Jan. 16 (Bloomberg) -- The worst may still be ahead for the world's biggest financial companies, trading in credit-default swaps shows.

Prices for contracts tied to the bonds of MBIA Inc., Bear Stearns Cos. and Washington Mutual Inc., which protect lenders and creditors against the possibility that debt payments won't be made, are higher for one year than for five, according to data compiled by Bloomberg. Longer-term protection is usually more expensive because the risk of nonpayment is greater.

It still costs more to take out insurance against default for one year even after New York-based Citigroup Inc., the largest U.S. bank, obtained $14.5 billion yesterday to shore up depleted capital. Lenders hold more than $200 billion of bonds and loans used to finance leveraged buyouts that they can't sell and are falling in value, based on data compiled by JPMorgan Chase & Co.

``It's very dangerous for some of these big institutions,'' said Doug Noland, a credit analyst in Dallas at David W. Tice & Associates. The firm's $924 million Prudent Bear Fund has returned 23 percent in the past year. ``We're going into an acute liquidity crisis for corporate borrowers.''

Most of the so-called inverted credit curves are concentrated in securities firms, banks and bond insurers that reported more than $100 billion in losses on mortgages to borrowers with poor credit. New York-based Moody's Investors Service last week predicted corporate defaults for all companies would rise fivefold this year as the economy slows.

No Security

Investors in at least 28 companies, including New York-based Merrill Lynch & Co., the world's largest brokerage, and Miami- based homebuilder Lennar Corp., are being charged more per year for short-term protection in the credit-default swap market, according to Bloomberg data and London-based CMA Datavision, which compiles prices on the contracts.

Credit-default swaps are a way of speculating on a company's ability to pay its obligations. A buyer receives the face value of the insured debt in exchange for the underlying securities or cash should a borrower fail to adhere to its debt agreements.

Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.

The market for credit-default swaps is the fastest growing among derivatives. It expanded to cover $45.5 trillion in debt at the end of June, up from $632 billion six years earlier, according to the International Swaps and Derivatives Association in New York.

MBIA Swaps

Credit-default swaps on MBIA, which itself sells protection against bond defaults, rose to the equivalent of 18.6 percent for one year after credit rating companies threatened in November to strip the Armonk, New York-based company of its AAA rating. That would have effectively crippled its ability to guarantee debt.

For five-year coverage, sellers are seeking the equivalent of about 9.8 percent a year, according to CMA Datavision.

The 18.6 percent translates to $1.86 million on $10 million of debt and implies a more than 30 percent chance that MBIA will default in the next year, according to a JPMorgan valuation model. For five-year insurance, holders would pay about $980,000 a year.

Six months ago buyers paid 0.23 percent for one-year credit- default swaps and 0.87 percent a year for five-year contracts. For every $10 million of debt, that's equivalent to $23,000 for one year and $87,000 annually for five years. A higher price indicates a lower perception of credit quality.

$2 Billion

MBIA, the world's biggest bond insurer, was forced to seek more than $2 billion in capital to keep its credit rating. The company said last week it faces losses and writedowns of more than $4 billion because of a slump in securities backed by mortgages given to borrowers with bad credit.

Standard & Poor's today said it will start a new examination of bond insurers including MBIA, one month after affirming their AAA ratings, because losses stemming from subprime mortgages will be worse than the firm anticipated. Fitch Ratings today affirmed its AAA guaranty ranking for MBIA, saying the company has built up enough capital to meet the ratings firm's short-term requirements.

Elizabeth James, a spokeswoman at MBIA, declined to comment.

The rising cost of short-term default swaps ``signifies near-term distress,'' said Greg Peters, head of credit strategy in New York at Morgan Stanley. The firm was the second-biggest seller of investment-grade corporate bonds last year behind New York-based Citigroup, according to data compiled by Bloomberg.

For most companies, the annual cost of protection against default increases as the length of the contracts rise. Contracts on AT&T Inc., the biggest U.S. phone company trade at 0.3 percent for a year and 0.52 percent for five years, CMA prices show.

Bear Stearns

At Bear Stearns, which helped trigger the subprime meltdown, one-year credit-default swaps trade at 3.44 percent, while five- year contracts cost 2.18 percent a year, CMA data show. The fifth-largest U.S. securities firm managed two hedge funds that collapsed in July as the value of their mortgage-backed securities sank. Losses on subprime mortgage securities drove the New York-based company to the first quarterly loss in its 85-year history and prompted Chairman and Chief Executive Officer James ``Jimmy'' Cayne to relinquish his CEO role.

