European banks with more than $100 billion of cash to raise by year-end will have to pay up because investors perceive them as the worst credits they’ve ever been.
The cost of insuring the senior and junior bonds of 25 banks and insurers doubled since April to records, according to the Markit iTraxx Financial indexes of credit-default swaps. The Euribor-OIS spread, a gauge of banks’ reluctance to lend to each other, reached the widest since April 2009 this month, while the cost for European banks to fund in dollars was near a 2 1/2-year high.
“This return of generalized banking risk marks a new phase in the unfolding European drama,” said Lisa Hintz, an analyst in New York at Capital Markets Research Group, a unit of ratings firm Moody’s Investors Service. “Investors have heightened concerns about sovereign and financial institution risk.”
Morgan Stanley’s estimate of the 80 billion euros ($116 billion) banks need until year-end doesn’t include the extra capital that regulators have ordered many to raise to protect against a re-run of the 2007 global financial meltdown. With the bond market shut to all but the strongest banks, weaker lenders, particularly those from the euro region’s so-called peripheral nations, are relying on the European Central Bank for its unlimited six-month loans.
Even when banks receive the ECB’s money, many are hoarding it rather than lending it on. French, German and Austrian lenders -- those from countries considered safer credits than the likes of Greece, Italy and Spain -- are the lenders depositing the most funds back with central banks, according to CreditSights Inc.
“The banks seem to prefer to deposit cash with the ECB rather than lend it out to others that need it,” said John Raymond, an analyst at the financial-research firm in London. “In itself, that’s a sign of stress in the interbank market” and means companies must also pay more to borrow, he said.
The extra yield investors demand to hold bank bonds rather than benchmark government debt surged to 302 basis points, or 3.02 percentage points, according to Bank of America Merrill Lynch index data. That’s the widest spread since July 2009 and up from 220 at the end of last month. Average yields jumped to an almost two-year high of 4.46 percent on Aug. 12, before dropping back to 4.44 percent, the data show.
Squabbles between politicians and policy makers over how to tackle the sovereign crisis have contributed to lenders’ pain because European banks are among the peripheral nations’ biggest creditors.
German Chancellor Angela Merkel ruled out common euro-area government bonds as a solution to the “dramatic crisis” that has already resulted in Greece, Ireland and Portugal having their credit ratings cut to below investment grade. Lars Frisell, the chief economist at Sweden’s central bank, said last week it wouldn’t “take much for the interbank market to collapse.” Frisell’s also a member of the Basel Committee for Banking Supervision, which sets guidelines on bank capital.
“There’s been a huge failure of policy makers to deal with the crisis and that’s led to a general loss of confidence,” said Peter Chatwell, a strategist at Credit Agricole SA (ACA) in London. “The last recession was so big and so recent that it’s remained at the front of the market’s psyche.”
Pledges of 365 billion euros in official loans to Greece, Ireland and Portugal failed to stop their bond yields soaring until President Jean-Claude Trichet’s ECB stepped in this month to buy up their debt and drive down rates. The ECB said yesterday it settled purchases worth 14.3 billion euros in the week through Aug. 19, down from 22 billion euros the week before.
The Markit iTraxx Financial credit-default swap indexes tied to banks’ and insurers’ senior and subordinated bonds both surged to all-time highs today.
The senior swaps gauge rose for a fifth day, climbing 12 basis points to a record 262, JPMorgan Chase & Co. prices show. That’s a 94 percent jump from the low for the year of 135 basis points on April 7. The previous intraday record-high was 260 basis points Aug. 11, according to Markit Group Ltd.
Junior Bond Risk
The equivalent index tied to financial borrowers’ riskier, junior bonds rose 21 basis points today to 462, which is a 120 percent increase from its April 7 low of 213.
The three-month Euribor-OIS spread increased to 70 basis points on Aug. 10, the widest since April 13, 2009, and was at 65 basis points today. The widening gap represents the increasing difference between the cost to banks of long- and short-term money.
“Funding is as big a constraint on lending as capital is,” Huw van Steenis, an analyst at Morgan Stanley in London, said in an Aug. 15 report. “This could lead to a grinding credit crunch in the southern euro zone as banks look to reduce dependency on both the ECB and wholesale funding, and be a major drag on economic recovery.”
Even as banks deposit loans back with the ECB, it’s the promise of this money that means a full-blown liquidity crisis as seen in 2008 is “reasonably remote,” Matt Spick, an analyst at Deutsche Bank AG (DBK) in London, wrote in an Aug. 18 client note.
The funds the Frankfurt-based lender has pumped into the financial system have brought down the cost of overnight bank borrowing in euros by 30 percent this month, Bloomberg data show.
At 89 basis points, the Eonia swap rate is close to levels last seen in March and has fallen from 125 basis points Aug. 1. The three-month euro interbank offered rate, or Euribor, is at 1.54 percent, having stayed within 10 basis points of this level since the beginning of June.
Still, Deutsche Bank’s Spick said he expects “a slower moving, but still-toxic, funding crisis.” Unless debt markets re-open in September, “this is likely to force another round of balance sheet deleveraging, bad news for banks and also the wider economy,” he wrote.
Meantime, U.S. investors are getting out of European bank debt. As of the end of July, the 10 largest U.S. money market funds cut their holdings of European bank securities by 9 percent from June 30 and by 20 percent from May 31, according to a Fitch Ratings report yesterday. Fitch said the funds it surveyed hold $658 billion of the total $1.53 trillion the industry invests.
The three-month cross-currency basis swap, which measures the cost of a bank selling dollar bonds and swapping the proceeds back to euros, was at minus 84.3 basis points, close to Aug. 11’s level, which was the most expensive since December 2008.
“The stress in the interbank lending markets is not easing,” said John Brady, senior vice president in the interest-rates product group at MF Global Inc. in Chicago. “The market remains skeptical of any near-term resolution to the debt crisis in Europe.”