Bank Credit Worst to Companies Since Crisis Peak
The debt of banks is trading at the biggest discount to the broader corporate bond market since the depths of the funding squeeze in November as Europe’s sovereign crisis again threatens to rattle global financial markets.
From Spain’s Banco Santander SA (SAN) to Morgan Stanley in New York, the cost of credit-default swaps on a basket of the largest banks in Europe and the U.S. is 266 basis points, compared with 137 for the Markit iTraxx Europe Index of 125 companies with investment-grade ratings. The 129 basis-point spread is the most since it reached 133 on Nov. 30.
The International Monetary Fund is seeking to boost its lending capacity from about $380 billion to shield the economy against Europe’s turmoil as 10-year bond yields in Spain, which has more than $900 billion of debt, rise above 6 percent. Bank securities, a barometer of the health of the financial system, have given up the gains generated by the unprecedented injections of public cash in Europe since late last year.
“The problem with emergency liquidity injections is that they become addictive,” said Alex Bellefleur, an analyst at Brockhouse & Cooper Inc. in Montreal. “That is especially the case when injections are trying to fight underlying flows that are accelerating. This is the dynamic we are currently in.”
The gap between the cost of credit-default swaps on banks and those linked to the wider market is approaching the record of 159 basis points on Nov. 25.
While the Washington-based IMF raised its 2012 global growth forecast to 3.5 percent from 3.3 percent, global bank debt has lost 0.09 percent on average this month through April 16, compared with a return of 0.9 percent for industrialized companies, Bank of America Merrill Lynch index data show.
Moody’s Investors Service is adding to the pressure on bank securities by reviewing lenders in the U.S. and Europe for downgrades, citing the “difficult” operating conditions caused by the sovereign crisis.
“There’s going to be a knock-on effect because big banks paying more to borrow short-term won’t on-lend to smaller ones, or will push up the price, reducing liquidity,” said Paul Smillie, an analyst in London at Threadneedle Asset Management, which oversees about $43 billion of fixed-income assets.
Elsewhere in credit markets, a benchmark gauge of U.S. company credit risk increased for the first time in three days, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, climbing 1.5 basis points to a mid-price of 100 basis points as of 11:58 a.m. in New York, according to Markit Group Ltd.
Rate Swap Spreads
The index typically rises as investor confidence deteriorates and falls as it improves. 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.
The U.S. two-year interest-rate swap spread, a measure of bond market stress, rose 0.31 basis point to 29.06 basis points as of 11:57 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.
Bonds of Chesapeake Energy Corp. are the most actively traded U.S. corporate securities by dealers today, with 95 trades of $1 million or more as of 12:01 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Europe is coming back in focus for investors as its borrowing costs soar.
“We had a positive first quarter,” said Oliver Judd, a credit analyst in London at Aviva Investors, which manages the equivalent of $419 billion. “Those sovereign fears are resurfacing with Spain now.”
6 Percent Mark
Yields on the nation’s 10-year bonds climbed to 6.07 percent this week, from this year’s low of 4.85 percent on Feb. 1. They crossed the 6 percent mark on April 16 for the first time since November, heading for the 7 percent level that prompted Greece, Ireland and Portugal to seek bailouts.
Spain’s central bank chief said yesterday the country risks missing deficit estimates unveiled last month, and confirmed the economy is now suffering its second recession since 2009. The economy will shrink 1.8 percent this year, the IMF forecast.
“The projected course of total revenues in the budget is subject to downside risks,” Bank of Spain Governor Miguel Angel Fernandez Ordonez told a parliamentary committee yesterday in Madrid.
Default swaps on Madrid-based Santander, Spain’s biggest bank, surged to 415 basis points as of yesterday from this year’s low of 230 basis points on Feb. 7, according to data provider CMA. Contracts on Morgan Stanley (MS) of New York climbed to 360 from the 2012 low of 247 on Feb. 8.
Investors are focusing on banks’ holdings of government debt, with hedge-fund manager John Paulson, who became a billionaire in 2007 by betting against the U.S. subprime mortgage market, said to be buying credit protection on European sovereign bonds.
Paulson of New York-based firm Paulson & Co., which manages about $24 billion, told investors on a call that he’s buying swaps on European debt, said a person familiar with the matter, who spoke on condition of anonymity. Armel Leslie, a spokesman for the firm, declined to comment on Paulson’s call.
Spanish banks are of particular concern as their holdings of the country’s debt and client withdrawals make them overly dependent on European Central Bank financing, Paulson is said to have told investors.
While investor confidence in the ECB’s two longer-term refinancing operations that injected cash into Europe’s financial system has faded, the loans have alleviated pressure on bank funding in money markets.
The Libor-OIS spread, the difference between the London interbank offered rate lending benchmark and overnight indexed swaps and used as a measure of banks’ reluctance to lend to each other, is approaching the lowest level in eight months. The measure is 32 basis points from as high as 50 basis points on Jan. 6. It was about 15 basis points a year ago.
Bellefleur estimates that Spanish banks are losing as much as 10 billion euros ($13.1 billion) of deposits a month and that the outflows are accelerating, with no prospect of reversing as austerity causes the economy to shrink.
Moody’s is reassessing bank credit in light of “fragile funding conditions” for lenders with global capital markets businesses and the “deteriorating creditworthiness of euro-area sovereigns.”
The New York-based firm said on April 13 it would postpone completing its review until the end of June because it’s “taking an appropriately deliberate approach.” Bank securities have come under pressure because euro-region lenders are the biggest holders of the countries’ debt.
“The short-term ratings are where the impact is going to be the greatest,” Threadneedle’s Smillie said.
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