Schulte Roth & Zabel LLP, a U.S. law firm that is known to work closely with hedge funds, requested a ruling for a “potential repudiation/moratorium event” by Argentina according to a letter dated June 20 to International Swaps and Derivatives Association (ISDA). If ISDA rules that credit-default swap payments (CDS) on Argentina’s debt have been triggered after government officials said the nation won’t make bond interest payments, then Citigroup Inc. and JPMorgan may be at risk to repay a substantial portion of the CDS losses on up to $906 million in defaulted bonds.
Greece defaulted in 2012 on its bonds and created a $3.2 billion potential loss to banks and other financial institutions that sold credit-default swaps on the nation’s sovereign debt. At the time it was revealed by ISDA that a stunning $15.7 trillion or about a fifth of the world’s GDP was outstanding in sovereign debt credit-default swaps.
JPMorgan Chase & Co. and Goldman Sachs Group Inc. had topped a list of the biggest credit-default swaps dealers since 2009 according to the annual Fitch Ratings survey. Barclays Plc, the U.K.’s second-largest lender, ranked third. Deutsche Bank AG and Morgan Stanley had been either first or second in the CDS exposure from 2004 through 2006, but they dropped to fourth and fifth after the 2008 collapse of Bear Stearns and Lehman Brothers.
Fitch states that ten banks make up approximately 67% of the global trading in the credit-swaps market. This limited number of “counterparties” represents a concentration of risk that is much narrower than before the Great Recession that started with the Lehman Brothers’ filing for bankruptcy protection in September 2008.
The U.S. Controller of the Currency reported at the end of 2013 that insured U.S. commercial banks and savings associations had credit derivate trading revenue of $2.9 billion in the fourth quarter, down about 34% or $1.5 billion from the prior quarter.
Banks express their exposure to credit derivative losses as “Value-at-Risk” (VaR). The five largest trading companies estimated their VaR at only $381 million. But the total of the face value of all derivatives outstanding was estimated at $237 trillion or about three times the world’s GDP of $87 billion.
JPMorgan continued as the largest trader of credit derivatives among U.S. commercial bank holding companies, with $5.4 trillion outstanding at the end of 2013. But surprisingly, Citigroup had the second-largest credit derivative exposure with $2.6 trillion outstanding, according to the Office of the Comptroller of the Currency.
Citigroup’s potential concerns regarding Argentina are in addition to its March 26th failure of the Federal Reserve “stress test” and the U.S. Justice Department’s demand for $10 billion in penalties to settle potential criminal liability for past issuance of flawed mortgage securities.
Argentina says it is now interested in negotiating with creditors after a U.S. Supreme Court ruling last week required the nation to pay its bonds in full or default. However, President Cristina Fernandez de Kirchner’s government said it’s unable to pay all the bond claims; such language may be interpreted as a default by ISDA.
A few bank dealers dominating the spectacularly big credit-default swaps market must have found a very profitable business. But that same concentration of trading means that potential painful losses are probably going to hurt JPMorgan and Citigroup.
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