As many readers may know, when credit default swaps trade on an “upfront” basis, meaning a premium has to be paid immediately for the contract to be effective, when the risk of default is perceived to be high.
Also note in this case that the upfront payment applies to GE Capital, which is NOT the same as GE parent. And the article explains that other factors may be adding to pressure on CDS prices. However, given the size of GE’s financial operations, this does not speak well to the odds of GE pulling itself out of this mess anytime soon. And the market pricing stands in sharp contrast with the AAA rating on GE Capital.
From MarketWatch (hat tip reader John):
The cost of insuring against a default by General Electric’s financial-services unit jumped to distressed levels Monday on concern about a potential credit-rating downgrade, brokers said.
Credit-default swaps on GE Capital traded 11% upfront on Monday, according to broker Phoenix Partners Group.
When contracts on credit-default swaps trade upfront, it means investors seeking protection against a default must pay fees immediately. These contracts usually require only annual payments, but when concerns reach extreme levels, sellers of protection demand money upfront as well….
Monday marked the first time that GE Capital CDS traded upfront….
GE Capital CDS prices may be surging because debt of the unit was probably included in many collateralized debt obligations, or CDOs, according to Tim Backshall, chief credit strategist at Credit Derivatives Research.
CDOs are structured products that hold mortgage-backed securities, corporate debt and other fixed-income securities. GE Capital debt may have been included in these vehicles because it was AAA rated but paid relatively high interest rates during the credit boom earlier this decade, Backshall explained.
Now that GE Capital is in danger of a downgrade, the dealers who set up these CDOs may be hedging themselves by buying CDS protection on the unit’s debt, he said