One-year credit-default swaps tied to Washington Mutual, the biggest U.S. savings and loan, trade at 6.85 percent, while five- year contracts cost 3.82 percent a year, CMA data show.

The Seattle-based company forecast a fourth-quarter loss last month after losses on subprime mortgages forced it to write down the value of its home lending unit by $1.6 billion and slash its dividend.

Russell Sherman, a spokesman at Bear Stearns, declined to comment. Washington Mutual's Libby Hutchinson didn't return a call for comment.

Too Expensive

Investors are buying protection for the shortest time possible because they believe that if the firms can ride out the next 12 months, the risk of default will plummet, said J.J. McKoan, a director of global credit at AllianceBernstein Holdings LP in New York, which oversees about $194 billion in fixed-income assets. That would make buying five-year insurance too expensive, he said.

The price increase in one-year contracts may also be in part because those credit-default swaps aren't as actively traded as five-year contracts, making them more sensitive to swings in demand, McKoan said.

``The curves are probably overstating the probability of a default in the short term right now,'' said Chuck Moon, head of investment-grade credit at Hartford Investment Management Co. in Hartford, Connecticut, which manages $30 billion in investment- grade credit.

Raising Capital

With the cost of short-term protection so high, now might be the time investors consider betting on a decline as firms shore up their balance sheets by raising capital, Bank of America Corp. strategists led by Jeffrey Rosenberg in New York wrote in a note to clients yesterday. The strategists recommended investors sell one-year credit-default swap protection on MBIA's bonds.

MBIA's ``credit risk should begin to decline,'' they wrote.

While the subprime collapse hasn't triggered a default among the 50 biggest financial companies by assets, investors are finding no comfort in their track record, said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.

``Investors don't know what they don't know about the exposures and how bad they could get,'' Backshall said.

For 30 years, the default rate of banks has averaged 0.4 percent annually and for other financial companies, 0.5 percent, according to Moody's. Only utilities have performed better.

Citigroup yesterday posted a net loss of $9.83 billion, the biggest in its 196-year history, as it wrote down the value of subprime-mortgage investments by $18 billion.

Cost of Borrowing

Merrill Lynch and Bank of America, the largest U.S. bank by market value, may also report their worst quarter this week because of losses from securities including collateralized debt obligations, according to analysts surveyed by Bloomberg. CDOs, packaged pools of mortgages, aren't traded on exchanges and their value is hard to determine, making investors concerned there may be more losses. The credit-default swap curves for Citigroup and Bank of America aren't inverted.

While the cost of borrowing dollars has dropped more than a percentage point since central banks announced a plan on Dec. 12 to counter a squeeze on lending, U.S. financial institutions are stuck with debt from leveraged buyouts they can't sell, inhibiting their capacity to lend. The three-month London interbank offered rate has dropped to 3.95 percent, down from 5.06 percent in the past month.

Countrywide Sale

Some companies are seeking investors to help avoid collapse. Countrywide Financial Corp. agreed last week to be bought by Charlotte, North Carolina-based Bank of America for $4 billion. Other banks such as Citigroup and Merrill, while not near default, are turning to Asian and Middle Eastern investors to shore up capital. Governments in those regions have helped supply about $59 billion to firms in the U.S. and Europe.

In the case of Calabasas, California-based Countrywide, those hedging against a bankruptcy were roiled last week after Bank of America's announcement.

Before the agreement, speculation of an impending default pushed the cost of Countrywide's five-year credit-default swaps as high as 31 percent upfront and 5 percent a year. Investors demand upfront payments when they see a heightened chance of a default. The cost has fallen to 3.13 percent a year with no upfront payment, according to Phoenix Partners Group, a derivatives broker in New York.

Potential to Collapse

The cost of one-year credit-default swaps may reflect even more concern as investors use them to hedge against the risk that firms on the other side of their trade may not pay obligations. The potential for a bond insurer such as MBIA to collapse has prompted investors holding securities insured by them to use credit-default swaps to hedge against the risk of default.

Lehman Brothers Holdings Inc., the largest U.S. underwriter of mortgage-backed bonds, bought credit-default swaps on bond insurers to protect its holdings in the event the insurers' credit ratings were cut, the New York-based firm's head of risk management, Christopher O'Meara, said on a conference call in December.

If losses from subprime mortgages continue and the chances of an economic recession rise, then investors may continue to demand higher premiums to hold high-risk assets, increasing the odds that a company will default, McKoan said.

``The longer you have these unusual credit conditions, the more likely it is for some accidents to happen,'' McKoan said.

To contact the reporter on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net

Last Updated: January 16, 2008 18:32 EST