General Electric Capital Corp’s debt is being treated by some credit traders as if it had already been reduced below triple-A. The clearest indication of this is the sellers of insurance on the debt are demanding an upfront payment of $850,000 in addition to an annual payment of $500,000 in annual payments to insure $10 million of GE Capital debt.
According to Reuters, on Friday it cost $710,000 annually, with no upfront payment. The move to selling GE Cap’s debt protection on an upfront basis will mean that the swaps will sell at a fixed annual coupon plus a premium paid when the insurance in purchased.
Why has the way GE Cap’s CDS are sold changed? Reuters says traders are spooked by the fact that Moody’s says it may still cut GE’s “Triple-A” rating. When a credit default swap contract starts trading on an upfront basis, it typically means that sellers are worried about the credit. The upfront payment means they will take less of a hit in the event the default occurs before the first principal payment. Hedge funds have dreamed up far more complicated uses for upfronts, of course, that typically involve buying and selling multiple contracts. But, at its heart, the upfront is basically downside protection for the seller of the CDS.
It’s rare for CDS on highly-rated debt to trade on an upfront basis. Typically, that treatment only applies to credit default swaps on large index bonds that cover a variety of capital. Lately, however, more and more companies have seen their debt protection traded on an upfront basis. GE has apparently joined the pack.