Europe Stress Relieved With Swap Gap Vanishing: Credit Markets

Europe Stress Relieved With Swap Gap Vanishing
CIT Group Inc. CEO John Thain, speaks during a television interview in New York. Photographer: Jonathan Fickies/Bloomberg

The bond market is saying that the threat of a European banking crisis is ending.

The gap between European and U.S. benchmark credit-default swap indexes, used to hedge against losses or speculate on creditworthiness, narrowed to 0.7 basis point yesterday, the lowest since June 4, prices from Markit Group Ltd. show. The risk premium on European debt soared to a record 23 basis points on May 7 on concern governments in the region would struggle to cut spiraling budget deficits.

Bond investors are turning their attention to the sustainability of the global economic recovery after European banks and regulators provided a better view into balance sheets of the region’s lenders and Spain sold 3.4 billion euros ($4.4 billion) of debt in an auction. Some of Europe’s biggest banks rushed to sell bonds today after 84 of 91 lenders passed stress test results on July 23.

“It takes one more worry off the map ahead,” said Scott MacDonald, the head of credit and economic research at Aladdin Capital Management LLC in Stamford, Connecticut, which oversees about $12.5 billion. “This was something you could quantify and you could qualify. It came, it went, and it was not as bad as people thought it could be.”

Rabobank Nederland NV, Banco Bilbao Vizcaya Argentaria SA and Credit Suisse Group AG came to the market with bond sales today, people familiar with the deals said.

Before sovereign debt concerns flared in April, the European swaps index hadn’t traded wider than its North American counterpart, according to Markit Group data going back to at least October 2005.

Snapping Rally

The Markit iTraxx Europe Index of credit swaps on 125 investment-grade companies rose 1.7 basis points to 105.3 as of 11:04 a.m. in New York, after falling for six straight days in the longest rally this year, according to Markit Group. The Markit CDX North America Investment Grade Index climbed 1.6 basis points to 104.1. The indexes typically fall as investor confidence improves and rise as it deteriorates.

Elsewhere in credit markets, Goldman Sachs Group Inc. and Citigroup Inc. plan to sell $788.5 million of bonds backed by commercial mortgages in the third deal to pool commercial mortgages from multiple borrowers this year, according to a person familiar with the offering.

The issue contains debt on 48 properties, said the person, who declined to be identified because the terms aren’t public. Before this sale, JPMorgan Chase & Co. was the most recent issuer of such securities with a $716.3 million offering on June 11, according to data compiled by Bloomberg.

AT&T Bonds

AT&T Inc. sold $2.25 billion of debt yesterday in its first dollar-denominated offering in almost 18 months. The 2.5 percent five-year notes from the largest U.S. phone company were priced to yield 77 basis points more than similar-maturity Treasuries, according to data compiled by Bloomberg. That compares with a spread of 300 basis points, or 3 percent, on the Dallas-based company’s 4.85 percent, five-year debt sold in January 2009.

CIT Group Inc. will meet with lenders this week to arrange $3 billion of first-lien debt as Chief Executive Officer John A. Thain seeks to reduce costs on some loans by almost 50 percent.

CIT, the New York-based commercial lender that emerged from bankruptcy in December, may pay 5 percentage points more than the London interbank offered rate, with a 1.75 percent Libor floor, on its loans, according to people familiar with the matter. Bank of America Corp., Deutsche Bank AG and Morgan Stanley will hold a meeting July 29 in New York to market the five-year loan, said the people, who declined to be identified because terms are private.

Morgan Stanley

Bonds from New York-based Morgan Stanley, the sixth-largest U.S. bank by assets, were the most-traded corporate securities by dealers yesterday, with 191 trades of $1 million or more, Bloomberg data show. Sydney-based Westpac Banking Corp. ranked second with 133 trades. The most active in junk bonds was CIT, with 86 trades. High-yield high-risk, or junk, debt is rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s.

Spreads on emerging-market bonds tightened 7 basis points to 272 basis points, the lowest since May 3, according to JPMorgan Chase & Co. index data, after ranging from as low as 229 on April 15 to as high as 359 on May 25.

Measures of European bank risk have been dropping since June as investors speculated the stress tests would offer clarity on lenders’ ability to survive another financial crisis and as a committee of regulators rewriting capital rules eased requirements that will force them to hold bigger cushions against losses.

Stress Tests

The seven banks that failed the tests had a combined capital shortfall of 3.5 billion euros, according to the Committee of European Banking Supervisors, which coordinated the initiative.

The risk premium on Spanish debt has declined since the Bank of Spain published stress tests on the nation’s lenders, showing a capital shortfall in the most extreme scenario of 1.8 billion euros. The government has already raised the funds that the savings banks may need, Finance Minister Elena Salgado said on July 23. Three days earlier, Spain sold 6 billion euros of treasury bills, the maximum target for the auction.

The difference between the cost of insuring European corporate and financial debt is also shrinking, and the gap will vanish as investor confidence in banks continues to improve, Goldman Sachs Group Inc. strategist Alberto Gallo said July 13.

Financial Index

The Markit iTraxx Financial index of swaps linked to the senior debt of 25 European banks and insurers, which on June 8 soared to 61 basis points more than the broader iTraxx index of 125 companies, has fallen to within 8.5 basis points of the corporate gauge, according to JPMorgan prices. The financial index has plunged 86 basis points to 114 basis points since June 8, according to JPMorgan.

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.

Banks are taking advantage of the better sentiment toward Europe’s financial industry to sell bonds before the summer lull.

Rabobank is adding 750 million euros to its existing 4.125 percent bonds due 2025, with the new notes priced to yield 90 basis points over swaps, according to two people with knowledge of the sale.


BBVA, Spain’s second-biggest bank, is selling 1.25 billion euros of five-year senior bonds that are priced to yield 170 basis points more than swaps, a person with knowledge of the deal said. Credit Suisse, Switzerland’s No. 2 lender, is issuing $1.5 billion of undated Tier 1 bonds in dollars that have a call option in five years and a coupon of 7.875 percent, a person familiar with the terms said.

Even as concern subsides about a sovereign crisis in Europe, “there’s a plethora of issues that will be waiting for everybody in September,” Aladdin’s MacDonald said, highlighting the economy. “The signals are not definitive as to where you’re going. They will leave room for ongoing doubt,” he said.

Pacific Investment Management Co.’s Mohamed El-Erian said “noisy” economic reports underscore the “unusually uncertain” outlook cited by Federal Reserve Chairman Ben S. Bernanke. The key economic issue is the U.S. labor market, El-Erian, Pimco’s chief executive and co-chief investment officer, said yesterday in a Bloomberg radio interview.

“The indicators that we look at suggest that the economy continues to lose momentum,” he said. “Ultimately, is the economy creating enough jobs to make people comfortable, to allow companies to invest?”

Losing Confidence

American consumers lost confidence in July, while home prices rose more than forecast in May. Global growth may average 3.25 percent to 3.5 percent in the next three to five years, below the 4.7 percent pace of the five years leading up to the 2008 slump, according to Morgan Stanley Asia’s Stephen Roach.

“Focus has switched from the European situation to economic data in the U.S. and globally,” Jason Quinn, co-head of high-grade and high-yield flow trading at Barclays Capital in New York, said in an interview. “The information that came out of the stress tests has helped to remove some of the uncertainty that was hanging over the market.”

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