Bank Risk Tumbling as Liquidity Rule Loosened: Credit MarketsCharles Mead
The cost of protecting bank bonds from default has fallen to the lowest level in as much as 20 months, pushed down at the same time regulators are loosening reserve rules and measures aimed at staving off another credit seizure.
Credit-default swaps tied to six U.S. lenders from JPMorgan Chase & Co. to Wells Fargo & Co. have plummeted to an average 110.2 basis points through yesterday from as high as 360 basis points in November 2011, when concern mounted that Europe’s fiscal woes would spread to a contagion. The gap in relative yields between $2.2 trillion of bank bonds and debt of industrial companies is at the narrowest since December 2008, Bank of America Merrill Lynch index data show.
The overhaul of the so-called liquidity coverage ratio at a Jan. 6 meeting in Basel, Switzerland, came after officials such as European Central Bank President Mario Draghi argued the rule would choke interbank lending and make it harder to implement monetary policies. Banks will be able to choose from a longer list of approved assets, including equities and securitized mortgage debt, to build up buffers against a crisis.
“Overall, the banks have better liquidity and capital cushions than they did a few years ago,” Robert Smalley, a credit strategist at UBS Securities LLC in Stamford, Connecticut, said in a telephone interview. Loosening liquidity rules “gives banks the ability to more productively deploy their balance sheet toward higher yielding assets,” he said.
Expanding the array of eligible assets may benefit Spanish and Italian banks with significant borrowings from the ECB. Swaps linked to UniCredit SpA, Italy’s biggest bank, dropped 14 basis points to 260 yesterday, the lowest since July 2011, according to prices compiled by Bloomberg. Contracts protecting debt of Banco Santander SA, Spain’s largest lender, fell 2 to 244, the lowest in 11 months.
“It’s a good victory for the banks,” said Roger Doig, a credit analyst at Schroders Plc in London. “The key for me is that it should help banks’ margins, but it is less clear that it frees the way for banks to lend more.”
Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. rose. The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, increased 0.8 basis point to a mid-price of 85.7 basis points as of 11:44 a.m. in New York, according to prices compiled by Bloomberg. The benchmark reached 85.1 on Jan. 2, the lowest since Sept. 14.
The measure typically rises as investor confidence deteriorates and falls as it improves. 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.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, increased 0.25 basis point to 13.25 basis points as of 11:45 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as company debentures.
Bonds of Torino, Italy-based Intesa Sanpaolo SpA are the most actively traded dollar-denominated corporate securities by dealers today, a day after a $3.5 billion offering, with 159 trades of $1 million or more as of 11:46 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Its $1.5 billion of 3.875 percent notes due January 2018 rose 0.7 cent from the issue price to 100.5 cents on the dollar to yield 3.75 percent.
Credit-default swaps linked to U.S. lenders including Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley declined 4.1 basis points yesterday to 110.2, the lowest level since May 2, 2011, Bloomberg prices show. The average has dropped from a record-high 453 basis points in October 2008 during the worst financial crisis since the Great Depression.
Investors were also heartened yesterday as 10 of the largest U.S. mortgage servicers including JPMorgan and Citigroup agreed to pay a combined $8.5 billion under a deal that will end case-by-case reviews of foreclosure-abuse claims stemming from a 2011 deal with regulators, the Office of the Comptroller of the Currency and the Federal Reserve said.
Executives of New York-based JPMorgan “are pleased to have it now behind us,” said Amy Bonitatibus, a spokeswoman for the bank. “We have helped nearly one million homeowners avoid foreclosure over the last four years and will continue to help others who may be struggling,” she said.
Bank of America also agreed to an $11.7 billion package designed to resolve most mortgage disputes with U.S.-owned Fannie Mae.
Swaps linked to European firms from Barclays Plc, the second-largest U.K. bank by assets, to Zurich-based UBS AG fell for the fourth day, declining 4.3 basis points to 160.9 basis points as of yesterday, the lowest since July 7, 2011. The average has tumbled from 409 in November 2011.
The extra yield investors demand to own the debt of banks globally, which expanded to an unprecedented 596 basis points in March 2009, was 1.56 percentage points as of Jan. 4, Bank of America Merrill Lynch index data show. That compares with a spread of 130 for the $3.7 trillion of bonds from industrial companies from AT&T Inc. to Leuven, Belgium-based Anheuser-Busch InBev NV.
“We’ve had so much tightening,” said Hank Calenti, an analyst at Societe Generale SA in London. Easing liquidity requirements “just confirms that perhaps that tightening is valid,” he said.
Regulators at the Basel Committee on Banking Supervision struggled throughout 2012 to revise the liquidity coverage ratio, or LCR. After failing to reach a final deal last month, it was left to central bank and regulatory chiefs such as Bank of England Governor Mervyn King to make a final decision.
“The new liquidity standard will in no way hinder the ability of the global banking system to finance a global recovery,” King said Jan. 6. “It’s a realistic approach. It certainly did not emanate from an attempt to weaken the standard.”
The LCR would force banks to hold enough easy-to-sell assets to survive a 30-day credit squeeze. It’s a key component of a package of capital and liquidity measures, known as Basel III, drawn up to avoid a repeat of the 2008 financial crisis that led to public bailouts of financial institutions. Basel III has been subject to mounting criticism for its complexity, amid delays to its implementation in the European Union and U.S.
The liquidity rule sets out a stress test that banks should apply to their books, assessing whether they would be able to generate enough cash from asset sales to meet their regulatory obligations. Banks had warned that the initial LCR proposal would force them to buy additional sovereign debt, more closely tying their fate to governments’ solvency.
“By increasing the categories of eligible liquid instruments available, it helps the banks get away from being so concentrated to sovereign debt, and regulators would like to break the sovereign debt-bank relationship,” Smalley of UBS said. For European banks, “there’s a hope that this will help loosen lending constraints, which should in turn engender economic growth,” he said.
The 17-nation currency bloc slid into recession in the third quarter and will probably contract by 0.1 percent this year, according to 49 economist estimates compiled by Bloomberg. The U.S. economy is poised for 2 percent growth in 2013 after expanding at a 2.2 percent pace last year, the data show.
“The move to loosen liquidity requirements may create the ability to lend more in the peripheral zone,” Calenti of Societe Generale said. “There’s an expectation that this will help to limit the level of economic contraction in Italy.”