European credit derivatives indices surged deeper into uncharted territory on Monday as credit markets squirmed at the possibility of a wave of structured product liquidations.
The iTraxx Crossover index, which measures the cost of insuring the debt of 50 mostly-junk rated names against default, rose 14 basis points to 568bp in morning trade, a fresh high. This means it cost €568,000 annually to insure €10m of Crossover debt over five years.
The market was reeling from news — as well as widespread rumours – that structured products such as CDOs were being liquidated. Fears intensified yesterday when Standard Chartered appointed an administrator to its Whistlejacket SIV.
“This highlights the vicious circle we remain in,” Jim Reid at Deutsche Bank wrote in a note. “As spreads widen, so triggers for structured products are breached which forces them to sell assets which in-turn runs the risk of destabilising other structures.”
In addition, American International Group damaged confidence in the financial sector yesterday by revealing “material weakness” in the way it accounted for credit derivatives. Analysts said there was no way of knowing how many other institutions were inaccurately accounting for their credit default swaps.
“The AIG case will in our view add to the scepticism towards the financial sector, and push out the moment where investors will start to trust that financials have written down their exposures,” said Willem Sels at Dresdner Kleinwort. “As it reduces investor appetite for financial paper, it will continue to make funding in the sector difficult, and extend the credit crisis.”
The iTraxx Europe index of 125 investment-grade credits rose to 108.5bp, a new high, against 101.4bp at Monday’s close.
The violent swings in credit derivatives spreads were a symptom of the complexity and opacity of the market and its participants, said Mehernosh Engineer at BNP Paribas. “In a sense we are trying to unwind the excesses of the last three years, but in a three day time period.”