GSE’s subordinated debt unlikely to trigger credit default swaps (CDS)

August 26, 2008 by · Leave a Comment
Filed under: Economic News 

Could this be the hidden grenade that will start the CDS market to implode?   Most likely not, but if you read the details, the government would have to step in at a point for it not to be considered a default under the credit default swap contracts.

What does this mean?

Most importantly it would mean more treasury printing to cover these payments which would in-turn mean more price inflation as we inject money into the system to cover these liabilities.  Keep an eye out for any press about the CDS market, please goto out “About” page and email us if you think your find is news worthy and we will cite you in the post.

Release:

Sellers of protection on Fannie Mae subordinated debt are unlikely to be required to pay out on the contracts even if the mortgage finance companies defer interest payments.

Losses from residential mortgages the companies guarantee have created concerns Fannie and Freddie may defer coupons if capital levels fall below minimums required by regulators.

Payments on credit default swaps insuring a company’s debt are typically triggered, requiring protection sellers to pay the buyer the sum insured, when an issuer misses an interest payment, or fails to repay the debt at maturity.

In the case of these government-sponsored entities, however, the companies are able to suspend payments under certain guidelines for as much as five years, or until the bond matures, without triggering payments on the credit default swaps, analysts said.

“There is a grace period for five years,” said Ricardo Kleinbaum, analyst at BNP Paribas in New York. “However, you would have an event of default if a maturing bond were not paid back. It’s also an event of default if the U.S. government takes them over or if there’s a restructuring.”

A restructuring could include extending the maturity of the debt, or reducing the principal amount of a bond and subordinating it to other debt.

However, these seem “unlikely as a first move for the agencies,” Kleinbaum said.

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