Will BP Trigger a 'Black Swan' Event?

in the world of structured finance?

Citing Moody's analysis, Zero Hedge reports that BP's bankruptcy would impair more than just the BP's debt holders and equity holders. The loss in CSOs (collateralized synthetic obligations, often using credit default swaps, or CDS) that reference BP and the companies that are involved in the Gulf oil spill - i.e. Transocean, Halliburton, Anadarko, and Cameron could be billions of dollars. If you include other oil and oil service companies that would be negatively affected by the spill, the amount could be hundreds of billions, as it would also involve companies totally unrelated to BP or oil industry but unfortunate enough to have their CDS packaged with BP's.

BP's Bankruptcy Would Impair 117 (18% Of Total) Collateralized Synthetic Obligations, Lead To Pervasive Losses (Tyler Durden, 6/21/2010 Zero Hedge)

"Even as increasingly desperate falling knife catchers try to convince someone, anyone to buy up some or all of their shares of BP stock, which is certainly on its way to a guaranteed doubling, tripling or more, the real investing community is ever more carefully looking at the worst case, and its implications. Said implications would be vast, and in addition to wiping out billions in capital from BPs direct counterparties which are already limiting their BP exposure, a topic we touched upon briefly previously, would also impair indirect holders of pre-packaged securitized BP exposure. Today Moody's provides an analysis of which CSOs (just like CDOs but packed purely with synthetic products - think Goldman's Abacus) would be impaired should BP go bankrupt. The rating agency does not stop there, and also analyzes what a bankruptcy of BP peers Halliburton, Anadarko Petroleum, Transocean Inc., and Cameron International would look like, and who would be wiped out. Below are the results, which upon further analysis will likely indicate total loss potential well beyond BP's total outstanding debt exposure.

"As the recent civil case involving Goldman and the Abacus (and soon potentially others) CDO showed, collateralized products have a special place in the heart of the regulators, due to their avalanche quality of blowing up seemingly completely unrelated entities, which share merely the stupidity of having invested in the same entity. BP, as a company with over $20 billion in debt outstanding, has over the years, seen many of its CDS packaged and repackaged in the form of many and increasingly more complex CSOs. Last week's blow out in BP spreads, in which the 1 Year CDS surged beyond 1,000 bps, has got many people concerned: the least of which are counterparties that are on the other side of the short risk trade. Others include investors in just such CSOs, and other companies whose CDS comprises various tranches in these synthetic obligations, as forced liquidations in any given CSO would result in the blow out spreads in even perfectly solvent companies who just have the displeasure of being packaged in one and the same CSO." [Emphasis is mine. The article continues.]

The whole point of structured finance is to transfer risk by securitization, tranching, credit enhancement and rating. But as we have seen in the past two years, instead of reducing the risk these CDOs seem to do the opposite and amplify the risk in times of acute financial stress. Zero Hedge article concludes:

"Should BP go down it will, on a diluted basis, wipe out many more pro rata billions in value once protection sellers scramble to cover margin and collateral calls. Add the other drilling usual suspects, and the losses could amount well into the hundreds of billions." [Emphasis is mine.]

I would love to know who wrote those protections. And the names of the unfortunate companies whose CDSs were packaged with those of BP.

Tweet