign CDS.  The announcements were big enough that some junior associates must be scrambling to update their pitchbooks.  Here are my thoughts on what changes need to be done to the pitchbooks and the trading ideas that come as a result.

EFSF Pitchbook - Use of Proceeds

The EFSF may

  • Lend money to countries at interest rates lower than the rates the EFSF has to pay
  • Make loans that have large mark to market losses on day 1, as much as 50% would not be considered unusual
  • Buy bonds from the ECB's residual positions, potentially at off market prices
  • Buy bonds from the open market at any time, though most likely when a member country feels the market is not valuing their debt correctly
  • Use guarantees by member countries to raise money to buy the debt of those member countries whenever speculators underestimate the creditworthiness of the member country
  • Allow political desires to take priority over economic analysis on any decision made
  • Lend to countries to provide equity support for weak or failing banks, though ideally get the right to make direct equity injections in the banks through preferred shares with no upside but all of the downside of an equity investment
  • Change rules on a moment's notice if and when the market no longer believes the existing rules provide enough support

The conclusion

The reality is that Germany, France, and the Netherlands, or maybe just Germany, will have to guarantee a combined 100% of EFSF issuance.  The original EFSF made a lot of effort to protect EFSF loans from losses.  All that those protections are gone and any rational investor has to assume the EFSF will have large mark to market losses up front and potentially large realized losses over time.  You would only lend to EFSF if it was fully backed by the AAA members, and ideally Germany as they are the strongest and biggest by far.  It remains to be seen if the entire market sees it this way, and if they do, will Germany be willing to provide that much support?

I remain highly skeptical that this plan will ever be implemented in a meaningful way because it will place too much pressure on the AAA nations.
 
Sovereign CDS Pitchbook

Credit Event Amendments:

The recent actions in Europe have made it obvious that the Restructuring Credit Event is overly complex.  The actions have shown a willingness of the EU and ECB to do anything and everything to avoid triggering a CDS Credit Event.  It is unclear that these steps were necessary or even wanted as the size of net exposure on sovereign CDS is small relative to the amount of debt outstanding, the counterparty risk should be well managed, and many of the regulated entities are actually short CDS.  In any case, in an effort to clarify CDS Credit Events for Sovereign Debt, 2 new Credit Events will be
added:

  • the "Pigs Fly" Credit Event, and
  • the  "Hell Freezes Over" Credit Event

The conclusion

I am not sure why you would buy protection on sovereign debt at this point.

Since "voluntary" Restructuring is not a Credit Event, you are relying on Failure to Pay.  You might get a Failure to Pay, but the EU and ECB have been bending over backwards to avoid that as well.  I would not bet on that changing.  CDS on sovereigns may have some value, but I would expect a long term shift in the basis.  Over time, investors will prefer to be short via bonds rather than CDS because of the risk of government intervention to avoid triggering CDS.  CDS made shorting the sovereign debt market relatively easy, but the realization that the governments are willing to do almost anything to avoid a Credit Event changes that.  I would be reducing basis positions right now.  If you own the bonds and the CDS, I believe that relationship will change and the CDS has the potential to tighten much more than the bonds.  I would be getting out of short positions in the CDS market quickly.  You have a brief window to get out, because banks aren't willing to write protection and it will take a few days for the medium fast money to figure out that there is no longer any depth to the bid in sovereign CDS and crush it tighter. 

If you can never get a Credit Event the CDS is worthless.  You can still get a Failure to Pay, but if Restructuring is totally useless, and governments can apply pressure to private institutions to avoid Failure to Pay, you have to price that in.  

Although corporate CDS should maintain its value, the basis there is likely to be impacted too.  If I am correct and the market realizes sovereign CDS is worth much less than they thought, then the basis there will move.  In desperation, some people caught short sovereigns will then sell protection on Main or XOVER, driving that tighter.  That will in turn take single name CDS tighter.  In early 2007, that basis grew because there were still sellers of protection, but banks and investment banks in particular (there were still actual investment banks in 2007) became capital constrained and couldn't or wouldn't buy big bond inventories.  We may see the spread widen again, this time because no one wants to own sovereign CDS which will impact other CDS markets more than the bond markets.

