Courtesy of the Credit Strategy team at SocGen on Friday, the following trade idea:
Buy Barclays 5-year senior or sub CDS vs the iTraxx Main: Barclays is one of the largest sellers of CDS on European sovereigns, according to EBA data, and its CDS is trading at close to five-year lows relative to the iTraxx Senior financials. As such, we believe the best way to position for a possible CDS event on Greece is via Barclays.
The starting point is that it would seem that Barclays is currently cheap compared to the Markit iTraxx Senior Financials. Graphically, with a peer comparison then (SocGen also thrown in, just to be fair):
Barclays does appear to be trading historically wide to the index at the moment (by being significantly tighter) — and for the trade to be successful, the bank and index would have to cosy up again.
Now, Barclays is not especially exposed to Greece CDS itself. Using the EBA data (click to expand):
Of course, what the team at SocGen are getting at are the potential knock-on effects to a credit event for Greece CDS rather than the direct effects.
But what’s to say that the other banks (and insurers) in the Financials index won’t take the a CDS event on Greece even worse? There are banks in the index, after all, that can’t fund themselves like Barclays has proven it can without recourse to the ECB’s LTRO. If the index keeps its distance from Barclays, the trade won’t make money since protection would have been sold way too cheaply, and the widening in the Barclays CDS may not be able to keep up.
Furthermore, the EBA data doesn’t actually tell you enough to make the type of conclusion that SocGen appears to be making. The EBA data doesn’t include index trades (we asked the agency when they came out with it just to check), and banks will often use indices like the Markit iTraxx SovX Western Europe to hedge their sovereign exposure.
That’s before mentioning that Barclays could have other assets or positions acting as hedges too, e.g. exposure to the sovereign as a counterparty or bonds. For all SocGen know, Barclays is net short Greece. Or net long. Or flat.
All of that said, if the counterparties with which Barclays had bought protection were unable to pay out when credit events started rolling in, then some of the hedges may not prove effective. But this is just yet another thing that one cannot know.
Maybe there are other reasons to go short Barclays relative to the basket of banks and insurance companies that constitute the Markit iTraxx Fins, but the whole sovereign exposure thing would have to be reasoned by way of disclosures other than the rather limited EBA dataset.
Where not to buy your sovereign CDS – FT Alphaville