Automaker bailout may trigger CDS payments

12 Dec 2008, Government proposals to bail out ailing US carmakers may trigger payments on credit default swap (CDS) contracts that protect their debt, though the likelihood of this will depend on the final wording of the legislation, Bank of America said.

Likelihood depends on final terms of restructuring Bill.

The White House and congressional Democrats on Tuesday night reached an agreement in principle on a US$15 billion proposal for bailing out US carmakers and forcing them to restructure or fail.

In addition to providing loans, the proposal would force carmakers to answer to a presidentially appointed trustee - or 'car czar' - and make the government their biggest shareholder.

'We find arguments both for and against an autos czar triggering CDS,' Bank of America analyst Glen Taksler said. 'The result may depend on the exact wording of a potential bailout package.'

Sellers of credit default swaps normally make payments to the buyer after a borrower fails to make a payment on their debt, or files for bankruptcy protection. A restructuring can also trigger payments on the contracts.

'Based on the draft Bill, we see two potential triggers for autos CDS, bankruptcy and modified restructuring credit events,' Mr Taksler said. But, 'both are gray areas'.

'We would expect the actual result to become subject to intense debate, with arguments very dependent on the wording of a final Bill, if one is passed.'

There are around US$3.3 billion in net GM CDS exposures outstanding, while Ford CDS exposures stand at around US$2.8 billion, according to data by the Depository Trust & Clearing Corp, which confirms the majority of CDS trades.

If payments on carmakers's swaps are triggered, they are unlikely to have systemic consequences as most of the losses have already been taken as the securities weakened.

Carmakers's credit default swaps are trading at extremely distressed levels. It costs around US$7.8 million to insure US$10 million of GM's debt for five years, in addition to annual payments of US$500,000, according to Markit Intraday.

Insuring US$10 million of Ford's debt for five years costs US$6.9 million, also in addition to annual payments of US$500,000.