This CDS report was written by Markit’s Gavan Nolan.
Both the Markit iTraxx and CDX HiVol indices today touched their widest levels since the roll in March as the problems in the US financial sector continued to cast a pall over the broader market. Lehman‘s spreads exceeded 770bp earlier today, with many investors doubtful that the firm can implement its turnaround plan without raising fresh capital.
The CDX HiVol has a significant financials weighting, unlike the iTraxx HiVol, which has no financials in its ranks. Much of the widening in the CDX was driven by its most volatile constituent, Washington Mutual. There are concerns that the nation’s largest thrift will be unable to raise capital or find a buyer. WaMu expanded rapidly during the housing boom but has been left with a poor quality loan book. Losses are mounting and more defaults could see its capital wiped out. Changes in accounting rules mean that any potential suitor would have to mark-to-market the acquired assets, not an attractive proposition in WaMu’s case. The government may decide to underwrite an acquisition, as in the case of Bear Stearns. However, the collapse of Bear Stearns would have had systemic risk implications, a factor that is not as relevant in WaMu’s case. The lender is now trading at 46 points upfront, indicating a high risk of near-term default.
WaMu’s precarious situation helped push the Markit CDX IG through 150bp for the first time this series. The Markit iTraxx Europe was as wide as 107bp before settling back to 104bp, still 2bp wider from the previous day. As well as financials, the deterioration was driven by energy-related names and retailers. The pricing environment for commodities has taken a downward turn, and steel producers such as ThyssenKriupp and Arcelor have suffered as a result.
Gloomy forecasts from two UK retailers pushed the sector wider. Home Retail Group, owner of the Argos and Homebase chains, spooked investors with its prediction of substantial writedowns on Homebase’s assets.
Supermarket chain WM Morrison in the lower-income north of England and expected to benefit from the economic downturn – added to the negative sentiment with a pessimistic forecast for the second-half of the year. J Sainsbury and Marks & Spencer, both constituents of the HiVol index, were significantly wider. Irish banks were the worst performers in the European financial sector amid concerns over asset quality, in particular their exposure to the domestic construction market.