When you want to get an idea of how the smart money people view the chances that a company will default on its debt, in otherwords, that it will need to seek protection from creditors in bankruptcy court, credit default swaps are a good indicator.
CDS are a form of insurance on a company's bonds. They're a way of making a bet on a company's future solvency or lack thereof. (Yes, it was CDS that contributed to the 2007 financial meltdown but that's another story.)
So what are CDS signaling about BP? That it is increasingly viewed a company whose financial future looks a lot dicier than it did even just a few weeks ago.
The Wall Street Journal reports that the CDS on BP's bonds are approaching what you'd expect with junk.
Traders in the market for insurance-like contracts called credit-default swaps have worried about BP all week, but today they smell blood. Earlier this morning, it cost about $557,000 a year to insure $10 million of BP’s bonds against default for five years compared with $386,000 Wednesday evening in New York -– a massive 44% jump, according to data provider CMA DataVision.This cost has since fallen to around $465,000, but traders remain nervous.
Gavan Nolan, a researcher at data firm Markit, said earlier today that BP’s credit-default swaps were trading like “a junk credit,” meaning bond investors were viewing BP the same way they might see a firm with a “junk”-level credit rating.
BP officials have been telling investors and anyone else that will listen that the company has the financial wherewithal to handle all the legitimate claims that will be made against it as well as the clean-up.
But BP has gotten a reputation of being overly optimistic during the entire Gulf oil spill crisis.
That the price of CDS on its debt has risen so substantially means a lot of people aren't buying into the company's confidence.
They're no doubt hearing voices like Matt Simmons. The investment banker who specializes in energy companies told Fortune magazine:
They have about a month before they declare Chapter 11. They're going to run out of cash from lawsuits, cleanup and other expenses. One really smart thing that Obama did was about three weeks ago he forced BP CEO Tony Hayward to put in writing that BP would pay for every dollar of the cleanup. But there isn't enough money in the world to clean up the Gulf of Mexico. Once BP realizes the extent of this my guess is that they'll panic and go into Chapter 11.
Simmons is definitely a pessimist on BP's future. And he appears to have a lot of company.