Markets

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

As the collective fear over banks' deteriorating health escalates, buying insurance to protect against nonpayment has become one of the best investments in the financial sector. Yet for all the negative headlines about Chinese lenders, their credit-default swaps still look pretty tame.

Too Tame
ICBC's credit-default swaps haven't responded to bad headlines with the same intensity as the contracts on some of its European peers
Sources: Bloomberg; CMA

A person who bought $10 million of credit-default swaps on Standard Chartered one year ago, for instance, would now be able to resell that contract for $23 million. The same investment in the bank's shares would be worth $4.3 million. A similar pattern holds true across most banks globally. The Markit iTraxx Europe Senior Financial CDS index has increased 127 percent over the past 12 months, while the MSCI Europe Banks index is down 31 percent:

Diverging Paths
As credit-default swaps for banks soared, their stocks went the other way
Sources: Bloomberg; CMA

In Asia, while bank derivatives have risen as well, they don't seem to fully reflect all the hand-wringing embedded in headlines. Contracts protecting Bank of China's debt against default are up 54 percent over the past 12 months to 186 basis points while its Hong Kong-listed stock has dropped 35 percent in the period.

A 54-percent rise sounds like a lot, but compared with the moves for Standard Chartered, or Deutsche Bank, it isn't. Bank of China's CDS are still also 16 percent below their peak earlier this month of 221 basis points, which was the highest since June 2012.

Brave Fear Gauge
Credit-default swap spreads are all about perception and Chinese banks don't seem to fully reflect theirs
Sources: Bloomberg; CMA
** Credit ratings are all Moody's

One could argue that because credit-default swaps on ING are only at 85 basis points, and the Dutch lender is rated Baa1 at Moody's, three levels below Bank of China, swaps on the Chinese lender are too cheap.

It doesn't work that way, however. CDS spreads are a barometer of perception. As people become more fearful of what might happen in the future, they purchase default swaps to hedge their exposure, pushing spreads up. Like insurance, very seldom is a contract actually executed. Money is made from reselling the contracts at a higher spread. In other words, buying CDS is equivalent to betting the news surrounding a company is going to get worse rather than better.

And right now, the news surrounding Chinese banks isn't exactly glowing.

Share of Pain
Shares of Industrial & Commercial Bank of China have dropped 33 percent over the past 12 months
Source: Bloomberg

As Bloomberg reported on Friday, while Chinese bank stocks are as cheap as they ever have been, David Herro, who manages about $30 billion at Harris Associates, doesn't think they're a buy yet. Kyle Bass, another high-profile investment manager, is engaged in a public battle with analysts in China about the real level of soured loans at Chinese banks. While it may be less than the 9 percent Bass estimates, it's also probably more than the official reported number of 1.7 percent.

These sort of debates brew distrust, which usually means more buyers of CDS, and higher spreads. Plus any time investors begin to question the health of European banks, as they certainly are now, default concerns start to swirl faster in Asia.

It all suggests that gauges of fear in this part of the world aren't as elevated as they should be. Chinese bank CDS spreads don't appear to  reflect the headlines.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net