Bank Stresses Reach Highest Level Since June, Libor Shows: Credit Market

Derivatives traders are more concerned than at anytime since June that European leaders will fail to address the crisis engulfing the region’s single currency, driving up the cost to borrow for financial companies.

Contracts used to bet on the future premium banks will charge each other for dollar loans in London over the federal funds rate almost doubled in November. The so-called FRA/OIS spread soared to 42.75 basis points, before easing back to 39.25 yesterday, UBS AG data show.

The measure shows banks are still wary of lending to each other, even as European Central Bank President Jean-Claude Trichet steps up his response to the region’s debt crisis by delaying withdrawing emergency liquidity from the system. The ECB said earlier this year that European banks’ ability to sell bonds may be hampered as governments seek to finance fiscal deficits amassed in part to finance a bailout of the banking industry.

“You come back inexorably to the link between sovereigns and financials,” said Matteo Regesta, an interest-rate strategist in London at BNP Paribas SA, the world’s biggest bank by assets. “Financial companies have issues with non-performing loans, fueling the idea they might need government help, which puts pressure on the sovereign, which the banks are also exposed to.”

The gains in the FRA/OIS spread in recent weeks signal the market’s expectation that the London interbank offered rate, or Libor, will increase in coming months, Bank of America Merrill Lynch strategists led by Jeffrey Rosenberg in New York wrote in a Nov. 30 note to clients.

Relative Yield

The premium European banks pay in the currency swaps market to borrow in dollars has almost doubled in the past three weeks, reaching the highest level since May on Nov. 30. The cost to protect against losses on their bonds jumped to a 20-month high before paring the increase yesterday.

Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar-maturity government debt fell 1 basis point from a 12-week high to 176 basis points, or 1.76 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields averaged 3.821 percent, the highest since July 27.

Bonds from New York-based American International Group Inc. were the most actively traded U.S. corporate securities by dealers, the day after the insurer sold $2 billion of bonds in its first offering since a bailout in 2008, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Trace tallied 188 trades of $1 million or more.

AIG Bonds Rise

AIG’s $500 million of 3.65 percent notes due January 2014 rose 0.4 cent to 100.37 cents on the dollar as of 3:42 p.m. in New York yesterday, Trace data show. The bonds were issued Nov. 30 at a 295 basis-point spread, according to data compiled by Bloomberg.

AIG’s $1.5 billion of 6.4 percent debt due December 2020 fell 0.26 cent to 99.478 cents on the dollar, Trace data show. Those notes were issued with a relative yield of 362.5 basis points, Bloomberg data show.

PineBridge Investments is marketing a collateralized loan obligation targeted at about $480 million, the first CLO from the manager since it completed its separation from AIG in March, according to three people familiar with the discussions.

The market for CLOs is beginning to open with $2.6 billion of deals backed by widely syndicated loans completed this year. The market had $91.1 billion of issuance at its peak in 2007, according to Morgan Stanley data. CLOs are a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and return.

Leveraged Loans

The Standard & Poor’s/LSTA US Leveraged Loan 100 Index rose 0.09 cent to 91.7 cents on the dollar, the first increase since Nov. 18. Prices on the index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, have declined from 92.72 cents on Nov. 9, the highest since May 3.

Leveraged loans and junk bonds are rated below Baa3 at Moody’s Investors Service or less than BBB- at S&P.

Citigroup Inc. sold $1.875 billion of five-year notes as part of terms for a cash infusion from Abu Dhabi Investment Authority in 2007. The transaction is a remarketing of 6.7 percent junior subordinated debt initially due in March 2042, the New York-based bank said in a filing with the Securities and Exchange Commission. The notes yield 250 basis points more than similar-maturity Treasuries, Bloomberg data show.

Emerging Markets

In emerging markets, relative yields fell 18 basis points to 254 basis points, the biggest decline since May 10, according to JPMorgan Chase & Co. index data.

The FRA/OIS spread reflects trading in the forward market on the premium of the three-month dollar Libor over what investors expect the overnight federal funds rate to average, the Libor-OIS spread. The gauge has climbed from 23 basis points on Oct. 29 and was at the highest level Nov. 30 since reaching 44.25 on June 28, UBS data show.

The spread reached a record 128.25 basis points in November 2008, as the collapse of Lehman Brothers Holdings Inc. two months earlier caused credit markets to seize up.

The Libor-OIS spread, a gauge of banks’ reluctance to lend, declined to 10.74 basis points after reaching 11.13 basis points Nov. 30.

The cost of insuring against a default on European company debt maintained an earlier decline after Trichet said at a press conference in Frankfurt that the ECB will keep buying government bonds to ease the “acute” tensions in financial markets.

Junk Bond Risk

The Markit iTraxx Crossover Index of credit-default swaps protecting 50 mostly junk-rated European companies fell 12 basis points to 492 as of 2:33 p.m. in London, according to Markit Group Ltd. The Markit iTraxx Financial Index of swaps on junior debt of banks and insurers has fallen 16 basis points to 296 after reaching a 20-month high of 311.5 on Nov. 30, JPMorgan Chase & Co. prices show.

Credit-default swaps typically fall as investor confidence improves and rise as it deteriorates. 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 contract protecting $10 million of debt.

Europe’s sovereign crisis also is causing a surge in the premium the region’s banks pay to borrow in dollars in the swaps market. The price of two-year cross-currency basis swaps between euros and dollars reached minus 50.6 basis points on Nov. 30, the largest effective premium for dollar borrowing in swaps since May, Bloomberg data show. The gap, which narrowed to minus 45.5 basis points yesterday, has widened from minus 30.3 basis points on Nov. 22.

Currency Swaps

Two-year cross-currency basis swaps between euros and dollars widened to as much as a record minus 92.5 basis points in October 2008.

Signs of strain are also showing up in the interest-rate swaps market. The difference between the rate to exchange floating- for fixed-interest payments for two years and the comparable-maturity Treasury yield, known as the swap spread, widened 3.5 basis points to 27.38 basis points after reaching 30.88 Nov. 30, the most since July.

The tensions in bank funding markets haven’t reached the levels that roiled the markets in May, when European leaders took measures to stem the sovereign debt crisis and bail out Greece, the Bank of America analysts wrote. Swap lines created by the Federal Reserve in 2008 and reinstated in May have relieved European banks’ dollar funding needs, the analysts wrote.

SEC Rules

The strains in May also were exacerbated by new SEC rules that forced money-market funds to shift more of their holdings into shorter maturity debt, causing a decline in demand for longer debt sold by banks.

“This recent increase in measures of funding pressures pales in comparison to what we saw earlier this year as the first round of sovereign crisis played out,” the Bank of America analysts wrote.

“With financial contagion gathering pace across countries and sectors, we reiterate our view that it is urgent for the ECB to intervene in the market to send a powerful message to global investors that the central bank stands ready to provide an unlimited line of defense for the euro area,” Jacques Cailloux, chief European economist at Royal Bank of Scotland in London, said yesterday in a note to clients.

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

To contact the editors responsible for this story: Paul Armstrong at; Alan Goldstein at

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