Nothing succeeds, as planned

Greece’s Risk of Default Increases to 98% as European Debt Crisis Deepens

By Abigail Moses - Sep 12, 2011, Bloomberg

Greece’s chance of default in the next five years has soared to 98 percent as Prime Minister George Papandreou fails to reassure international investors that his country can survive the euro-region crisis.

“Everyone’s pricing in a pretty near-term default and I think it’ll be a hard event,” said Peter Tchir, founder of hedge fund TF Market Advisors in New York. “Clearly this austerity plan is not working.”

It now costs a record $5.8 million upfront and $100,000 annually to insure $10 million of Greek debt for five years using credit-default swaps, up from $5.5 million in advance Sept. 9, according to CMA.

Papandreou’s promises to adhere to deficit targets that are conditions of the European Union and International Monetary Fund’s bailout were undermined by data showing Greece’s budget gap widened 22 percent in the first eight months of the year. The nation’s two-year note yield climbed toward 70 percent, while its stock market has plummeted by a third in the past seven weeks.

The default probability for Greece is based on a standard pricing model that assumes investors would recover 40 percent of the bonds’ face value were Greece to fail to meet its obligations.

The nation’s government now expects the economy to shrink more than 5 percent this year, more than the 3.8 percent forecast by the European Commission, as austerity measures deepen a three-year recession. The euro slipped to its lowest level against the yen since 2001 amid concern about the future of the 17-bloc region.

Regional Contagion

The risk of contagion beyond Greece pushed sovereign credit-default swap prices to record highs across the euro region. European bank debt risk also rose to the highest ever amid speculation French lenders will be downgraded because of their holdings of Greek bonds.

The Markit iTraxx SovX Western Europe Index of credit- default swaps on 15 governments soared 18 basis points to a record 354. The Markit iTraxx Financial Index linked to senior debt of 25 banks and insurers increased 14 basis points to 314 and the subordinated index jumped 15 to 550, both the highest ever, according to JPMorgan Chase & Co.

“The contagion impact of a default will be severe, because next in the firing line will be Italy, Spain and it will take in the whole of the European banking sector too,” Suki Mann, a strategist at Societe Generale SA in London, wrote in a note. “This trio are already under intense pressure, but it will get much worse.”

Portugal, Italy

Credit-default swaps on Portugal, Italy and France surged to records, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Portugal jumped 79 basis points to 1,213, Italy rose 40 basis points to 503 and France was up 11 at 189.

The euro weakened as much as 2 percent to 103.90 yen, the lowest level since June 2001. The common currency dropped 0.4 percent to $1.3600.

The ASE Index of Greek stocks fell 4.4 percent to 847.48, from 1,286 on July 22. Greece’s two-year note yields jumped more than 12 percentage points to a euro-era record 69.551 percent, after climbing 9.8 percentage points last week.

Chancellor Angela Merkel’s government is debating how to support German banks should Greece fail to meet budget-cutting terms of its rescue package, three coalition officials said Sept. 9. Credit-default swaps on BNP Paribas SA, Societe Generale SA and Credit Agricole SA, France’s largest banks, surged to all-time highs on bets they’ll have their ratings cut by Moody’s Investors Service this week.

French Banks

Swaps on SocGen were 53 basis points higher at 443, Credit Agricole increased 41 to 331 and BNP Paribas rose 31 basis points to 306, according to CMA.

Moody’s placed the three banks’ ratings on review in June to examine “the potential for inconsistency between the impact of a possible Greek default or restructuring and current rating levels,” the rating company said at the time. Downgrades are likely as the review period concludes, said the people with knowledge of the matter, who declined to be identified because the information is confidential.

The cost of insuring corporate debt rose to the highest levels in 2 1/2 years, according to JPMorgan. The Markit iTraxx Europe Index of 125 companies with investment-grade ratings was up 6.5 basis points at 198.5 after rising to as high as 204.

Contracts on the Markit iTraxx Crossover Index of 40 companies with mostly high-yield credit ratings climbed 22.5 basis points to 797.5 after earlier touching 811.5, the highest since May 2009. An increase signals worsening perceptions of credit quality.

A basis point on a credit-default swap protecting 10 million euros ($13.7 million) of debt from default for five years is equivalent to 1,000 euros a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.