 

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Fri, 07/22/2011 - 09:36 | 1480194 wsmith
wsmith's picture

Tyler,

Can you give me the CDS spreads for South Korea.

You motherfuckers never talk about it.

But that's where I live.

Anway, so long.

And God bless all you Marxist cocksuckers.

http://geraldcelente.proboards.com

Fri, 07/22/2011 - 09:40 | 1480208 oogs66
oogs66's picture

101 for Korea.

 

Weirdly enough, for all the hype about China saving the world, their CDS is 86

Fri, 07/22/2011 - 09:49 | 1480256 wsmith
wsmith's picture

forgive my ignorance.

Is that good or bad?

http://geraldcelente.proboards.com

Fri, 07/22/2011 - 09:57 | 1480320 ZeroPower
ZeroPower's picture

Its relative to the others; all you can imply is that Korea is slightly more risky than China.

Fri, 07/22/2011 - 16:21 | 1482377 ManufacturedOpinion
ManufacturedOpinion's picture

Tyler,

 

Why do you let this faggot keep pumping the celente boards?

Just stick a boot in his ass (and a dick in his mouth) and shut him the fuck up !!!

Fri, 07/22/2011 - 09:39 | 1480198 wsmith
wsmith's picture

Forgive me.

I'm stoned on soju.

http://geraldcelente.proboards.com

Fri, 07/22/2011 - 10:16 | 1480432 snowball777
snowball777's picture

No touch dick. Play StarCraft!

Fri, 07/22/2011 - 16:21 | 1482382 ManufacturedOpinion
ManufacturedOpinion's picture

Tyler,

 

Why do you let this faggot keep pumping the celente boards?

Just stick a boot in his ass (and a dick in his mouth) and shut him the fuck up !!!

Fri, 07/22/2011 - 09:41 | 1480201 GeneMarchbanks
GeneMarchbanks's picture

Euro-TARP, need I say more?

No need for trading ideas here... I wouldn't go anywhere near these make-it-up-as-we-go 'plans'

Fri, 07/22/2011 - 09:41 | 1480211 Paralympic Equity
Paralympic Equity's picture

Credit event is no credit event, bitcheues

Fri, 07/22/2011 - 09:42 | 1480213 vote_libertaria...
vote_libertarian_party's picture

So it looks like Merkels party will get wiped out at the next election.

Fri, 07/22/2011 - 09:56 | 1480306 holdbuysell
holdbuysell's picture

So CDS are now becoming useless for gauging sovereign default risk due to the backstops.

What's next?

Fri, 07/22/2011 - 11:28 | 1480860 camoes
camoes's picture

Best way to play the game is still shorting Euro Banks and Insurers...CDS has too much counterparty and political intervention risk IMHO...or just short the Euro if you don't want risk of govt bailing out the banks (again).

Fri, 07/22/2011 - 09:56 | 1480309 ZeroPower
ZeroPower's picture

In desperation, some people caught short sovereigns will then sell protection on Main or XOVER, driving that tighter

 

Or for those that cant/wont get out of their negative short CDS positions, a long on Main, SovX, what have you, should be just as fine; so i dont think a massive tightening is too grave a danger in their respective indices.

Fri, 07/22/2011 - 10:43 | 1480600 Thisson
Thisson's picture

I disagree with Tchir's conclusions with respect to CDS.  The fact that the powers are bending over backwards to avoid triggering a credit event tells you everything you need to know: pressure is building towards a credit event, with disastrous consequences.  Belief in wizards runs rampant: they are not more powerful than the market and the damn is going to break at some point.  The main concerns I have about CDS is: 1) counterparty risk and 2) In the event of a credit event, are you going to be paid out in useless scrip fiat currency?

Do NOT follow this link or you will be banned from the site!