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BP Swaps Rise to Record at 36% Odds of Default: Credit Markets

BP swaps rise to record at 39% odds of default
The BP Plc company logo is displayed outside the company's headquarters in London. Photographer: Simon Dawson/Bloomberg

June 16 (Bloomberg) -- Credit investors are pricing in a 36 percent chance BP Plc will default within five years as it tangles with the Obama administration over cleanup costs and claims for the biggest oil spill in U.S. history.

The default risk implied by credit-default swaps is up from 7 percent a month ago, according to CMA DataVision prices using a standard model used to value the derivatives. BP swaps climbed 70.5 basis points to 576.5. BP debt due next year traded today at distressed levels, with investors demanding as much as 1,251 basis points in yield more than Treasuries.

BP, whose executives met today with President Barack Obama at the White House, said it agreed to place about $20 billion over several years into a fund to compensate residents along the Gulf of Mexico. The company, which had $27.7 billion in cash flow from operations in 2009, was cut six levels to BBB -- two levels from junk -- from AA by Fitch Ratings because of mounting costs from the underwater well that’s spewed crude for eight weeks.

“There’s still so much uncertainty as to what ultimately the liability is and what the government is going to do,” said Jason Chen, a partner and head of research at hedge fund Sancus Capital Management in New York, founded in August by former JPMorgan Chase & Co. traders.

BP’s $750 million of 1.55 percent notes due in 2011 rose 0.75 cent to 93 cents on the dollar as of 2:49 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority, after earlier trading as low as 88 cents before news of the escrow fund. The bonds traded the most ever yesterday, according to data compiled by Bloomberg.


The securities, which rose as high as 101.2 cents in February, pay a spread of 736.5 basis points. Bonds that trade with relative yields of more than 1,000 basis points, or 10 percentage points, are considered distressed.

One-year credit swaps on BP debt were up 354.5 basis points to 997, CMA prices show.

The default probability, which is based off a standard pricing model published last year by the International Swaps and Derivatives Association, assumes investors would recover 40 percent of face value were BP to fail to meet its obligations. The probability rises as recovery expectations increase.

The credit swaps price doesn’t necessarily reflect a fundamental belief the company is at risk of bankruptcy. The contracts are used by everyone from bondholders to derivative trading partners to protect against or speculate on declines in the company’s creditworthiness. Demand from banks to hedge against losses on derivatives trades or loans can often overwhelm investor appetite to sell protection on companies.

BP’s ‘Recklessness’

The movement in credit swaps also was exacerbated as at least some traders increased the annual fixed payments they demand for the contracts to 500 basis points from 100 basis points.

Tristan Vanhegan, a spokesman for London-based BP, declined to comment on default-swap and bond prices.

Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a protecting $10 million of debt. Swaps typically rise as investor confidence deteriorates and fall as it improves.

In his first address to the nation from the Oval Office, Obama said he would force BP Chairman Carl-Henric Svanberg to set aside “whatever resources are required to compensate the workers and business owners who have been harmed as a result of his company’s recklessness.”

Kenneth Feinberg, who also oversaw the fund that paid families of the Sept. 11 attacks, will act as an independent third party to judge claims and authorize payments to Gulf Coast residents.

Borrowing Costs

BP’s shorter-term borrowing costs are rising in a signal lenders are increasingly concerned they may face losses. BP notes due in 2011 yield 53.9 basis points more than the company’s 4.75 percent bonds due in 2019, Trace data show. The shorter-maturity debt yielded 326 basis points less as of April 29.

Investors typically demand additional yield on shorter-maturity debt when risk is concentrated in the nearer term, causing the so-called yield curve to invert.

BP’s cost to clean up the spill may escalate enough to threaten the oil company’s future, said former Shell Oil Co. President John Hofmeister, who now runs the advocacy group Citizens for Affordable Energy.

“The current political movement by the U.S. government is basically an unlimited liability,” Hofmeister, who ran the U.S. operations of Royal Dutch Shell Plc, Europe’s largest oil company by market value, from early 2005 through mid-2008, said yesterday at a Bloomberg Link Boards & Risk Conference in Washington. “At some point the entity will have to defend itself.”

60,000 Barrels

The BP well is gushing as much as 60,000 barrels of oil a day, the government said, raising for the fifth time an official estimate that had begun at 1,000 barrels a day in April.

BP had $6.84 billion in cash and near-cash as of the end of the first quarter, according to a regulatory filing. It has spent $1.6 billion to stop the leak, clean it up and compensate local businesses and residents, according to figures posted on the company’s website. Liabilities may reach $37 billion, Credit Suisse Group AG estimated in a June 2 report.

Interest rates on some floating-rate municipal bonds guaranteed by BP have surged to as much as 10 percent on concern the costs of the cleanup and litigation are spiraling higher.

Yields on short-term bonds backed by BP to build sewage and solid-waste disposal facilities at a chemical plant in Will County, Illinois, and a refinery in Texas City, Texas, were as low as 0.5 percent at the beginning of the month. BP backs more than $3.5 billion of U.S. municipal obligations, according to Bloomberg data.

Asset Values

BP bonds have lost 14.6 percent this month, after declining 2.62 percent in May, according to Bank of America Merrill Lynch index data. The overall U.S. energy company index has fallen 1.3 percent in June.

The fall in BP’s bond prices has to be seen in the “context of the asset values and the earnings capability of this company,” said Joel Levington, managing director of corporate credit at Brookfield Investment Management Inc. in New York. “When you’re talking about a company that can earn $20 billion in 2011, before its dividend, that’s significant flexibility.”

Bonds of some companies associated with drilling and the spill may be attractive because their liabilities are more easily understood than BP’s, according to Chen. The leak began after an explosion on the Deepwater Horizon rig owned by Transocean Ltd. Anadarko Petroleum Corp. owns 25 percent of the well.

Anadarko Debt

Anadarko’s $750 million of 6.2 percent bonds due in 2040 fell 1.25 cents to 81.75 cents on the dollar, the first decline in five days, Trace data show. The debt traded as low as 75 cents on June 9. Transocean’s $1 billion of 6 percent debt due in 2018 dropped 2.06 cents to 86 cents on the dollar, the first decline in four days.

Elsewhere in credit markets, Bank of America Corp. sold $1.25 billion of bonds backed by auto loans, according to a person familiar with the transaction.

GMAC Inc.’s Ally Bank plans to sell $792.3 million of bonds backed by auto loans, according to another person familiar with that transaction.

To contact the reporters on this story: John Detrixhe in New York at; Shannon D. Harrington in New York at

To contact the editor responsible for this story: Alan Goldstein at

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