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Sovereign Default Swaps at Record Over Companies

Greece's Finance Minister George Papaconstantinou
Greece, Ireland and Portugal’s efforts to reduce the region’s biggest fiscal deficits are being hampered by declining tax revenue as budget cuts slow growth and boost unemployment. Photographer: Hannelore Foerster/Bloomberg

Investors are paying record-high premiums to insure against default on European sovereign bonds relative to corporate notes as governments struggle to reduce fiscal deficits while companies repair balance sheets.

An index of credit-default swaps on 15 European governments now exceeds a gauge of investment-grade credit risk by about 50 basis points, according to data from CMA and JPMorgan Chase & Co. Corporate swaps are historically more expensive than sovereign contracts.

The gap between the indexes “highlights the difference between how fundamentally strong non-financial corporate credit is versus how weak governments are,” said Aziz Sunderji, a credit strategist at Barclays Capital in London. “Corporate balance sheets look strong, cash liquidity buffers are large, and earnings have surprised to the upside. Most of the problems are originating from the sovereign side.”

Greece, Ireland and Portugal’s efforts to reduce the region’s biggest fiscal deficits are being hampered by declining tax revenue as budget cuts slow growth and boost unemployment. Corporate treasurers are enjoying surging profits after slashing headcounts and costs during the worst recession in decades.

The net amount of protection bought and sold on western European nations using swaps has jumped 13.8 percent so far this year to $134.5 billion, while the total global net notional during the same period fell 6.6 percent to $2.35 trillion, according to the Depository Trust & Clearing Corp., which runs a central registry that captures most trades.

Corporate Debt Falls

Companies in Britain’s benchmark FTSE 100 share index pared total debt by 185 billion pounds ($290 billion) over the past year to 2.16 trillion pounds at the end of the second quarter, the lowest level in two years, Bloomberg data show. Debt of non-financial borrowers in the Bloomberg European 500 Index declined 33.4 billion euros ($44 billion) to 2.5 trillion euros.

Confidence in non-financial companies is benefiting from improving profitability, more deleveraging and the ability to raise new equity, which governments can’t do, said Vivek Tawadey, head of European credit research strategy at BNP Paribas SA in London.

“Investors are finding that there’s much more clarity and transparency in the non-financial sector,” he said.

The Markit iTraxx SovX Western Europe Index is trading at 156.5 basis points, near an all-time high, while the Markit iTraxx Europe Index has more than halved from its 2008 peak to 106.25. Markit’s sovereign gauge, where Europe’s indebted peripheral countries are more heavily represented, has exceeded the corporate measure since March.

Contracts on Ireland surged 38 basis points to a record 428.3 basis points today, according to CMA, on growing concern the cost of bailing out Anglo Irish Bank Corp. will increase. The country’s Finance Ministry said there’s “no truth in a rumor” that the government may ask for external aid for its finances.

Default Protection

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A basis point on a contract protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year.

The cost of insuring Portuguese government debt exceeds default swaps on Portugal Telecom SGPS SA by 164 basis points, while contracts on Spain cost 90 basis points more than on Madrid-based Telefonica SA and swaps on Italy cost 26 more than the nation’s biggest utility Enel SpA, CMA prices show.

“We’re in a situation where corporates can and do and will trade through sovereign ceilings,” said Simon Ballard, a strategist at RBC Capital Markets in London. “Conventional thinking suggests that’s wrong and unsustainable, but people are looking more idiosyncratically at the market.”

U.S. Borrowers

In the U.S., 19 companies in the Markit CDX North America Investment Grade Index have swaps that are trading below contracts on Treasuries, the most since February when derivatives on 41 companies were cheaper than swaps on the world’s largest economy, CMA data show.

Net debt for non-financial borrowers in the Standard & Poor’s 500 Index fell $33 billion in the second quarter to a three-year low of $1.56 trillion, according to the most recent company data compiled by Bloomberg. That drove leverage to 1.2 times earnings before interest, taxes, depreciation and amortization, down from 1.5 a year earlier and the lowest since the end of 2005. Net debt subtracts total cash, marketable securities and collateral from the sum of short- and long-term borrowings.

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