The cost to protect against a default by U.S. banks soared by the most since the month Lehman Brothers Holdings Inc. failed after Standard & Poor’s cut the AAA rating on the government’s debt.
Credit-default swaps on Bank of America Corp., the nation’s biggest bank by assets, rose by the most on record and reached the highest since May 2009, while contracts tied to Morgan Stanley debt increased the most since September 2008. Swaps on insurers Hartford Financial Services Group Inc., MetLife Inc. and Prudential Financial Inc. rose, and a benchmark gauge of corporate credit risk climbed to the highest since July 2010.
The downgrade triggered investor concern that fallout could impair the health of banks that have been recovering from the worst financial crisis since the Great Depression two years ago. Investors including BlackRock’s Peter Fisher speculated S&P may be forced to lower its ratings on banks, while Morgan Stanley said in a regulatory filing that market reaction from the government downgrade could have “a material adverse effect on our business, financial condition and liquidity.”
“This has never happened so I don’t think anybody really knows” the ultimate impact of the sovereign downgrade, said David Withrow, head of taxable fixed income at Fifth Third Asset Management. “It certainly could have an impact on the credit rating of banks, which could impact counterparty risk. What the level of impact is nobody really knows right now.”
S&P in a late-day statement said the U.S. downgrade doesn’t have “an immediate or direct impact” on bank ratings. “None of the banks we rate in the U.S. has an issuer credit rating higher than the U.S. sovereign rating,” S&P said in the statement. “The sovereign downgrade does not alter the government support assumptions that we factor into our ratings on four banks.”
BlackRock’s Fisher said in an interview earlier in the day that the ratings company may be forced to lower bank grades after cutting the sovereign ranking that supports some of the lenders.
“They’re going to have to follow through and start knocking down ratings on all sorts of things or look like they’re just mucking around in American politics,” said Fisher, BlackRock’s global head of fixed-income. With banks including Bank of America, Morgan Stanley and Citigroup Inc. already rated four levels lower than the U.S. government’s S&P rating of AA+, “there’s some fudge room there,” he said.
Contracts on Charlotte, North Carolina-based Bank of America, which rise as investor confidence deteriorates, soared 87.6 basis points to 295 basis points as of 4:30 p.m. in New York, according to data provider CMA. That’s the highest since May 2009.
Swaps on New York-based Morgan Stanley jumped 80.2 to 280.1, the highest since June 2010, CMA prices show.
Bank of America swaps also climbed as American International Group Inc. sued the lender to recover losses on mortgage-bond investments.
Morgan Stanley said the U.S. downgrade could impact its credit ratings and require it to post more collateral on some loans, the New York-based company said today in a filing with the Securities and Exchange Commission.
“Because of the unprecedented nature of negative credit rating actions with respect to U.S. government obligations, the ultimate impacts on global markets and our business, financial condition and liquidity are unpredictable and may not be immediately apparent,” the firm wrote.
The average credit swap price on the six biggest U.S. banks -- Bank of America, JPMorgan Chase & Co., Wells Fargo & Co., Citigroup, Goldman Sachs Group Inc. and Morgan Stanley -- jumped 51.5 basis points to 210.9 basis points. That’s the largest gain since September 2008 when Lehman Brothers filed for bankruptcy and caused credit markets to seize up.
Swaps on Goldman Sachs jumped 44 to 210, CMA prices show. JPMorgan contracts climbed 25 to 135, while those on Wells Fargo rose 25 to 135, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Contracts on Citigroup added 47.8 to a 210, CMA prices show.
The contracts 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.
Contracts on the Markit CDX North America Investment Grade Index, tied to the debt of 125 companies, jumped 12.5 basis points to 115.5 basis points as of 5:47 p.m. in New York, according to Markit Group Ltd.
“We haven’t seen this kind of volatility since 2008,” said Rich Gordon, a fixed-income market strategist at Wells Fargo.
Swaps on Hartford Financial, the insurer that repaid a $3.4 billion bailout last year, rose 34.3 to 249.2, CMA prices show. Contracts on MetLife, the largest U.S. life insurer, rose 44.3 to 229.3, while contracts on Prudential, the second-biggest life insurer, climbed 28.3 to 189.4.
Swaps on GE Capital Corp., a finance unit of General Electric Co., rose 50.7 basis points to 230.5.