Trading in credit-default swaps insuring the biggest German and French banks’ debt is soaring as the euro-region crisis spreads.
Deutsche Bank AG (DBK), Germany’s biggest lender, was the most- traded company of 1,000 issuers tracked by the Depository Trust & Clearing Corp. in the week through Sept. 16, up from 12th the week before. Credit Agricole SA (ACA) climbed to seventh place from 43rd, while Societe Generale (GLE) SA soared to eighth from 58th.
Banks hold more than half of the bonds issued by other lenders and are hedging that risk in the credit-swaps market. U.S. lenders Wells Fargo & Co. (WFC), JPMorgan Chase & Co. (JPM) and Morgan Stanley (MS) also jumped into the top 10 most-traded companies, according to the DTCC, amid speculation the world’s largest economy is headed for another recession.
“In this game, Greece is the mouse and the elephant in the room is the banks,” said Alberto Gallo, head of European credit strategy at Royal Bank of Scotland Group Plc in London. “The problem is that the banks hold each other’s bonds.”
Traders bought and sold 83 credit-default swap contracts on Deutsche Bank last week, covering a daily average of $270 million of debt, up from $150 million in the past month, according to New York-based DTCC, which runs a central registry for the market.
Swaps covering a daily average of $160 million of Credit Agricole’s debt traded, up from $120 million in the past month, while contracts linked to SocGen jumped to $150 million from $130 million, DTCC data show.
A total of 5,967 trades are outstanding on Deutsche Bank, covering $5.4 billion of debt, up from $5.1 billion three months ago, DTCC data show. Outstanding swap volumes on Credit Agricole and SocGen are little changed in the quarter, covering $2.9 billion of debt each.
Banks hold 56 percent of the bonds issued by other lenders, according to RBS calculations based on European Central Bank data. They’re also suffering because of their holdings of securities issued by the euro region’s most-indebted governments.
The crisis has spawned as much as 300 billion euros ($406 billion) in credit risk for European banks, the International Monetary Fund said this week as it called for capital injections to support markets. Greece, Ireland and Portugal have already sought international bailouts and speculation is increasing that the next countries to fall will be Spain and Italy.
Standard & Poor’s cut ratings or lowered the outlooks on Italian banks including UniCredit SpA (UCG), the nation’s biggest, this week after the government’s credit was downgraded for the first time in five years.
“The Italian downgrade was a major event,” said Gary Jenkins, head of fixed income at Evolution Securities Ltd. in London. That the nation wasn’t on review for a downgrade, typically the first step in cutting a rating, “is extremely unusual and in itself shows S&P’s concern,” he said.
Credit Agricole and SocGen had their long-term credit ratings cut one level by Moody’s Investors Service on Sept. 14. French and German banks have the biggest holdings of Greek debt, according to the Basel, Switzerland-based Bank for International Settlements.
Moody’s lowering of Bank of America Corp. and Wells Fargo’s ratings on Sept. 21 also helped push European bank-bond yield spreads wider, with the Barclays Capital Euro Aggregate Banking Senior Index climbing to a record 339 basis points, from 322 in the previous session.
The cost of insuring European bank bonds using credit- default swaps rose to a record this month, with the Markit iTraxx Financial Index of default swaps on the senior debt of 25 lenders and insurers climbing to as high as 314 basis points on Sept. 12, according to JPMorgan. The gauge fell three basis points to 299 as of 10 a.m. in London today.
Swaps on Deutsche Bank jumped to a record 225 basis points on Sept. 12, and now cost 210 basis points, from 96 basis points on July 1, according to CMA prices. Credit Agricole rose to an all-time high 322 basis points this month and are now at 310, from 130 at the beginning of July. Contracts tied to SocGen’s debt jumped to a record 435 in September, from 128 at the start of this quarter and are now at 413, according to CMA.
Credit-default swaps allow investors to hedge against debt losses or speculate on creditworthiness. A basis point on a contract protecting 10 million euros of debt for five years is equivalent to 1,000 euros a year.
“People who bought protection on banks and sovereigns have trades that are in the money now,” said Peter Tchir, founder of hedge fund TF Market Advisors in New York. “Now they’re getting nervous and buying more protection.”
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