Uncertainty over the health of the financial sector and its participants, from hedge funds to investment banks via prime brokers, has roiled global markets this week, and credit derivatives markets have not been spared.
Financial names across Europe, North America, Asia and the Pacific have been unsparingly sold off this week, as equity investors fret over the ability of these companies to fund their activities amid a worsening credit squeeze.
In the credit derivatives markets, which allow investors to bet on the likelihood of a company defaulting on its outstanding debt, spreads on those banks and brokers that have significant exposure to subprime have steadily widened. In other words, the market thinks the risks associated with holding their debt have increased.
In some cases, five-year credit default swaps on banks have more than tripled from an average of around 30bp before the crisis hit the Street.
Spreads range from 85bp for Goldman Sachs to 165bp for Bear Stearns. Lehman Brothers, the object of persistent rumours that its Aurora lending arm is in trouble, was trading around 150bp in New York last night.
Strategists at BNP Paribas said even the AAA rated Rabobank widened 5bp to 25bp - after hitting 30bp intraday - as European banks continue to grapple with subprime contagion.
Radian, the monoline insurer, hit 1020bp - meaning it would cost more than $1m annually to insure $10m of Radian’s debt over five years. GMAC’s ResCap, a mortgage lender, reached 1000bp, while Countrywide’s 5yr CDS widened more than 125bp to 500bp, because of concerns of a possible bankruptcy due to severe liquidity problems, BNP Paribas said.
But Dresdner Kleinwort said while the ongoing stress in money markets is a challenge to banks and a worry for investors, the probability of a default of a major bank remains almost negligible despite the criticality of liquidity to banks’ survival:
This suggests that CDS levels are very attractive. But, uncertainty and liquidity concerns are sufficiently high for some markets to remain effectively frozen. Everyone seems to be looking for where ‘the bodies are buried’. The market should know - it buried them! But, at that point, they didn’t look like bodies.
In index trading, the iTraxx Europe index of investment grade names widened some 6bp to 59bp, driven by weakness in its financial components.
Meanwhile, the iTraxx Crossover index a closely-watched indicator of European credit sentiment, hit a ten-day high of 400bp as European equity markets sold off and US futures pointed to disappointing open.
