While shares in Bradford & Bingley plunged on Monday, risk premiums on the bank’s debt were little changed.
The credit market judged the onslaught of bad news (a profit warning, scaled-back rights issue and the chief executive’s resignation) as more or less offset by the good news (that private equity firm Texas Pacific would inject £150m into the UK lender.)
However, analysts warned that by scaling back its rights issue from £300m to £250m, B&B had shaken the market’s confidence that other banks would successfully replenish their capital through rights issues.
The cost of insuring B&B’s debt against default was flat at about 180 basis points, traders said, meaning it cost €180,000 per year to insure €10m of the bank’s senior debt over five years.
Meanwhile, B&B shares fell 25 per cent to 66p.
The dislocation between B&B’s shares and its debt is the latest example of a trend that Jim Reid at Deutsche Bank calls a “structural break in the relationship between bank credit and equities.”
Since the rescue of Bear Stearns in mid-March, the cost of insuring the debt of a basket of European banks in the iTraxx Senior Financials index has fallen more than 100bp. However over the same period the same companies’ equity performance has been virtually flat.
Reid puts this down to three main themes:
1) The perception that there is little appetite from the authorities to test what would happen to the whole financial system if we saw financial debt defaults. With the added perception that allowing the equity of troubled institutions to be wiped out being something than authorities will tolerate and even encourage at times of stress.
2) The probability of default diminishing due to a mass recapitalisation of the sector. [However] there are now some doubts over how many more deals the equity market will tolerate.
3) The on-going concerns about how the financial sector is going to make anything like the same amount of money in a deleveraging world.
While Reid believes the structural break between bank credit and equity will persist for several years, he says the biggest short-term unknown would be the failure of a high-profile rights issue.
It is less important for those currently in the process of rights issues as the capital raising has been underwritten, however it would not bode well for future deals that are probably necessary. We still think it would be a better debt story than an equity one as we still believe that the authorities have little appetite to test the outcome of debt defaults in the sector.
In the wider market, the main iTraxx Europe investment grade index widened 5bp to 82bp. The iTraxx Crossover index of mostly junk-rated credits rose 17.4bp to 464.7bp