Bank Stress Gauges Show Pain Lasting Through ’11: Credit Markets

Bank Stress Gauges Show Pain Lasting Through ’11
A customer enters the UniCredit SpA headquarters in Milan. Photographer: Giuseppe Aresu/Bloomberg

Three weeks after European leaders hailed an “historic” agreement to restore confidence to the region’s banking system, rising gauges of stress in funding markets signal tensions will last at least through year-end.

The gap between three-month euro interbank borrowing and lending rates rose to the widest since March 2009 yesterday in the forward market, used to speculate on future interest rates, according to data compiled by Bloomberg. The cost for European banks to fund in dollars surged this month, with the three-month cross currency basis swaps falling to as much as 1.32 percentage points below the euro interbank offered rate, the most since December 2008.

“We are in the midst of the crisis,” Chiara Manenti, a fixed-income strategist at Intesa Sanpaolo Spa in Milan, said in a telephone interview. “The liquidity in the money market is not flowing normally between banks. Tensions in the funding markets will remain through year-end, and will be more pronounced in Europe.”

Traders are wagering the struggle of the region’s banks to obtain short-term funding will worsen as yields of Europe’s most indebted nations surge, heightening concern that Italy may follow Greece, Ireland and Portugal in needing a bailout. The gap between two-year German interest-rate swaps and similar-maturity government bond yields climbed to the most since November 2008.

Building Stress

Stress is building after European Union leaders agreed Oct. 27 to bolster lenders’ capital, increase the size of a regional stability fund and persuade bondholders to accept a 50 percent loss on Greek debt. The spread between Euribor, the rate at which European banks say they see each other lending in euros, and the average cost of their funding, priced to December reached 93 basis points yesterday, according to UBS AG data. The gap was 89.4 basis points today.

Shut out of the wholesale funding markets, banks in the region are becoming increasingly reliant on the European Central Bank as a lender of last resort. Spanish banks borrowings from the ECB rose 10 percent to 76 billion euros in October, the highest level in more than a year, while Italian firms reliance increased 6 percent to 111.3 billion euros.

Elsewhere in credit markets, a benchmark gauge of U.S. corporate credit risk fell, snapping four days of increases. The Markit CDX North America Investment Grade Index of credit default swaps, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, decreased 0.6 basis point to a mid-price of 135.8 basis points at 11:44 a.m. in New York. The measure has increased 6.6 basis points from Nov. 11.

Jefferies Bonds

The index typically falls as investor confidence improves and rises as it deteriorates. Credit 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 Jefferies Group Inc. rose for the first time in four days, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The $500 million of 3.875 percent notes due in November 2015 rose 2.38 cents to 77.38 cents on the dollar as of 11:18 a.m. in New York after yesterday falling to as low as 74.5 cents, Trace data show. The yield fell to 11.1 percent from 12 percent. The bonds are paying 10.2 percentage points more than similar-maturity U.S. Treasuries.

The notes have fallen from 101.5 cents at the start of September, following MF Global Holdings Ltd.’s bankruptcy filing on Oct. 31.

U.S. interest-rate swap spreads, a measure of stress in credit markets, rose yesterday to the highest level in more than two years. The difference between the two-year swap rate and the comparable-maturity Treasury note yield increased 0.87 basis points to 52.31 basis points, the most since June 8, 2009, Bloomberg data show. The measure declined 1.18 today to 51.13.

Rate Cut

Europe’s money-market rates are rising even after ECB President Mario Draghi unexpectedly cut its benchmark interest rate to 1.25 percent from 1.5 percent on Nov. 3.

The three-month Euribor rose on Nov. 16 for the first time since Oct. 28, and was fixed higher again today at 1.465 percent, according to the European Bankers Federation.

Credit-default swaps on the region’s banks from HSBC Holdings Plc to Italy’s Unicredit SpA soared to a record 300.8 basis points yesterday from 209.2 on Oct. 28, the day after the agreement, according to data from CMA.

‘Tremendous Stress’

Spanish government bond yields rose to a euro-lifetime high yesterday after the Treasury sold 3.56 billion euros ($4.79 billion) of a new January 2022 benchmark security, paying an average of 6.975 percent. France, rated AAA, sold 8.05 billion euros of debt, as 10-year yield gap with Germany widened past 2 percentage points for the first time since the common currency’s introduction.

“The stress in the interbank market is increasing,” said Alessandro Giansanti, a senior interest-rates strategist at ING Groep NV in Amsterdam in an interview on Nov. 16. “The widening of the French government yield spread is affecting French banks’ ability to receive money in the interbank market.”

The extra yield investors demand to hold 10-year bonds from France, Belgium and Austria instead of similar-maturity German bunds all increased to euro-era records this month, Bloomberg data show. Italy’s 10-year yield climbed above 7 percent this week as Prime Minister Mario Monti formed a cabinet for his so-called technocrat government.

Emergency Funding

“There are still funding problems within the European banking system,” James Bianco, president of Bianco Research LLC in Chicago, said yesterday in a radio interview on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. “There is still tremendous stress. The Spanish 10-year yield hit 7 percent. There are more losses among the banks that own that debt within Europe.”

U.S. money market firms have slashed their holdings of European bank securities leading to a drought in dollar funding in the region. Prime money market funds reduced holdings of securities issued by European banks by 14 percent in September, according to Fitch Ratings. The 10 largest U.S. funds with a combined $654 billion reduced European bank assets to 38 percent of holdings, the lowest level since at least 2006 when Fitch started compiling the survey.

Italian banks may be forced to increase their reliance on emergency funding from the ECB as their liquidity levels have fallen to levels not seen since January 2009 after the value of the government securities they held tumbled, the central bank wrote in its Financial Stability Report published on Nov. 3.

‘Very Discouraging’

The ECB announced in October it would reintroduce year-long loans for the regions’ banks as the sovereign debt crisis threatens to lock local money markets. It had previously coordinated with the Federal Reserve to provide euro-area banks with dollars. The central bank offered 12-month loans last month and will off a 13-month loan in December.

“On paper EU politicians have solved this crisis many times over, but in reality they haven’t actually done enough and that’s what is keeping this from getting anywhere near a resolution,” said Otto Dichtl, a London-based credit analyst for financial companies at Knight Capital Europe Ltd. “It’s very discouraging and frustrating and just prolongs the uncertainty which is killing the market.”

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