Libor Flatlines as Europe-Wary See Stress: Credit Markets
Stresses in the global financial system have stopped easing as European policy makers signal they’re unlikely to extend a third round of unlimited loans to the region’s banks and as bond yields in Spain and Portugal begin to rise again.
The three-month London interbank offered rate has held at about 0.47 percent every day in March, after sliding from this year’s high of 0.58 percent on Jan. 3. Measures from interest- rate swap spreads to the relative yields on short-term bonds sold by the world’s biggest banks also show the health of the financial system isn’t improving.
Former European Central Bank Governing Council member Axel Weber said yesterday financial institutions shouldn’t count on additional three-year loans following more than 1 trillion euros ($1.3 trillion) in two long-term refinancing operations beginning in December. Italian Prime Minister Mario Monti warned that Spain may reignite the debt crisis, while Portugal bond yields are at levels suggesting traders expect another bailout.
“The compression in the Libor spreads is running out of steam,” said Vincent Chaigneau, global head of interest-rate strategy at Societe Generale SA in Paris. “The LTROs have done a great deal in reducing the liquidity risk, but now the feeling is that probably the ECB is not going to repeat that. Some members of the ECB council are getting uncomfortable with all the liquidity created.”
Default Swaps Fall
Predictions in the forward market for the gap between the dollar Libor and overnight index swaps, or FRA/OIS (USFOSC1) spreads, beginning in June averaged 33 basis points this month, according to UBS AG data. The spread was as high as 59 basis points in December.
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. declined, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreasing 0.3 basis point to a mid-price of 89 basis points as of 11:40 a.m. in New York, according to Markit Group Ltd.
Series 18 of the benchmark, which is reconstituted each September and March, started last week.
The index typically falls as investor confidence improves and rises as it deteriorates. Credit-default 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.
Bonds of Charlotte, North Carolina-based Bank of America Corp., are the most actively traded U.S. corporate securities by dealers today, with 89 trades of $1 million or more as of 11:43 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The second-largest U.S. bank by assets sold $1.25 billion of 3.875 percent, five-year debt on March 19.
Tasc Inc., a provider of systems engineering and advisory services, increased the size of a term loan it’s seeking to refinance a portion of the company’s senior subordinated notes due 2016 to $75 million from $65 million, said a person with knowledge of the transaction.
The debt due in 2015 will pay interest at 3.25 percentage points more than Libor, said the person, who declined to be identified because the terms are private. Libor will have a 1.25 percent minimum. Chantilly, Virginia-based Tasc is proposing to sell the loan at 98 cents on the dollar, compared with 98 cents to 98.5 cents originally offered, the person said, reducing proceeds for the company and boosting the yield to investors.
While three-month dollar Libor fell almost 6 basis points in February, ending the month at 0.4843 percentage points, the borrowing benchmark has declined only about 1 basis point since. Libor, the rate at which banks say they can borrow in dollars from each other, serves as a reference for about $360 trillion of financial instruments worldwide.
The ECB’s second LTRO round and Greece’s 130 billion-euro bailout drove declines in February, said Carlos Pro, interest- rate strategist in New York at Credit Suisse Group AG in New York. Greece is working to reduce national debt to 120 percent of gross domestic product by 2020 from 160 percent last year.
“Those were two big catalysts for funding markets moves in terms of actual funding and confidence,” Pro said in a telephone interview. “In March, I don’t see any big catalyst ahead, so it’s only natural to see Libor coming down at a significantly more moderate pace.”
Rate Swap Spreads
The gap of Libor over the federal funds rate, known as the Libor-OIS spread, has held at about 0.33 percentage point for the last two weeks, following a slide from 0.5 in January.
Interest-rate swap spreads, a gauge of fear in debt markets, have traded between about 24 and 29 basis points since March 1, ending a contraction from 52.1 basis points in December. The measure was at 23.81 as of 11:36 a.m. in New York.
Swap spreads are based in part on expectations for Libor and are used as a gauge of investor perceptions of credit risk. Swap rates serve as benchmarks for investors in many types of debt, including mortgage-backed and auto-loan securities.
The extra yield investors demand to hold bank bonds maturing in one to three years rather than government securities has climbed to 213 basis points after reaching 208 on March 20, the lowest since August, according to Bank of America Merrill Lynch index data. The index has declined from this year’s high of 330 on Jan. 3.
“I would find it very counterproductive and counterintuitive if banks were to assume that as these two operations have materialized that there was more to come,” Weber said at an event in Paris yesterday. “The working assumption that the ECB will always be there I don’t think is a good assumption.”
Monti noted Spain’s struggle to control its finances before a finance ministers meeting in Copenhagen starting on March 30, where officials will seek agreement to raise a 500 billion-euro ceiling on bailout funding.
“It doesn’t take much to recreate risks of contagion,” Monti said during the weekend at a conference in Cernobbio, Italy. Days after his Cabinet approved a bill to overhaul Italy’s labor laws, Monti praised Spain’s efforts to loosen work regulations while advising it to focus on cutting the national budget. Spain “hasn’t paid enough attention to its public accounts,” he said.
Yields on Spanish 10-year bonds have declined to 5.36 percent from 5.37 percent. The yield reached 7.07 percent in November. Yields on Portugal’s benchmark bond are 11.45 percent and reached as high as 17.39 percent on Jan. 30.
Rising overnight funding rates have also contributed to Libor’s stagnating, according to Kenneth Silliman, head of U.S. short-term rates trading at Toronto Dominion Bank’s TD Securities unit in New York.
The Fed Fund effective rate, a volume-weighted average on trades by major brokers published daily by the Federal Reserve Bank of New York, was at 0.14 percent as of March 26, up from 0.04 percent at the end of last year.
Banks among those that submit rates daily to the British Bankers’ Association for their daily Libor fixing may face ratings cuts, contributing to the halt in the gauge’s slide, said Alex Roever, JPMorgan Chase & Co.’s head of short-term fixed-income strategy.
Moody’s Investors Service said Feb. 16 it was reviewing 17 banks and securities firms with global capital markets operations for downgrades, including Morgan Stanley, Goldman Sachs Group Inc., JPMorgan, Citigroup, and Bank of America.
“There is a fair amount of confusion stemming from the credit of several banks in the Libor panel being on review by Moody’s for a potential downgrade,” Roever said in a telephone interview. “There is some question of what might happen there. It is not creating enough anxiety to push the rates out, but it’s not letting them come in either.”
Libor also has come under scrutiny in a series of lawsuits in which investors accused banks represented on the Libor panel of distorting market prices by hiding the banks’ true borrowing costs.
The spread between Euribor (EUR003M), the rate at which European banks say they see each other lending in euros, and the average cost of their funding, priced to June (EUFOSC1) in the forward market is 27.4 basis point, down from 51.8 basis points at the start of the month.
The one-year cross-currency basis swap used to convert euro based funding into those denominated in dollars shrank to 42 basis points below the euro interbank offered rate today, which reduced the premium traders are paying from dollar loans from 57 basis points on March 1.
“The combination of higher competing money-market yields and no real improvement in sentiment, even though there wasn’t a deterioration, since the second LTRO hasn’t been enough to push Libor rates lower,” Silliman said. “Libor does certainly correlate to where banks are getting funding but it clearly has a sentiment component. For now we think it is going to be minimal moves in Libor and we have a bias towards wider swap spreads.”
To contact the reporter on this story: Liz Capo McCormick in New York at firstname.lastname@example.org
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