Wednesday, March 4, 2009

Berkshire CDS Just Hit All Time Wides

First General Electric, now BRK. Berkshire Hathaway CDS not helping market today... The implied risk of Warren Buffett's derivatives bet and his 2008 losses have pushed BRK 5 year CDS to an all time wide today, offered at 540bps after closing at 510 yesterday. Indicatively the IG11 index of investment grade names is currently at 244bps, implying the market views BRK's AAA rating a little more like BB (or the investment grade universe is massively mispriced).

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10 comments:

s said...

is there a back of the envelope way of translating spread to default prob/recover rate etc.. kind of an easy relative value way of looking at cds vs. cash vs equity

Peatey said...

Tyler can probably add more insight, but the general form is this:

Yearly default probability = Spread / (1 - Recovery assumption%)

So if you think the bond gets 0% recovery in the event of default, then the yearly default probability = spread, which makes sense (you have to pay 10% to protect yourself against 90% chance of par and 10% chance of zero. The >0% recovery assumption is where credit analysis comes in.

CreditTrader said...

BRK now 512.5/537.5 - was 535/555 at the open so getting a little better but still wider on the day. You cannot separate default prob from recovery in the implied calc but at 40% recovery, BRK has a 30% default risk over 5Y.

CreditTrader said...

Peatey is right but in reality you gotta take the curve into account and the market's best guess at recovery still seems 40% in IG (30% HY and 55%LCDX). BRK bonds not getting crushed signals yet another round of CDO-hedge related protection buying...

Peatey said...

CreditTrader, is there a back of the envelope way to take the curve into account? Would love to learn if there is a relatively simple method that doesn't require a calculator, Bloomberg or otherwise.

Irrational Doomsday Blog said...

Looks to me like the same thing happening to GE is happening here.

Daniel said...

Dumb question, but who are the entities on the hook if Berkshire defaults? If Berkshire does default, do they have enough to pay back the losses? I suppose this could be applied to any CDS issuer, I just don't understand WHO or WHY anyone would think it still makes sense given what's happened already.

CDS is essentially put options on Bonds right? So if you can short the stock to hedge a put sale, why don't these entities short the bond to hedge the CDS issuance?

S said...

daniel,

seems to me if the cds seller has to pay stock is 0. hence the short. see deninger at market ticker blogspot he has a rant about the circular shorting re cds sellers hedging their exposure

Daniel said...

S,

Thank you for pointing me to deninger. If I'm understanding this correctly, AIG didn't bother to hedge their CDS issues at all?

babar ganesh said...

could be that the buyers of the infamous puts which are now closer to the money and worth a lot MTM are hedging their counterparty risk.